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Avoidance Powers -- Preferences, Statutory Liens, Postposition
Transactions, Preferential Offsets, Limitations
C. PREFERENCES [§ 547]
a) Preference avoidance provisions are not directed at wrongdoing per se on anyone's part; instead, they work to promote equality of treatment among creditors [See Sampsell v. Imperial Paper Corp., 313 U.S. 215 (1941); Barash v. Public Finance Corp., 658 F.2d 504 (7th Cir. 1981)] and discourage dismemberment of the debtor [see In re Caso Products, Inc., 23 B.R. 245 (Bankr. E.D. Mich. 1982)].
b) While many transactions (such as liens not sufficiently perfected to be valid against trustee) can be attacked as preferences, the more stringent requirements for preference avoidance often require attack on some other ground (e.g., § 544(a)).
2. Definition of Voidable Preference [§ 547(b))The trustee may avoid:
a) any transfer
b) of property of the debtor
c) to or for the benefit of a creditor
d) for or on account of an antecedent debt
e) made while the debtor was insolvent
f) made within 90 days before filing or, if the transferee creditor was an insider, within one year before filing [NOTE: old requirement, that insider have had reasonable cause to believe that the debtor was insolvent at the time of the transfer, eliminated by the 1984 Act]
g) that enables such creditor to receive more than the creditor would receive in a Chapter 7 liquidation.
3. Elements of Voidable Preference
(1) § 101(50) definition: ". . . every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest."
(2) Examples: IRS seizure of debtor's bank account pursuant to tax lien, In re R&T Roofing, 79 B.R. 22 (D. Nev. 1987); seizure of property pursuant to writ of execution, In re Veteran Plate Glass Co., 71 B.R. 74 (Bankr. N.D. Ohio 1987); reclamation of rugs from debtor by entity who supplied them on "consignment" or "sale or return" basis but took no security interest, In re A.J. Nichols, Ltd., 21 B.R. 612 (Bankr. N.D. Ga. 1982); a judgment lien obtained against debtor, In re Underwood, 24 B.R. 503 (Bankr. N.D. Miss. 1982); bond redemption, In re De Feo Fruit Co., 24 B.R. 220 (Bankr. W.D. Mo. 1982); early repayment of loans held by CEO of debtor, In re Gold Coast Concepts, Inc., 23 B.R. 228 (Bankr. S.D. Fla. 1982); perfection of security interest, In re Merritt, 7 B.R. 876 (Bankr. W.D. Mo. 1980); creditor's setoff, In re Mims, 33 B.R. 95 (Bankr. M.D. Fla. 1983); certificate of deposit pledged as collateral for letter of credit, First Interstate Credit Alliance, Inc. v. American Bank of Martin County, 845 F.2d 293 (11th Cir.), cert. denied, 109 S. Ct. 557 (1988).
b) Of Property Of The Debtor
(1) Code provides no definition of "property" but § 541 expansively delineates what is "property of the estate."
(2) Property must belong to the debtor. Begier v. IRS, 110 S.Ct. 2258 (1990) (trust fund tax payments from debtor's general accounts were transfers of property held in trust and therefore cannot be avoided as preferences). A payment by a third party on behalf of debtor does not qualify. See Building Dynamics, Inc. v. Grisope Elec. Co., 134 B.R. 715 (Bankr. W.D. N.Y. 1992)(debtor contractor's payment of contract proceeds to subcontract not voidable because, under state law, proceeds were held in trust for the subcontractor and, hence, were not "property of the estate"); In re M.J. Sales & Distribution Co., 25 B.R. 608 (Bankr. N.Y. 1982)(payment by surety of debtor's judgment creditor); In re Rector, 14 B.R. 1008 (Bankr. E.D. Tenn. 1981) (payment by debtor's ex-spouse of debtor's attorneys fees). Nor do funds held in trust by the debtor; Bethlehem Steel Corp. v. Tidwell, 66 B.R. 932 (M.D. Ga. 1986); see also In re Momentons Computer Systems Int'l, 66 B.R. 512 (N.D. Cal. 1986)(funds owed to debtor but paid to sheriff pursuant to writ of execution which, under state law, never became property of debtor).
