Southern California Bankruptcy Law Blog

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part VIII)

Posted in Chapter 11, Chapter 13, Chapter 7

small pile of penniesHere is the eighth defense against preference avoidance actions, the so-called de minimis transfer defense.  This defense has two versions.

Defenses To Preference Avoidance Actions, Part VIII:

The De Minimis Transfer Defense

A.        The De Minimis Transfer Defense, Part I

Suppose an individual with primarily consumer debt files a personal bankruptcy.  And suppose that debtor had $400 garnished during the ninety-day prepetition period.  Is it worth the Court’s time to entertain an adversary proceeding to avoid the garnishment pursuant to § 522(h)?  Congress answered that question in the negative by including § 547(c)(8):

The trustee may not avoid under this section a transfer — . . . if, in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $600.

Of course, in practical terms even $600 is too small an amount to justify the filing of a § 522(h) adversary proceeding.  The dollar amount warranting the action cannot be made precise.  A bankruptcy attorney with a client who can exempt wages that were garnished during the prepetition preference period and wants to avoid the garnishment using § 522(h), you will need to explain the costs associated with the action prior to committing to the representation.

B.        The De Minimis Transfer Defense, Part II

For cases in which the debtor’s debts are not primarily consumer debts, Congress included a larger de minimis cut-off:

The trustee may not avoid under this section a transfer — . . . if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $6,225.

You might be tempted to conclude that if the debtor’s debts are not primarily consumer debts, they must be business debts.  While that is undoubtedly true in many cases, an individual debtor without a business can file a personal bankruptcy in which the debts are not primarily consumer debts.

This frequently happens when the debts are primarily — i.e., more than 50% of the total debt — tax obligations.  See, e.g., In re Westberry, 215 F.3d 589, 591 (6th Cir. 2000)

Almost without exception, the bankruptcy courts that have addressed this question have determined that tax debt should not be considered consumer debt for purposes of the codebtor stay.  See, e.g., In re Stovall, 209 B.R. 849, 854 (Bankr.E.D.Va.1997); In re Dye, 190 B.R. 566, 567 (Bankr. N.D. Ill. 1995); In re Marshalek, 158 B.R. 704, 706 (Bankr. N.D. Ohio 1993); In re Greene, 157 B.R. 496, 497 (Bankr. S.D. Ga. 1993); Goldsby v. United States (In re Goldsby), 135 B.R. 611, 613-15 (Bankr. E.D. Ark. 1992); In re Reiter, 126 B.R. 961 (Bankr. W.D. Texas 1991); Harrison v. Internal Revenue Service (In re Harrison), 82 B.R. 557, 558 (Bankr. D. Colo. 1987); Pressimone v. Internal Revenue Service ( In re Pressimone ), 39 B.R. 240, 244 (N.D. N.Y. 1984).  We find the weight of these opinions and their reasoning persuasive.

Of course, the debtor may have consumer debts as well.  In such a case, the debtor will have to have had quite a bit garnished during the prepetition preference period to warrant filing a § 522(h) adversary proceeding.

If you’re facing a preference avoidance action, and need an analysis of your case and the possible application of the de minimis transfer defense to your case, contact a California board certified bankruptcy law specialist to help you.

 

Image courtesy of Flickr (Licensed) by John H Kleschinsky

 

 

Preferential Transfers IV: Defenses To Preference Avoidance Actions (Part VII)

Posted in Chapter 11, Chapter 13, Chapter 7

Here is the sixth defense against preference avoidance actions, the so-called domestic support defense.  This one is short.

Defenses To Preference Avoidance Actions, Part VII:

The Domestic Support Defense

A comparison of the Bankruptcy Code prior to October 17, 2005 with its current incarnation (the 2005 law that changed the Code is the Bankruptcy Abuse And Consumer Protection Act — “BAPCPA,” or as it sometimes less charitably called, BAPCraPA) reveals that Congress intended to strengthen the Code’s protection of recipients of domestic support.  “Domestic support” is defined in § 101(14A).  The definition is long so I will not repeat it here.  The gist is that it includes alimony and child support, and must be owed to a spouse, former spouse, or child of the debtor, or a governmental unit.

