Bankruptcy Article #11

Preferences, under the Bankruptcy Code, are transfers of property of the debtor which are avoidable (or reversible), if they are:

  1. to or for the benefit of a creditor;
  2. for or on account of an antecedent debt owed by the debtor before the transfer was made;
  3. made while the debtor was insolvent;
  4. made within 90 days before the filing of the petition (or within one year if the creditor was an insider);
  5. that enables the creditor to receive more than the creditor would have received if the case were filed under Chapter 7.

Preference avoidances by bankruptcy trustees are designed to prevent creditors from gaining an advantage over other creditors where they have bettered their position within a relatively short time period prior to a bankruptcy filing. Some creditors, fearful of a preference assertion from a trustee, do not seek to possess property or assets of a debtor when the debtor is in apparent financial distress. The creditors believe that they will be required to return money or property to the trustee and they are reluctant to incur the wrath of the Bankruptcy Court. These fears, though justified, should not discourage creditors from aggressively pursuing a debtor's assets.

If the creditors are able to demonstrate they have defenses to the trustee's assertion of an avoidable preference, they will be able to retain the money or property. If not, the assets will need to be returned to the trustee. Creditors have a variety of defenses available to them: contemporaneous exchange; ordinary course of business; purchase money security interest; new value; spousal support; or the $600 limit regarding consumer goods. 11 U.S.C. Section 547(c). Each of these defenses permits the creditor to retain the benefit of the transfer. Interpretation of the Bankruptcy Code in the area of preferential transfers is a work in progress, and creditor's counsel should be prepared to research the latest case law to determine whether a defense exists to the trustee's assertions.

Trustees are occasionally aggressive in pursuing transfers that are arguably preferential. A well worded letter to the trustee explaining the defense(s) available to the creditor can cause the trustee to abandon his or her quest for avoidance. As a result, a creditor should not be reluctant to seek assets of the debtor; as worst, the creditor may be required to return them. Just as likely, the creditor may demonstrate multiple defenses which allow the creditor to retain those assets.

First Circuit cases on preferences include In re HealthCo. International, Inc. 132 F 3d. 104 (1st Cir. 1997), (addressing the ordinary course of business defense) and In re Ralar Distributors, Inc. 4 F 3d 62 (1st Cir. 1993) (in which the recoupment defense was successful in preventing the return of transferred assets). As in all bankruptcy matters, it is important to study both the cases which arise from the First Circuit as well as any other Supreme Court and Circuit Court cases considered "state of the art" by bankruptcy practitioners. Recent interpretations of well worn statutes may render an otherwise sensible argument obsolete.