(3) Cases split on whether IRS pre-petition levy upon a taxpayer's bank account terminates the taxpayer-debtor's interest in the funds and removes them from the bankruptcy estate. Compare E. John Vito, Inc. v. First American Bank, 1991 Bankr. LEXIS 306 (Bankr. D. Md. Feb. 22, 1991)(Adv. No. 90A-0178-PM) (estate's interest extinguished) with West Aire, Inc. v. United States, 131 B.R. 871 (Bankr. D. Nev. 1991)(estate's interest not extinguished).
c) To Or For the Benefit Of A Creditor [§ 547(b)(1)]
(1) A creditor and, therefore, a credit transaction, must be involved.
(2) A guarantor, surety or endorser is a creditor (holding a contingent claim). See In re Church Building & Interiors, Inc., 14 B.R. 128 (Bankr. W.D. Okla. 1981) (release of guarantees in exchange for a security interest in debtor's property benefitted guarantor); In re Jet Florida, Inc., 69 B.R. 83 (Bankr. S.D. Fla. 1987)(airline ticket clearinghouse to which payments were made deemed not to be a creditor).
d) For Or On Account Of An Antecedent Debt
Owed By The Debtor [§ 547(b)(2)]
(1) The transfer must follow the creation of debt.
(2) Examples: Compare In re Kelly, 3 B.R. 651 (Bankr. E.D. Tenn. 1980) (loan extended on June 12, 1979, deemed antecedent debt where security interest was not perfected until August 15, 1979) with In re Martella, 22 B.R. 649 (Bankr. D. Colo. 1982) (lapse of 6 weeks between extension of loan and perfection of security interest, held no antecedent debt); see also In re Camp Rockhill, Inc.,12 B.R. 829 (Bankr. E.D. Pa. 1981) (lapse of 56 weeks between perfection of security interest and extension of loan, held antecedent debt) [see "contemporaneous exchange" exception in § 547(c)(1) discussed infra]. See Lewis v. Diethorn, 893 F.2d 648 (3rd Cir.), cert. denied, 111 S. Ct. 369 (1990)(debtor's payment under settlement agreement in return for dismissal of state court suit and removal of lis pendens is not "for or on account of an antecedent debt" and thus not voidable as a preference).
e) Made While Debtor Insolvent [§ 547(b)(3)]
(1) Balance sheet test of whether debts exceed assets, at fair value, excluding exempt or fraudulently transferred property. § 101(29); H.R. Rep. No. 95-595 at 312.
(2) Determined as of date of transfer. In re Camp Rockhill, Inc., supra.
(3) Method of valuation not clear. Compare Constructora Maza, Inc. v. Banco de Ponce, 616 F.2d 573 (1st Cir. 1980) (liquidation value) with In re Taxman Clothing Co., 905 F.2d 166 (7th Cir. 1990)(for purpose of determining whether debtor was solvent during the preference period, appraisal may be higher "going concern" retail value an not value after store closed); Edward R. Bacon Co. v. Grover, 420 F.2d 678 (9th Cir. 1970) (going concern value); Tennessee Chemical Co. v. Shell Canada, Inc., 143 B.R. 468 (Bankr. E.D. Tenn. 1992)("going concern" value); In re Utility Stationary, 12 B.R. 170 (Bankr. N.D. Ill. 1981) (unless company is on its "death bed," use going concern value).
(4) Insolvency is presumed during 90 days prior to bankruptcy. Creditor's lack of knowledge of insolvency is no defense. E.g., In re Anders, 20 B.R. 468 (Bankr. M.D. Fla. 1982).
(a) Transferee must first introduce some evidence of debtor's solvency. Compare In re Thomas Farm Systems, Inc., 18 B.R. 541 (Bankr. E.D. Pa. 1982) (debtor's letter indicating solvency shortly after transfer sufficient to rebut presumption) with In re Eichorn, 11 B.R. 81 (Bankr. D. Mass. 1981) (same facts found insufficient to rebut presumption); see In re Maytag Sales and Service, Inc., 23 B.R. 384 (Bankr. N.D. Ga. 1982) (where creditor offers no evidence on solvency, trustee not required to present evidence).
