March 2014

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

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.

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 IV)

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.