Chapter 1 INTRODUCTION

• Jurisdiction: United States

Chapter 1 INTRODUCTION

The Bankruptcy Code was designed to protect two distinct interests. First, a debtor files bankruptcy expecting to be relieved of unmanageable debt and to obtain a "fresh start." Likewise, creditors, typically unwilling participants in the debtor's bankruptcy, expect fair treatment. Although since the 1978 enactment of the Bankruptcy Code many interest groups have tried to obtain better treatment, these two basic tenets, upon which the Bankruptcy Code is premised, remain.

The Bankruptcy Code was substantially amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which was signed into law by President George W. Bush on April 20, 2005. The majority of the provisions became effective on Oct. 17, 2005. The changes made by BAPCPA generally affect only preference cases filed in bankruptcy proceedings commenced after Oct. 17, 2005.

The preference provisions of the Code are Congress's attempt to provide equal treatment for pre-petition creditors by allowing the trustee or the debtor-in-possession to avoid or recover certain payments made to creditors during the 90 days prior to filing a bankruptcy petition. The 90-day period was determined based on Congress's presumption that the debtor is insolvent during the 90 days prior to filing. Pre-petition payments¹ made during this period on account of antecedent or past-due debt are potentially recoverable, although there are statutory defenses to avoidance. By providing a regime that includes recovery of preferential payments but allowing for certain defenses, Congress sought to encourage vendors to sell to the debtor on credit during the debtor's slide into bankruptcy, while discouraging out-of-the-ordinary collection tactics. In spite of these goals, few creditors who supported the debtor during the days prior to its bankruptcy will welcome receipt of a letter demanding return of money and the subsequent complaint seeking to recover the alleged preferential payments.

Venue

Venue is proper in the bankruptcy court where the bankruptcy case is pending for all cases filed before BAPCPA's effective date. In those cases filed after BAPCPA's effective date, for actions to recover a non-insider transfer of less than $10,000, an avoidance complaint must be brought in the defendant's district. Likewise, an avoidance action to recover a consumer debt of less than $19,250 or a debt (excluding a consumer debt) against a non-insider of less than $12,850 must be brought in the defendant's district.² For cases filed prior to the effective date of BAPCPA, venue is proper in the defendant's district if the amount in controversy is less than $1,000 in a business case and less than $5,000 in a consumer case. For all other pre-BAPCPA actions, venue is proper in the plaintiff's district.

Trustee's Burden of Proof

The trustee must prove each of the following if he or she is to prevail on an action to recover a preferential transfer:

• The transfer was to or for the benefit of a creditor;
• The payment was for or on account of an antecedent debt owed by the debtor before the payment was made;
• The payment was made while the debtor was insolvent;
• The payment was made within 90 days before the date of the bankruptcy petition, or the payment was made within one year before the date of the bankruptcy petition if the recipient is an insider of the debtor; and
• The payment enables the creditor to receive more than the creditor would receive if the case was a chapter 7 case, the transfer had not been made, and the creditor received payment of its claim through the chapter 7 distribution.

If the trustee cannot prove each of the above elements, then the case should go no further. Under Ashcroft v. Iqbal,³ the plaintiff may not sustain a preference defendant's motion to dismiss if it has not provided factual and legal elements to support the prima facie case.⁴

Entities finding themselves defendants in a preference action should consider the following:

• Can the trustee prove that the transfer was of property of the debtor? If not, or if the trustee cannot prove the source of the payment, the payment is not avoidable. For example, if the transfer was from nondebtor property, or for example out of trust funds for which the debtor is only acting as trustee, then the payment is not made from property belonging to the debtor and therefore is not a preferential payment. Similarly, if the transferred property was held by the debtor as an agent for a principal, the property may not be that of the debtor. The determination of what is property is generally determined by state law.⁵ Certain federal and state laws may create a trust, such as the Perishable Agricultural Commodities Act (PACA). Thus, payments to creditors of funds that are subject to statutory liens are also not property of the estate.
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