(b) Once presumption of insolvency rebutted, trustee must prove insolvency. See Rule 301, Fed. R. Evid.
f) Made Within The Preference Time Periods Of Ninety Days Or, For Insiders, One Year [§ 547(b)(4)]
(1) Transfers made within ninety day period preceding filing may be avoided as preference. (If outside 90 day period but state law provides for preference avoidance, use § 544(b).) (If post-petition, use § 549; see In re Walter's Disposal Service, Inc., 73 B.R. 6 (Bankr. W.D. Mo. 1986). For an involuntary case, preference period is counted from the date involuntary petition is first filed. E.g., In re Baker & Getty Financial Services, Inc., 98 B.R. 300 (Bankr. N.D. Ohio 1989). See Committee of Unsecured Creditors v. Mellon Bank N.A., 945 F.2d 635 (3rd Cir. 1991), cert. denied, 112 S. Ct. 1476 (1992) (refiling within 90-day preference period of financing statement in new state to which debtor relocated not voidable as it was mere continuation of previously perfected interest).
(2) Insider Transferee -- preference period extends back one year. [NOTE: old requirement, that insider transferee must have had "reasonable cause" to believe that debtor was insolvent when transfer occurred, eliminated by 1984 Act.]
(a) "Insider" defined in § 101(30); in general, someone having a "sufficiently close relationship with the debtor that his conduct is made closer than those dealing at arm's length with the debtor." H.R. Rep. No. 95-595 at 312. See "Preferences, Post-Petition Transfers, And Transactions Involving A Debtor's Downstream Affiliate," 5 Bank. Dev. Journal 1 (1988); Holloway v. Browning Interests, 955 F.2d 1008 (5th Cir. 1992)(factors in determining "insider" status include closeness of relationship and whether transctions were conducted at arms length; former wife deemed "insider"); In re Hollar, 100 B.R. 892 (Bankr. S.D. Ohio 1989)(debtor's girlfriend was not "insider").
(b) Section 101(30)'s definition of "insider," insofar as it encompasses a "person in control" of a debtor cannot apply to the government since it is expressly excluded from the definition of "person" in 101(33). In re Yonkers Hamilton Sanitarium, Inc., 22 B.R. 427 (Bankr. S.D. N.Y. 1982).
(c) Payments to creditors who dealt at arm's length with a debtor can nevertheless be subject to the one-year preference recovery period applicable to "insider" creditors when the payments benefit the insiders. Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186 (7th Cir. 1989); see also In re Southwest Equipment Rental, 137 B.R. 263 (Bankr. E.D. Tenn. 1992); but cf. In re Arundel Housing Components, Inc., 126 B.R. 216 (Bankr. D. Md. 1991).
(3) Date of Transfer
(a) How is period computed
Nelson Co. v. Amquip Corp., 128 B.R. 930 (E.D. Pa. 1991) (90-day preference period is counted backward from petition date, not forward from transfer date -- which in this case would have resulted in 90th day falling on a Sunday and,under Bankr. Rule 9006(c), being extended to the Monday petition date).
(b) Deed Recordation
In re Chenich, 100 B.R. 512 (BAP 9th Cir. 1989) (transfer of grant deed occurred on recordation date); accord In re Freedlander, Inc., 107 Bankr. 88 (E.D. Va. 1989) (recordation of deed of trust within 90 days of bankruptcy filing resulted in preferential transfer).
In re Lucas, 107 Bankr. 332 (D.N.M. 1989) (attachment was perfected upon service of writ of garnishment and any profits subsequently distributed were attached at same time, and thus, transfers were not preferential).
(d) Check cases
Barnhill v. Johnson, 112 S. Ct. 1386 (1992)(transfer occurs when check is honored by drawee bank, and not when check is delivered).
