PREFERENTIAL TRANSFERS: A FOCUS ON THE 3RD CIRCUIT

Compiled By: Brent C. Diefenderfer 1 CGA Law Firm P.C. May 2012

I. INTRODUCTION. This article examines the current status of preferential payment jurisprudence in the Third Circuit. In general, the preference provision of 547 permits the trustee to avoid a transfer to a creditor who has received a payment on the eve of the debtors bankruptcy. The trustee has the power to reach back and recovery certain payments and transfers of the debtors property. This provision aims to ensure that creditors are treated equitably, both by deterring a failing debtor from giving preferential treatment to its most demanding creditors in an effort to stave off a hard ride into bankruptcy, and by discouraging creditors from racing to dismantle the debtor. 2 II. ELEMENTS OF A PREFERENTIAL PAYMENT. 11 U.S.C. 547(b) 3

A. Transfer. The term transfer is broadly defined in 101 as every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption. 4 It should be noted that there is no doubt that the term transfer includes the granting of a security interest. 5 B. Property of the Debtor. The payment must be derived from an interest of the debtor in property. 6 This term not defined in the Bankruptcy Code. Because the purpose of the avoidance provision is to preserve the property includable within the bankruptcy estatethe property available for distribution to creditorsproperty of the debtor subject to the preferential transfer provision is best understood as that property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings. If a 3rd party voluntarily pays a debt of the debtor, it is not a preference. 7 For a more complete analysis and for interpretative cases, see Mere Conduit and Earmarking defenses as discussed infra. C. To or for the Benefit of a Creditor. The creditor must receive some benefit in order for the transfer to be a preference. This can be direct or an indirect benefit. Under the Bankruptcy Code, any party that has a right to be paid by the debtor is a creditor.

