What is a "Preferential Transfer"? - Part One
A preferential transfer is a transfer to a creditor shortly before the debtor files for bankruptcy. Other creditors affected by the debtor’s bankruptcy have the option to sue the creditor shown prior preference for payment when: 1) a transfer exists to the benefit of the credit for prior debt; 2)the debtor was insolvent when the transfer was made; 3) the transfer was made 90 days prior to the bankruptcy filing; 4) the transfer allowed the preferred creditor to receive a larger payment than if the transfer was part of a bankruptcy filing.
What is a Preferential Transfer?A preferential transfer - also referred to as a "preference" - is a transfer made prior to a bankruptcy filing to a creditor by a debtor to the exclusion or detriment of its other creditors. This is merely a working definition and each of the the elements, as set forth in Section 547(b) of Title 11 of the United States Code (the "Bankruptcy Code"), must be demonstrated by the party attempting to recover the preference. The party making the payment, i.e. the debtor, is often referred to as the "transferor" and the recipient as the "transferee".
What Are the Elements of a Preferential Transfer?Under Section 547 of the Bankruptcy Code, a trustee in bankruptcy may sue a party who received a payment (or other interest of a debtor in property) from a debtor where: (1) the transfer was made within 90-days of the bankruptcy filing (or 1 year where a payment is made to an "insider"); (2) the transfer was to or for the benefit of the recipient; (3) the transfer was on account of an antecedent debt owed before the transfer; (4) the transfer was made while the debtor was insolvent; and (5) the transfer enabled the creditor to receive more than it would have under a Chapter 7 bankruptcy case, if the transfer had not been made and if that creditor received payment of that debt to the extent it would be paid under the Bankruptcy Code.
Why Are There Statutory Defenses?Congress determined that businesses and people who continued to do business with a debtor even as it is experiencing financial difficulty should not be penalized for doing so. As a result, certain statutory defenses to a preference claim were adopted to protect creditors who can demonstrate those defenses.
What is the New Value Defense?Under Section 547(c)(4) of the Bankruptcy Code, a creditor who provides new value to a debtor after the transfer from the debtor may prevent a trustee in bankruptcy from recovering the transfer. New value is defined in Section 547(a)(2) of the Bankruptcy Code.
Example: You sell a debtor goods. The debtor pays you for the goods following its receipt of the goods. The debtor files for bankruptcy within 90-days of paying you for the goods. If you sold and delivered additional goods to the debtor after the transfer, you would argue that additional goods were new value that either off-sets or exceeds the amount of the transfer.
What is the Ordinary Course Defense?To prove an ordinary course defense under Section 547(c)(2), the transferee must prove that the transfer was: (1) in payment of a debt incurred in the ordinary course of the business of the debtor and the transferee; and (2) made within the ordinary course of business of the debtor and the transferee or made according to ordinary business terms.
Example: A creditor and debtor have an on going pre-bankruptcy business relationship involving the sale of goods where the debtor historically pays the transferee approximately 30 days from invoice. If the payment was for a sale within the usual business between the parties and made approximately at the same time as in the past, the creditor can argue that the transfer was made in the ordinary course of business. However, if the transfer was made well outside the normal range of payments in the past, then it would not be within the ordinary course of business.
What is the Contemporaneous Exchange Defense?Under Section 547(c)(1) of the Bankruptcy Code provides that where there is a substantially contemporaneous exchange of new value for the transfer, a trustee cannot recover the transfer. The transaction must be intended by the debtor and creditor to be contemporaneous.
Example: If, within 90-days before the debtor's bankruptcy filing, you sell the debtor goods that he pays C.O.D., you have provided new value in exchange for the contemporaneous payment for those goods. Since the debtor's assets are not diminished by the transaction, the trustee should not recover the transfer.