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Home > New Defenses To Bankruptcy Preference Claims

New Defenses To Bankruptcy Preference Claims

By:  Leo M. Gibbons, Esquire

Recent changes to the bankruptcy preference law enhanced the defenses of creditors to preference claims. In a preference claim, the bankruptcy estate, the trustee, or a creditor’s committee is seeking return of money paid to the unsecured creditor in the 90 day period preceding the filing of bankruptcy by the debtor. Under the Bankruptcy Code, these payments are called preferences and preferential payments by the bankruptcy debtor to an unsecured creditor can be avoided and the unsecured creditor can be required to pay back the money it received within 90 days of debtor’s (its customer’s) bankruptcy.

Two changes in the preference law were enacted and serve to benefit the interests of unsecured creditors. First, Section 547(b) was amended to provide that the trustee can avoid payments/transfers to an unsecured creditor “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably known affirmative defenses under Subsection [547](c)”. Prior to this amendment, a bankruptcy trustee often made claims against all unsecured creditors who received payments from the bankruptcy debtor in the 90 days prior to bankruptcy based merely on an examination of the debtor’s payment ledgers and check registers, and without any inquiry into defenses that may be possessed by the unsecured creditor.  The bankruptcy estate/trustee must now do some actual investigation and due diligence into these claims before making a demand of the unsecured creditor and seeking to avoid the payments during the preference period. At minimum, this would appear to require that the estate/trustee inquire as to possible defenses such as whether the debt at issue, and payment thereof by the debtor, was in the ordinary course of business between the debtor and the unsecured creditor, and also whether value was given by the unsecured creditor, either contemporaneously with the transfer, or whether such value was given subsequent to the payments or transfers at issue by the debtor. Additional considerations that may be beneficial to an unsecured creditor in defending a preference claim are: what a court will consider to be reasonable due diligence by the estate/trustee before making a preference demand or filing a preference claim against the unsecured creditor; and  appropriate remedies for the failure of the estate/trustee to exercise reasonable due diligence.

The second and more recent change in the preference law involves situations where a lease or executory contract exists between the debtor and an unsecured creditor and, during the period between March 13, 2020 and March 13, 2022 the parties amend the lease or contract to defer or postpone payments otherwise due under the lease or contract. These payments are referred to as “covered arrearages” or “covered payments”. Under the amendment, the estate/trustee is prohibited from avoiding payments made by the debtor for these type of arrearages during the above-referenced period. Covered arrearages, however, do not include fees, penalties or interest imposed during the two year period.

Taken together, the changes to the preference law provide unsecured creditors with additional tools that both require a greater degree of diligence by the trustee and provide a substantial defense for the unsecured creditor, especially while the economy continues to recover from the COVID-19 Pandemic.