(e) Judgment Liens
Sterling Die Casting Co. v. Local 365 UAW Welfare and Pension Fund, 126 B.R. 673 (Bankr. E.D.N.Y.), aff'd, 132 B.R. 99 (E.D.N.Y. 1991)(lien against debtor's property arises when a federal court judgment is docketed in county where the property is located, not when judgment is entered).
g) Enables Such Creditor To Receive More Than In A Liquidation [§ 547(b)(5)]
(1) "Greater percentage test": transfer is preferential if it enabled a creditor to receive a greater percentage of his claim than he would have received if the transfer had not occurred and he had participated in the distribution. H.R. Rep. No. 95-595 at 177; Barash v. Public Financial Corp., 658 F.2d 504 (7th Cir. 1981).
(2) Transfers to fully secured creditors generally are not preferential since creditor generally would not receive more than in a liquidation. Compare In re Pineview Care Center, Inc., 142 B.R. 677 (D.N.J. 1992) (prepetition transfers fully secured creditor not preferential even if debt was guaranteed by insider); Miller v. Rausch-Alan Inc., 129 B.R. 179 (Bankr. D. Minn. 1991) (payment to fully secured creditor not voidable); In re Ken Gardner Ford Sales, Inc., 10 B.R. 632 (Bankr. E.D. Tenn. 1981), aff'd, 23 B.R. 743 (E.D. Tenn. 1982), with In re Robinson Drilling, Inc., 877 F.2d 32 (10th Cir. 1989) (debtor's payment to creditor in excess of amount of the mechanic's liens constituted preference).
(3) Transfers to undersecured creditors are credited first to the unsecured portion of the debt. E.g., In re Kudford Fruit Products, Inc., 99 B.R. 18 (Bankr. C.D. Cal. 1989).
4. Exceptions [§ 547(c)]
a) Substantially Contemporaneous Exchange For New Value § 547(c)(1)
(1) Elements: transfer
(a) intended by both debtor-transferor and creditor-transferee to be a contemporaneous exchange for new value [subjective element]; see In re Silver, 1991 WL 155484 (Bankr. D.N.M. 1991) (exception could not apply even though recipient of transfer released an unavoidable judgment lien after receiving payment, when debtor had no knowledge of the lien);
(b) was in fact substantially contemporaneous [objective element]. See In re Hersman, 20 B.R. 569 (Bankr. N.D. Ohio 1982) (use of credit card by debtor, held that contemporaneous exchange not intended) (but see exception found in § 547(c)(2)).
(2) Preserves rules of Dean v. Davis, 242 U.S. 438 (1917) (mortgage signed when loan made but, through inadvertence, not recorded until seven days later; held, no preference), and National City Bank v. Hotchkiss, 231 U.S. 50 (1913) (unsecured loan made at 10:00 a.m.; creditor, after learning of debtor's financial problems, obtained collateral at 2:00 p.m.; held, transfer for antecedent debt and preference). See Pine Top Ins. Co. v. Bank of America, 1992 U.S. App. LEXIS 16212 (7th Cir. July 22, 1992)(No. 91-1175/1361)(follows Dean, collateral exchange held contemporaneous even though delayed 3 weeks, where parties fully intended provision of collateral when loan made); Drewes v. Vatnsdal, 139 B.R. 472 (Bankr. D.N.D. 1991)(mortgage recorded ten months after loan to brother-in-law, even though mortgage executed at time of loan, was not substantially contemporaneous). In re Hartwig Poultry, Inc., 70 B.R. 748 (Bankr. N.D. Ohio 1987) (45 day period too protracted to be contemporaneous exchange for new value); In re Damon, 34 B.R. 626 (Bankr. D. Kan. 1983) (transfer of security interests in vehicles more than 25 days after funds advanced to purchase them held not substantially contemporaneous); 4 Collier on Bankruptcy ¶ 547.37 (15th ed. 1982). See also cases discussed supra at C(3)(d) with respect to "antecedent debt."