The changes to § 547(c)(7) reflect this intent.  The new version is stripped of the former version’s qualifying language, and simply states:  “The trustee may not avoid under this section a transfer — . . . to the extent such transfer was a bona fide payment of a debt for a domestic support obligation.”

The inclusion of the qualifier, “bona fide” indicates that Congress took into consideration payments that might superficially be characterized as domestic support, but were something else entirely.  See In re Futoran, 76 F.3d 265 (9th Cir. 1996) (payment of future spousal support in exchange for termination of marital agreement held to be an avoidable preference).

However, given the paucity of case law on § 547(c)(7), it appears that trustees and DIPs don’t think it is worth the effort to attempt to avoid transfers that look like domestic support.

If you’re facing a preference avoidance action, and need an analysis of your case and the possible application of the domestic support defense to your case, contact a California board certified bankruptcy law specialist to help you.

 

Image courtesy of Flickr (Licensed) by vastateparksstaff

Preferential Transfers IV: Defenses To Preference Avoidance Actions (Part VI)

Posted in Chapter 11, Chapter 13, Chapter 7

Man reading legal docsHere is the sixth defense against preference avoidance actions, the so-called statutory lien defense.

Defenses To Preference Avoidance Actions, Part VI:

The Statutory Lien Defense

Some liens are voluntary, the result of the debtor voluntarily granting a lien to a creditor.  Examples include home mortgages and car loans.

Other liens are involuntary and are recorded against the debtor’s wishes.  For example, if a creditor obtains a judgment against the debtor, the creditor can record a judgment lien against an asset — such as the debtor’s home.

Another type of involuntary lien is a statutory lien, which is a lien that arises by operation of some statute.  For example, if a homeowner is behind on homeowners association dues, the HOA can record a lien pursuant to a statute.  See, e.g., Cal. Civ. Code § 1367.1.  Statutory liens are the focus of § 547(c)(6):  “The trustee may not avoid under this section a transfer — . . . that is the fixing of a statutory lien that is not avoidable under section 545 of this title.”  Thus, if the statutory lien is not avoidable under § 545, it is not avoidable.  (One of the challenges in understanding statutes is having to follow chains of references from one part of the statute to another.  This is one of those challenges.)

Section 545 provides: Continue Reading

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part V)

Posted in Chapter 11, Chapter 13, Chapter 7

Floating Lien Defense does not actually float on waterHere is the fifth defense against preference avoidance actions, the so-called floating lien defense.

Defenses To Preference Avoidance Actions, Part V:

The Floating Lien Defense

In my last post I discussed the security interest defense, and noted that § 547(c)(3) requires that the security agreement must clearly identify the collateral securing the debt.  The example that set the stage for the discussion of § 547(c)(3) was of the purchase of a car.  The debtor took possession of the car and at the same time transferred a security interest in the car to the creditor.  Thus, the debtor had the car at the time of the transfer.

However, a lien can be created even before the debtor has the collateral, or even before the collateral comes into existence.  Such a lien is called a floating lien.

For example, suppose the debtor is a business that  regularly purchases widgets from a supplier, and then resells them at its retail outlets.  The parties can create a lien that specifies that all future deliveries of widgets become collateral securing a floating debt the debtor has to the supplier.  As the inventory is sold, the debt is paid from the proceeds, with the unsold inventory serving as collateral for the unpaid portion of the debt. Continue Reading

Nicholas Gebelt is speaking on Preferential Transfers on May 8 in Orange, CA and May 15 in Pasadena, CA

