• Recognizing New Protections Available to Creditors to Defend Preference Actions
  • November 22, 2005 | Authors: Robert T. Barnard; Lawrence T. Burick; Nicholas J. DiMichael; Robert C. Folland; Alan R. Lepene; Louis F. Solimine
  • Law Firms: Thompson Hine LLP - New York Office ; Thompson Hine LLP - Dayton Office ; Thompson Hine LLP - Washington Office ; Thompson Hine LLP - Cleveland Office ; Thompson Hine LLP - Atlanta Office ; Thompson Hine LLP - Columbus Office ; Thompson Hine LLP - Cincinnati Office
  • Effective October 17, 2005, businesses that are creditors of companies that file bankruptcy petitions may take advantage of new protections provided by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCA"), passed by Congress and signed into law by President Bush earlier this year. Particular protections that you should be aware of relate to defending preference actions which are frequently brought in commercial bankruptcy cases.

    Preference actions are authorized by 11 U.S.C. § 547(b), and allow a trustee or a debtor-in-possession to recover payments it provided to creditors during the 90-day period leading up to the bankruptcy filing. Although it may seem unfair to the particular creditor who is the target of such action, the rationale and purpose behind the preference provision is to prevent a troubled debtor from favoring some creditors, to the detriment of all others, during the period leading up to the debtor's bankruptcy petition. In order to recover a transfer under 11 U.S.C. § 547(b), the trustee must establish: (1) a transfer of an interest of the debtor in property, (2) to or for the benefit of a creditor, (3) made while the debtor is insolvent, (4) during the 90 days prior to the date of the filing of the bankruptcy petition, and (5) that enables the creditor to receive more than such creditor would have received if the debtor had been liquidated in accordance with chapter 7 of the Bankruptcy Code, and the transfer in question had not been made.

    In addition to defending on the basis that the trustee has failed to establish each of the elements of a preferential transfer set forth in the preceding paragraph, the creditor should also be aware of the affirmative defenses to preferential transfers provided by 11 U.S.C. § 547(c). One of the affirmative defenses generally available to creditors is the ordinary course of business defense. To establish this defense under former law, the creditor was required to establish the alleged preferential payment was received in the ordinary course according to the specific dealings between the parties and according to relevant industry standards. Accordingly, the creditor would review prior transactions with the debtor to determine if the preferential payment fell within the historical payment pattern, and, if the transfer was within the historical payment pattern, consider the payment practices of the particular industry in which the parties operated. Quite often, testimony by representatives of the creditor regarding industry payment practices would not be considered sufficient to establish this defense. Instead, the creditor would need to identify an expert in the industry to provide testimony with respect to the industry's payment customs. Needless to say, this resulted in increased costs to defend, resulting in the trustee having greater leverage in settlement negotiations.

    However, BAPCA presents the creditor with the potential opportunity to avoid those defense costs and maintain greater leverage in settlement negotiations by broadening the ordinary course of business defense contained in 11 U.S.C. § 547(c)(2). As of today, the creditor that is the target of a preference action may choose between establishing ordinary course as between the parties or ordinary course according to relevant industry standards. This modification significantly strengthens the creditor's position during settlement negotiations. Should an acceptable settlement not be reached, resulting in the matter proceeding to trial, the creditor will want to consider whether to present evidence establishing the transfer was made in ordinary course as between the parties or was made in accordance with industry standards, or both, in order to enhance its likelihood of success. Thompson Hine attorneys with vast experience in formulating preference defense strategies can provide insight in such analyses and determinations in regard to the ordinary course of business defense, as well as advice concerning the other affirmative defenses to preference actions contained in 11 U.S.C. § 547(c).

    Additionally, creditors may now utilize protections which resulted from amendments of two other preference provisions of the Bankruptcy Code. First, creditors have the benefit of an additional defense that immunizes from preference recovery all payments under $5,000 in the aggregate to any one creditor. With this alteration, many nuisance preference actions that are typically settled by creditors in order to avoid the fees and expenses of litigation will be eliminated. Second, creditors have the benefit of defending preference actions to collect business transfers totaling less than $10,000 in the bankruptcy court where the creditor resides, as opposed to the bankruptcy court in which the bankruptcy case is pending. The impact of these changes will result in creditors being subject to far fewer preference claims in the future.