MICHAEL G. LOUIS, ESQUIRE

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, effective for most provisions in October 2005, is complex in both scope and application, and continues to greatly impact the way bankruptcies are handled in the United States. While making bankruptcy more difficult for debtors and their attorneys, the Act also creates significant changes for creditors defending against preference actions. The Act now prohibits the debtor and/or trustee from moving actions for potentially preferential transfers less than a certain amount and revises the "ordinary course of business" defense.

What is Preference?
Every year, MacElree Harvey attorneys defend many preference claims that are brought against our clients. A preference describes a situation where a creditor is paid more than he or she would receive under a Chapter 7 liquidation by a debtor for an antecedent debt while the debtor is insolvent within 90 days of filing or within one year if that creditor is an insider. The purpose of the rule is to prevent a debtor from paying his friends and the customer he likes and then filing for bankruptcy soon thereafter, thereby treating his friends and insiders better than other creditors.

Trustees in Chapter 7 cases and attorneys for unsecured creditors in Chapter 11 cases often send a letter to every creditor that received a payment within 90 days of the bankruptcy filing and demand the return of the payment as a preferential transfer. The creditor then must prove to the trustee or attorney for the unsecured creditor's committee that the creditor falls within one of the many exceptions to the preferential transfer provision of the Bankruptcy Code. Often, the bankruptcy would be filed in another jurisdiction on the other side of the country so that the cost of settling would be less than the cost of defending the action.

The "New Value" Defense
Previously, the primary defense used in a preference action was that the transfer was intended by the debtor and the creditor who received it to be a contemporaneous exchange for "new value" given to the debtor and, in fact, that a substantially contemporaneous exchange actually occurred. In other words, the creditor sold widgets to the debtor and the debtor immediately paid for the widgets. This qualifies as a complete defense. The new value defense also allows an offset of each dollar of new goods or services that occur after a payment that would be a preference (offset for subsequent goods sold but not paid for).

The "Ordinary Course of Business" Defense
The more complicated defense is the "ordinary course of business" defense. Under the old Code, a creditor was required to prove that the transfer was in the ordinary course of business or financial affairs of the debtor and the creditor, and according to ordinary business terms. To prevail, the creditor was previously required to establish both a subjective ordinary course of dealing between the parties and compliance with an objective industry standard. Proving the objective industry standard could be difficult and expensive, and left open to interpretation the delineation of the relevant industry. Proof of "ordinary business terms" is no longer a requisite component of the defense as a consequence of the 2005 amendments. The avoidance action can now be successfully defended by proof of either ordinary course dealings between the parties or conformity with industry standards.

For example, if the creditor can prove that in the ordinary course of dealings between the bankrupt debtor and the creditor over the last six months or one year, the debtor paid the creditor on average 60 days of being billed by the creditor, then 60 days would constitute the ordinary course for the parties. This would mean that if the payments made within the 90 day preference period before the debtor filed bankruptcy are made at or within a reasonable proximity of 60 days of the invoice for the sale of widgets or service provided by creditor to debtor then creditor would have a complete defense.

Filing Restrictions
The new amendments also require that the preference is for at least $5,000 and if the preference is for under $10,000 that the lawsuit be filed in the district in which the defendant resides. Therefore, the debtor no longer has the tactical benefit of a distant forum to force settlements from preference defendants who necessarily conclude that it is not economically feasible to defend in a foreign jurisdiction a transfer involving less than $10,000.

The preference provisions have also been amended to benefit secured lenders who have delayed in perfecting their security interests. Perfection of a security interest is a transfer that is "subject to avoidance." To be subject to avoidance, the transfer must have occurred within the preference window, which is 90 days for general creditors and one year for insiders. Consequently, if a security interest is not created and perfected simultaneously and creation pre-dated the preference period, special rules under the Bankruptcy Code will determine when the transfer will be deemed to have occurred and whether perfection is susceptible to avoidance. Under prior bankruptcy law, purchase money security interests perfected within 20 days related back to the date of its creation. The new Act expands the relation back period to 30 days.

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