Southern California Bankruptcy Law Blog

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.