Avoidable Preference Litigation in Bankruptcy Cases

Gavel and bankruptcy law documents.

The United States Bankruptcy Code includes a provision relating to avoidable preferences.  The statutory provision authorizes the bankruptcy trustee to recoup — or “clawback” — certain payments made to creditors within the period preceding filing of the bankruptcy petition.  Recovered funds become part of the bankruptcy estate available to pay creditors. 

If a trustee pursues an avoidable preference claim, recovering the payment often results in bankruptcy litigation within the bankruptcy case.  This type of bankruptcy action is referred to as preference litigation, avoidable preference litigation, or simply a preference action.

What Is An Avoidable Preference?

Section 547 of the Bankruptcy Code addresses preferences and the circumstances under which the trustee may seek to avoid payments or transfers of interest made by the debtor to a creditor prior to filing for bankruptcy.  Payments subject to the clawback provision must meet these requirements:

  1. The debtor made the payment or transfer to a creditor of the debtor;
  2. The payment or transfer was on account of an antecedent or prior debt existing before the transfer;
  3. The debtor was insolvent when the payment or transfer was made;
  4. The payment or transfer occurred within 90 days of the debtor filing for bankruptcy, for non-insider creditors; or the payment or transfer occurred within one year of filing, if the creditor is an insider of the debtor (such as a business partner, friend, or relative); and
  5. By virtue of the payment or transfer, the creditor received more than he or she would have received in a Chapter 7 bankruptcy case under a pro rata distribution pursuant to the Bankruptcy Code (in the absence of the payment).

The burden of proof is on the trustee in preference litigation.  The trustee is required to demonstrate all the elements required by the Code.

How Does a Trustee Assert a Preference Claim?

Recovery of payments and transfers that qualify as avoidable preferences is not automatic.  The trustee must assert a claim and, if necessary, file an action in bankruptcy court to obtain judgment on the claim.

In the early stages of the bankruptcy process, when the trustee is reviewing the bankruptcy petition and supporting schedules and statements, as well as during the meeting of creditors, the trustee looks for payments or transfers that may meet the requirements for being avoidable.  In some cases, the trustee may use a process called a Rule 2004 examination to obtain additional evidence relating to transfers and payments that potentially qualify as avoidable.

For consumer debts, potential non-insider avoidable preferences include payments or transfers exceeding $600.  For business debt payments, potential non-insider avoidable preferences include payments exceeding $6,425. (These figures are subject to change every three years.  The next adjustment date is April 1, 2019.)

If the trustee finds a qualifying transfer, the creditor receives a demand letter from the trustee.  At this point, the creditor does not have a legal obligation to return the money or property.  The trustee must file an action with the bankruptcy court and obtain a judgment for the repayment obligation to arise.

The Bankruptcy Code provides exceptions to the avoidable preference rules, which constitute defenses to trustee’s claim.  If a creditor receives a demand letter from the trustee making a preference claim, the creditor should retain an attorney experienced in bankruptcy litigation to defend against the claim. 

Exceptions that constitute potential defenses to a trustee’s claim of a preferential transfer include:

  • The debtor made the transfer or payment in the ordinary course of business;
  • The transfer or payment was made in exchange for something that increased (or at least did not decrease) the debtor’s assets, referred to as the contemporaneous exchange new value exception; or
  • The creditor gave the debtor new value (usually goods or services) after the payment, referred to as the subsequent new value

Sometimes, a creditor facing a demand letter can reach a settlement with the trustee and avoid litigation over the preference.  If a bankruptcy litigation attorney represents the creditor, the attorney works with the trustee to try to negotiate a settlement.

If the trustee and creditor do not settle, the trustee will file an action in court to litigate the issues relating to the avoidable preference.  If a preference claim turns into litigation, representation by experienced bankruptcy counsel is strongly advised.

Assistance from Experienced Bankruptcy Litigation Attorney in Avoidable Preference Cases

Avoidable preference cases are factually complex.  The bankruptcy laws and rules that apply are also complicated. 

Many factors affect whether a trustee decides to pursue a preference claim or preference litigation in a bankruptcy case.  Even if a trustee makes a claim over an avoidable preference, the creditor can defend against the claim, assert one or more of the exceptions, or negotiate a settlement.

To thoroughly investigate the facts surrounding a transfer or payment, determine whether it meets the requirements for an avoidable preference, and evaluate available exceptions and defenses, assistance from an experienced bankruptcy litigation attorney is essential.  Applying the law and rules to a specific case requires complex legal analysis.

In my practice at the Dave Burns Law Office, I represent creditors and debtors in adversary proceedings in the United States Bankruptcy Courts in Minneapolis and St. Paul. If you are facing a potential avoidable preference claim in a bankruptcy case, I welcome you to contact me at (612) 677-8351 or by sending an email to me at dave@daveburnslaw.com. I am available to meet with clients in both Minneapolis and St. Paul and welcome inquiries from clients and referring attorneys throughout the State of Minnesota.

Categories: Bankruptcy, Litigation

The Dave Burns Law Office hopes you find this article helpful. But please do not rely on it as legal advice. The law changes regularly and the outcome of any legal matter depends on its unique circumstances. View full disclaimer