Defense of Preference Litigation

What Is a Preference?

Section 547 of the Bankruptcy Code provides a strong means for trustees to avoid and recover transactions made within the ninety days prior to the bankruptcy filing (within 2 years for insiders) under the presumption that all such payments benefitted one creditor over others, thus providing that creditor preferential treatment.

Section 547(b) states:
(b) Except as provided in subsections (c), (i), and (j) of this section, the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property —

1. to or for the benefit of a creditor;
2. for or on account of an antecedent debt owed by the debtor before such transfer was made;
3. made while the debtor was insolvent;
4. made—
   1. on or within 90 days before the date of the filing of the petition; or
   2. between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
5. that enables such creditor to receive more than such creditor would receive if—
   1. the case were a case under chapter 7 of this title;
   2. the transfer had not been made; and
   3. such creditor received payment of such debt to the extent provided by the provisions of this title.

So, what is a preference? Think of it like this: If someone knew that they weren’t going to be able to pay all of their bills and may go out of business, is it possible that person might choose to pay debts to family or friends or preferred businesses first before paying a random third party? Or choose to pay their most important supplier or contractor before others, if you call that a choice, solely for reasonable business purposes, trying to keep the business afloat. Not only does it not require intent on behalf of the party receiving the payment (the potential Defendant), but it does not necessarily require intent by the debtor making the payment.

Common Defenses in Preference Actions

How can you defend if liability does not require that you did something wrong? It is not all bad news. While the trustee may file suit seeking to avoid the alleged preferential transfers and recover (i.e. “Clawback”) money from you, the trustee may not avoid such transfers to the extent the statutory elements above are not met or the transfers fit within several affirmative defenses contained within Section 547(c) of the Bankruptcy Code.

The transfer is not avoidable and recoverable if, for example, The transfer is not an interest of the debtor in property – 11 U.S.C. §547(b)

• The transfer was not to or for the benefit of a creditor – 11 U.S.C. §547(b)(1)
• The transfer was not for or on account of an antecedent debt – 11 U.S.C. §547(b)(2)
• The transfer was not made while the debtor was insolvent – 11 U.S.C. §547(b)(3)
• The transfer was not within 90 days before the date of the filing of the petition (or between ninety days and one year before the date of the filing of the petition, if an insider) – 11 U.S.C. §547(b)(4)
• The Defendant did not receive more than defendant would have received if the bankruptcy case were a hypothetical case under chapter 7 of the Bankruptcy Code and the transfer had not been made – 11 U.S.C. §547(b)(5)

The most common defenses that may be available to a Defendant under Section 547(c) may include:

• the transfer was a contemporaneous exchange for new value given to the debtor (i.e., the debtor received something of value in exchange for the transfer); 11 U.S.C. §547(c)(1)
• after such transfer, Defendant gave new value to or for the benefit of the debtor (i.e., the Defendant extended additional credit to the Debtor after receiving the transfer) 11 U.S.C. §547(c)(4); or
• the transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the recipient (i.e., Defendant made the transfer under ordinary business terms). 11 U.S.C. §547(c)(2)

Other defenses include:

• Defendant acted as a conduit or pass-through for another person or entity
• Defendant had a lien or the right to assert a lien

Although that sounds simple enough, it is not quite that straight forward. The defense based on the transfers having been made in the ordinary course of business is especially complicated. There is a special language that needs to be conveyed to Plaintiff. It is not simply that the Defendant did not do anything wrong or that it would not be fair to require Defendant to pay money to Plaintiff on top of all other losses.

Ultimately, these very unfair laws allow Plaintiffs to try to take money from you. On one hand, it is like Robin Hood, stealing (i.e. “legally clawing back payments”) from those who have been paid (at least in part) during the 90 days before the bankruptcy filing, and giving it to those who have not been paid. But it is not necessarily about taking from the rich and giving to the poor. In many cases, we are talking about Defendants who have suffered significant financial pains from the bankruptcy, such as loss of business and unpaid bills, and now the Defendant is being sued for more money, and will undoubtedly have to pay legal expenses. And the Defendant didn’t do anything wrong! How is that fair? It is not, but it is the law. Fortunately, there are defenses available to you. We cannot guarantee results, but in the vast majority of cases, the very nature of the law and litigation process in these cases will very likely lead to a cost savings if you hire a lawyer to defend the case. We can discuss all of that with you during a consultation. Call us at (302) 655-5303 or contact us today at info@tobialaw.com.