(3) "New value" is defined in § 547(a)(2). Creditor must prove with specificity that the measure of new value was given in direct return for an equivalent measure of property transferred by debtor. In re Arrow Air, Inc., 940 F.2d 1463 (11th Cir. 1991). See In re F & S Central Mfg. Corp., 13 C.B.C. 805 (Bankr. E.D.N.Y. 1985) (agreement to partially subordinate an existing obligation is "new value"); In re Duffy, 3 B.R. 263 (Bankr. S.D.N.Y. 1980) (forbearance by car lessor from repossessing rented vehicle did not enhance value of debtor's estate; therefore, no "new value" given). See generally, Note, "New Value and Preference Avoidance In Bankrputcy," 69 Wash. U.L.Q. 875 (summer 1991).
b). Payment In The Ordinary Course Of Business [§ 547(c)(2)]
(1) Elements: Transfer is:
(a) Payment of debt incurred in ordinary course of business or financial affairs of both debtor and transferee; AND
(b) Made in ordinary course of business or financial affairs
of both debtor and transferee; AND
(c) Made according to ordinary business term
[NOTE: 1984 Act eliminated earlier requirement that "ordinary course of business" transfer be made within 45 days after the debt was incurred.]
(2) Requirement Of Satisfying All Three Criteria
(3) Purposes: validate and encourage ordinary credit transactions handled on a current basis with troubled debtors to forestall rather than hasten bankruptcy. See H.R. Rep. No. 95-595 at 373; Logan v. Basic Distribution Corp., 957 F.2d 239, 243 (6th Cir. 1992); In re Fulghum Constr. Co., 872 F.2d 739 (6th Cir. 1989). Kallen v. Litas, 47 B.R. 977 (N.D. Ill. 1985).
c) Enabling Loans [§ 547(c)(3)]
Purpose: essentially to validate properly perfected purchase money security interests. See In re Kelley, 3 B.R. 651 (Bankr. E.D. Tenn. 1980); cf. In re Tressler, 771 F.2d 791 (3rd Cir. 1985) ["contemporaneous exchange" exception may not be used to validate purchase money security interest perfected outside 10-day period of § 547(c)(3)].
d) Preference Offset By Unsecured New Value [§ 547(c)(4)]
Rule: New value given after the preferential transfer, to the extent it is unsecured and goes unpaid, is offset. See Reigle v. Mahajan, 906 F.2d 942 (3rd Cir. 1990) (limited partner's guarantee of new loan is "new value," so payment made by debtor on pre-existing debt in exchange is not voidable after a preference); In re Check Reporting Services, Inc., 140 B.R. 425 (Bankr. W.D. Mich. 1992); In re Bishop, 17 B.R. 180 (Bankr. N.D. Ga. 1982).
e)Perfected Security Interests In Receivables And Inventory ("After Acquired Property Clauses" and "Floating Liens") [§ 547(c)(5)]
(1) Rule: No preference recognized unless and only to the extent creditor improves its position during the preference period [90 days or, for insider, 1 year] or the date during the preference period on which value was given.
(2) Purpose: Prevents creditor with a security interest in receivables or inventory from improving its position at the expense of unsecured creditors.
(3) Application: Compare deficiency at commencement of preference period (or when value given) with deficiency on filing date to determine improvement
Value Petition Given On Filed On June 1 September 1 Debt $50,000 $50,000 Receivables 40,000 50,000 Deficiency 10,000 -0-
f) Statutory Liens [§ 547(c)(6)]
(1) A statutory lien [defined in § 101(47)] which is not avoidable under § 545 is not preferential.
(2) Examples: holder of a mechanic's lien, even if perfected within preference period, will not have received a preference because this statutory lien is not voidable under section 545. See 4 Collier on Bankruptcy ¶ 547.42 (15th ed. 1982); see In re Debmar Corp., 21 B.R. 858 (S.D. Fla. 1982) (dicta) (discussion of whether § 547(c)(6) applies to IRS lien within preference period).
g) Transfers Of Less Than $600 By Consumers [§ 547(c)(7)]
5. When Is A Transfer Made?
(1) Burden Of Proof: § 547(g) provides the trustee has the burden of proving the avoidability of a transfer under 547(b) and the creditor has the burden of proving an exception under 547(c).
(2) Jury Trial: Seventh Amendment does not require jury trial in a preference action where creditor files a claim; it does if no proof of claim is filed, Langenkamp v. Culp, 111 S.Ct. 330 (1990) (per curiam); cf. In re Newman Companies, 76 B.R. 135 (Bankr. E.D.Wis. 1987).