Posted in Chapter 11, Chapter 13, Chapter 7

If you’ve been following my blog posts on preferential transfers and would like more in-depth coverage, I will be speaking on this topic on May 8 in Orange, California and again on May 15 in Pasadena, California.  In addition to the topic of Preferential Transfers: Preference Actions and Substantive Defenses, I will also cover the topics of 1) Fraudulent Transfers: Actual Intent and Affirmative Defenses and 2) Appellate Procedure and Strategies: Appeals from Final Orders and Interlocutory Appeals.  I will present this talk at the National Business Institute’s “Bankruptcy Litigation 101″ seminar in Orange, CA on May 8, 2014 and the “Bankruptcy Litigation 101″ seminar in Pasadena, CA on May 15, 2014.  Two other speakers will be joining me.  In all you’ll learn how to:  spot potential adversary issues, draft complaints and resolve/defend them; confidently handle preference and fraudulent transfer actions; get tips on what bankruptcy judges expect and how to avoid common mistakes when you bring or defend an adversary proceeding; understand how the Federal Rules of Civil Procedure have been altered in the Bankruptcy Rules and by local court rules; and examine appellate procedure and rules so you’re prepared to take your case to the next level.

If you have some experience filing bankruptcies and would like to expand your practice into bankruptcy litigation, I hope to see you there.

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part IV)

Posted in Chapter 11, Chapter 13, Chapter 7

Here is the fourth defense against preference avoidance actions, the so-called net result defense.

Defenses To Preference Avoidance Actions, Part IV:

The Net Result Defense

Suppose you borrowed $10,000 from ABC Bank.  After paying back ABC Bank the $10,000, you borrowed another $7,000 from ABC Bank.  And suppose you filed for bankruptcy protection less than ninety days after repaying the $10,000 to ABC Bank.  Can the trustee assigned to your case avoid the $10,000 payment as a preference?  The answer to this question is the point of § 547(c)(4):

The trustee may not avoid under this section a transfer — . . . to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor —

(A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor.

Based on our discussion of § 547(b), we might conclude that the trustee can recover the entire $10,000.  However, § 547(c)(4) limits the recover to the net preference, which is $3,000.  Thus, while you repaid $10,000, the net benefit that ABC Bank derived from the transaction was only $3,000 because it gave you $7,000 after the repayment.

Put another way, when you paid the bank $10,000, your subsequent bankruptcy estate was diminished by $10,000.  When the bank later gave you $7,000, the subsequent bankruptcy estate was replenished by $7,000, leaving a net shortfall of $3,000.  Therefore, the trustee would only be able to recover $3,000 rather than the entire $10,000. Continue Reading

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part III)

Posted in Chapter 11, Chapter 13, Chapter 7

Here is the third defense against preference avoidance actions, the so-called security interest defense.

Defenses To Preference Avoidance Actions, Part III:

The Security Interest Defense

Suppose you wish to buy a new car that costs $30,000, but you don’t have $30,000.  Your solution is to borrow money for the purchase.  The lender wants some assurance that it will be repaid, so it insists that you sign a contract that gives it the right to repossess the car in the event that you default on the loan.  When you sign the contract you transfer a security interest in the car to the creditor, making the car collateral or security for the loan.  The creditor is then said to have a security interest in the car.  However, the creditor must take an additional step the perfect this interest:  it must record the transaction with the Department of Motor Vehicles .  Otherwise, the debt you have to the creditor is just an unsecured loan.

In similar fashion, any security interest — whether in a car, or a home, or some other property — must be recorded with the appropriate government authority to be perfected.  Otherwise, the underlying debt is merely an unsecured obligation.

Now suppose you file for bankruptcy protection less than ninety days after the transaction.  Can the trustee assigned to the case undo the transfer of the security interest, thus rendering the debt unsecured?  The answer to that question is the focus of the security interest defense that is embodied in § 547(c)(3):

The trustee may not avoid under this section a transfer — . . . that creates a security interest in property acquired by the debtor —

(A) to the extent such security interest secures new value that was —

(i) given at or after the signing of a security agreement that contains a description of such property as collateral;

(ii) given by or on behalf of the secured party under such agreement;

(iii) given to enable the debtor to acquire such property; and

(iv) in fact used by the debtor to acquire such property; and

(B) that is perfected on or before 30 days after the debtor receives possession of such property.

We have already discussed the meaning of “new value” as it is defined in § 547(a)(2), so we won’t spill any more ink on it.  The key elements of part (A) are:  the security agreement must clearly identify the collateral, and the debt must be purchase money debt, i.e., the debt was incurred to purchase the collateral.  Thus, this defense is unavailable to the loan sharks on late-night TV who promise to lend you money if you put up your already paid off car as collateral.