7. Sovereign Immunity
D. STATUTORY LIENS [§ 545]
1. Statutory liens [defined in § 101(47)] are recognized but only if they (1) are enforceable against a bona fide purchaser and (2) do not become effective simply upon insolvency. See 4 Collier on Bankruptcy ¶ 545.01 (15th ed. 1982)
2. Examples: mechanic's lien, warehouseman's lien.
3. Rule: trustee can avoid a statutory lien if:
a) the lien first becomes effective on insolvency; or
b) the lien is not perfected or enforceable on the date of filing against a bona fide purchaser (whether or not one exists); or
c) the lien is for rent; or
d) the lien is for distress for rent.
4. Special Rules For Chapter 7 Liquidations Only: For liquidation (but not reorganization) cases, the trustee has two special powers:
a) § 724(a) permits avoidance of any lien securing governmental or private penalty.
b) § 724(b) provides that statutory tax liens are subordinated to administrative expenses and certain priorities.E. POSTPETITION TRANSACTIONS [§ 549]
1. Rule: Postpetition transfers that are not authorized are generally voidable. [§ 549(a)] E.g., In re Bob Grissett Golf Shoppes, Inc., 50 B.R. 598 (Bankr. E.D. Va. 1985) (unauthorized payments to landlord for both pre-petition and post-petition rent obligation voidable).
a) Transfers occurring during the gap between an involuntary petition and an order for relief to the extent postpetition value is given. [§ 549(b)]
b) Transfers of real property located outside county where case commenced, either at judicial sale or by good faith purchaser without knowledge of bankruptcy for fair value, are valid until copy of petition is recorded in appropriate county. [§ 549(c)] See In re Dennis, 14 B.R. 125 (Bankr. E.D. Pa. 1981)(sale set aside notwithstanding § 549(c) where mortgagee had not perfected title on date of filing and, therefore, was not yet bona fide purchaser)
3. Sovereign Immunity
United States v. Nordic Village, Inc., 112 S. Ct. 1011 (1992) (§ 106(c) does not waive sovereign immunity for action seeking avoidance of post-petition payment to IRS where no proof of claim filed).F. PREFERENTIAL OFFSETS [§ 553(b)]
1. Rule: offsets occurring within 90 days of filing which improve creditor's position (i.e., decrease creditor's insufficiency) avoided.
2. Discussed in outline/lecture on offsets.G. LIMITATIONS ON AVOIDANCE POWERS
1. Statute of Limitations: § 546(a) provides that an avoidance action under §§ 544, 545, 547 or 548 "may not be commenced after the earlier of (1) two years after appointment of a trustee . . .; and (2) the time the case is closed or terminated." In re Cardullo, 142 B.R. 138 (Bankr. E.D. Va. 1992) (two year limitation period does not apply to debtor-in-possession); In re Schraiber, 141 B.R. 1008 (Bankr. N.D. Ill. 1992)(period in which chapter 11 trustee could file preference claim ran from date order appointing trustee was signed--not date it was docketed); See In re One Marketing Co., 17 B.R. 738 (Bankr. S.D. Tx. 1982) (limitations do not apply to debtors in possession exercising powers of trustee in chapter 11 under § 1107).
2. Delayed Perfection: § 546(b) makes trustee's powers under §§ 544, 545 and 549 subject to generally applicable law that permits perfection to be effective against an entity that acquires rights in the property before perfection (e.g., ten day filing period for purchase money security interests under § 9-301(2) of the U.C.C.).
3. Reclaiming Seller: § 546(c) insulates statutory or common law rights to reclaim goods sold in the ordinary course of business from trustee's powers under §§ 544(a), 545, 547 and 549
a) Consistent with § 2-702(2) of U.C.C., must demand reclamation in writing within 10 days of debtor's receipt of goods.
b) Court may deny reclamation if it grants administrative expense or a lien. See In re Metal Tech Mfg., Inc., 5 B.R. 859 (Bankr. D. Utah 1979) (must give adequate protection).