But what if you file your bankruptcy papers just a few days after making the purchase, and the creditor hadn’t gotten around to recording the security interest with the DMV?  That’s the raison d’être of part (B).  The creditor has up to thirty days after the transaction to record the security interest and be protected from the trustee’s avoidance of the security interest.

If you’re facing a preference avoidance action, and need an analysis of your case and the possible application of the security interest defense to your case, contact a highly skilled bankruptcy attorney to help you.

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part II)

Posted in Chapter 11, Chapter 13, Chapter 7

This is the second post devoted to defenses against preference avoidance actions.  It covers the so-called ordinary course of business defense.

Defenses To Preference Avoidance Actions, Part II:

The Ordinary Course Of Business Defense

Suppose a corporate debtor in Chapter 11 has a lease on the building in which it conducts its business.  Suppose the debtor has lease payments of $25,000 per month.  If it makes its usual on-time payments during the ninety-day prepetition period — i.e., a total of $75,000 — will the DIP (the Debtor-in-Possession, who is the debtor serving as a quasi-trustee) successfully avoid those payments?  Based on 11 U.S.C. § 547(c)(2), the answer is “no”:

The trustee may not avoid under this section a transfer — . . . to the extent that such 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 transferee, and such transfer was —

(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or

(B) made according to ordinary business terms.

Although this Code subsection appears to have two possible conditions ((A) and (B)), each of which focuses on the nature of the payments, there is a third crucial requirement embedded in the introductory language:  the underlying debt itself must have been incurred in the ordinary course of business.  Continue Reading

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part I)

Posted in Chapter 11, Chapter 13, Chapter 7

In my last post I looked at avoidance of preferences.  I now turn to defenses against such actions.  This will be a multi-part series because some of the defenses are a bit complicated and hard to understand.

Defenses To Preference Avoidance Actions:  Part I

The recipient of a prepetition transfer is not without defense against a preference avoidance action.  The defenses are given in § 547(c) and (h).  Once the trustee has met the burden of proving avoidability, “the creditor or party in interest against whom recovery or avoidance is sought has the burden of proving the nonavoidability of a transfer under subsection (c) of this section.”  11 U.S.C. § 547(g).

Keep in mind however, if any of the five requirements of the definition is not satisfied, then the transfer is not avoidable because it is not a preference.  Therefore, if you are asked to defend against a preference avoidance action, first determine whether the transfer really fits within the definition.  If it does not, then you have a defense by proving that the transfer wasn’t a preference in the first place.  Of course, you should also appeal to any applicable § 547(c) defenses as well, since you won’t know, a priori, whether your defense based on the definition will succeed.

This and the next several posts will deal with the § 547(c) defenses.  Continue Reading

Preferential Transfers III

Posted in Chapter 11, Chapter 13, Chapter 7

In my last post I looked at the definition of a preference.  I now turn to its consequences.

Avoiding Preferences

The reason preferences are significant for the recipients is found in beginning of § 547(b):  “. . . the trustee may avoid any transfer of an interest of the debtor in property . . .”  (In case you don’t speak legalese, this use of the word “avoid” means to make void or of no effect; to invalidate.)

This means that if the case is one under Chapter 7, 12, or 13, the chapter trustee can undo the transfer and seize the asset.  And in a Chapter 11, the Debtor-In-Possession (“DIP”) has the same power.  See 11 U.S.C. § 1107(a).

By the way, in most Chapter 11 cases there is no Chapter 11 Trustee.  Instead, the debtor serves as a quasi-trustee known as the debtor-in-possession.  This doesn’t mean that the fox is guarding the henhouse:  the U.S. Trustee and the judge keep the DIP on a fairly tight leash.  And if things get out of hand, the Court can appoint a Chapter 11 Trustee pursuant to 11 U.S.C. § 1104.

The trustee will learn of the transfer because the debtor is required to report it in item 10 of the Statement of Financial Affairs.  Failure to report the transfer is perjury that can afford free room and board for the debtor. Continue Reading