D. For or on Account of Past Debts. The term antecedent debt is not defined by the Bankruptcy Code, but a debt is antecedent if it is incurred before the transfer. 9 In other words, the debt must have preceded the transfer.10 Debt is antecedent, for
135 N. George St., York, Pennsylvania 17401; (717) 848 4900; bdiefenderfer@cgalaw.com;, www.brentcdiefenderfer.com Fiber Lite v. Molded Acoustical Products, Inc. (In re Molded Acoustical Products, Inc.), 18 F.3d 217, 219 (3d Cir.1994). 3 The burden of proving each of these element lies with the Chapter 7 trustee. 11 U.S.C. 547(g); In re Forman Enterprises, Inc., 293 B.R. 848, 855 (Bankr. W.D. Pa. 2003); Official Committee of Unsecured Creditors v. Conceria Sabrina, 195 B.R. 602, 612 (Bankr.M.D.Pa.1996). 4 11 U.S.C. 101(54). In re Am. Rehab & Physical Therapy, Inc., 04-14562, 2006 WL 1997431 (Bankr. E.D. Pa. May 18, 2006) 5 In re Tops Appliance City, Inc., 372 F.3d 510, 516 (3d Cir. 2004) 6 United States v. Begier, 496 U.S. 53, 58, 110 S.Ct. 2258, 2263 (1990). 7 National Bank of Newport v. Herkimer County Bank, 225 U.S. 178 (1912) 8 11 U.S.C. 101(5), 101(10); Discussed in In re Mowry, Bkrtcy.W.D.Pa.2001, 263 B.R. 499; See generally In re Bake-Line Group, LLC, Bkrtcy.D.Del.2007, 359 B.R. 566; In re USA Detergents, Inc., Bkrtcy.D.Del.2009, 418 B.R. 533. 9 In re Philadellphia Newspapers, 2012 WL 983594. 10 In re Contempri Homes, Inc., 269 B.R. 124, 127-28 (Bankr. M.D. Pa. 2001).
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preference purposes, when debtor becomes legally obligated to pay it before transfer is made. 11 Imperative 3rd circuit cases are listed in the footnotes below. 12 E. Made While the Debtor was Insolvent. A Debtor is presumed to be insolvent during 90-day preference period, 13 and a trustee had no obligation to come forward with evidence to demonstrate debtors' insolvency at time of alleged preferential transfers, unless and until preference defendant came forward with some evidence to rebut that presumption. 14 This presumption is rebuttable and creditor who wishes to contest the claim of insolvency must present sufficient evidence that the debtor was solvent on the date of the transfer. 15 Additional 3rd circuit interpretative cases are listed below in the footnotes.
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F. Made within 90 days prior to the Bankruptcy. (1) The 90-day preference period for transactions not involving insiders is calculated by counting backward from date of filing of bankruptcy petition, as opposed to forward from date of transfer. 17 (2) Transfer made by check is deemed to occur on date check is honored, rather than date of payee's receipt of check, for preference purposes.18 Honor date of check, rather than date check was delivered was significant date for purposes of calculating 90-day preferential transfer period. 19 (3) However, an insider of debtors can only be impaired to extent that they received preferential benefit within one year prior to filing of bankruptcy petition. 20 G. Allowing the Creditor to Receive More than in a Chapter 7. To be avoidable as a preference, the transfer must enable the creditor to get a paid a greater percentage of its claim than it would have received had the transfer not taken place and had the debtors assets been liquidated and distributed in a chapter 7 proceeding. 21 The analysis therefore is to look to the class of creditors to which the creditor receiving the transfer
11 U.S.C.A. 547(b). In re CVEO Corp., 327 B.R. 210 (Bankr. D. Del. 2005) Peltz v. New Age Consulting Services, Inc., Bkrtcy.D.Del.2002, 279 B.R. 99; Karagianis v. G.F.C. Consumer Discount Co., E.D.Pa.1983, 34 B.R. 108; In re USDigital, Inc., Bkrtcy.D.Del.2011, 443 B.R. 22; In re CM Holdings, Inc., Bkrtcy.D.Del.2000, 264 B.R. 141; In re USDigital, Inc., Bkrtcy.D.Del.2011, 443 B.R. 22; In re Hayes Lemmerz Intern., Inc., Bkrtcy.D.Del.2005, 329 B.R. 136. 13 11 U.S.C.A. 547(b)(3), (f). See generally In re R.M.L., Inc., Bkrtcy.M.D.Pa.1996, 195 B.R. 602; In re Camp Rockhill, Inc., Bkrtcy.E.D.Pa.1981, 12 B.R. 829, 14 In re Allegheny Health, Educ. & Research Found., 292 B.R. 68 (Bankr. W.D. Pa. 2003) 15 Federal Rule of Evidence 301 16 In re Labrum & Doak, LLP, Bkrtcy.E.D.Pa.1998, 227 B.R. 383; In re Midway Games Inc., Bkrtcy.D.Del.2010, 428 B.R. 303; In re American Classic Voyages, Co., D.Del.2008, 384 B.R. 62; In re Davis, Bkrtcy.W.D.Pa.1990, 120 B.R. 823; In re Art Shirt Ltd., Inc., E.D.Pa.1988, 93 B.R. 333; In re Thomas Farm Systems, Inc., Bkrtcy.E.D.Pa.1982, 18 B.R. 543; In re Fonda Group, Inc., Bkrtcy.D.N.J.1989, 108 B.R. 956; In re Bernard Technologies, Inc., Bkrtcy.D.Del.2008, 398 B.R. 526; In re USN Communications, Inc., Bkrtcy.D.Del.2002, 280 B.R. 573; In re Lids Corp., Bkrtcy.D.Del.2002, 281 B.R. 535 17 In re J.A.S. Markets, Inc., Bkrtcy.W.D.Pa.1990, 113 B.R. 193 18 Barnhill v. Johnson, U.S.N.M.1992, 112 S.Ct. 1386, 503 U.S. 393. 19 In re Lease-A-Fleet, Inc., Bkrtcy.E.D.Pa.1992, 141 B.R. 853 20 Matter of Dan-Ver Enterprises, Inc., Bkrtcy.W.D.Pa.1986, 60 B.R. 568, affirmed 67 B.R. 951 21 11 USC 547(b). See Kimmelman v. Port Auth. of N.Y. & N.J. (In re Kiwi Intl Air Lines, Inc., 334 F.3d 311 (3d Cir. 2003); Zenith Indus. Corp v. Longwood Elastomers, Inc.(In re Zenith Indus. Corp., 319 B.R. 810, 815 (Bankr. D. Del. 2005); HLI Creditor Trust v. Export Corp., (In re Hayes Lemmerz Intl, Inc.) 313 B.R. 189 (Bankr. D. Del. 2004).
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would belong in a chapter 7 proceeding and to determine how a creditor in that class would fare in a chapter 7 proceeding involving the debtor. III. PREFERENCE CLAIM DEFENSES AND EXCEPTIONS.

The trustee has the burden of proving the avoidability of a transfer under Sec. 547(b).22 However, the party against whom recovery is sought has the burden of proving that a transfer is not avoidable under sec. 547(b) based on the following exceptions. 23 Creditors have no Seventh Amendment right to jury trial when sued by bankruptcy trustee to recover allegedly preferential transfers. A. CONTEMPORANEOUS EXCHANGE OF NEW VALUE DEFENSE

(1) The trustee may not avoid a transfer to the extent the transfer was intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor and in fact a substantially contemporaneous exchange.24 The most common example of the contemporaneous exchange exception is a cash-on-delivery (COD) for goods delivered, or payments in exchange for waiver or release of lien rights against the debtors property. To prove that transfers by a debtor were not avoidable as preferential in a bankruptcy proceeding, because they fell within the contemporaneous exchange defense, the transferee had to show that the transfers were (1) intended by the debtor and the transferee to be a contemporaneous exchange for new value given to the debtor, and (2) in fact a substantially contemporaneous exchange. 25 Determination of whether parties intended contemporaneous exchange for new value is question of fact, in preference proceeding. 26 New value may not consist of esoteric or intangible benefits but instead must actually and in real terms enhance worth of debtor's estate so as to offset reduction in estate that transfer caused. 27 (2) i. Specific Examples in the 3rd Circuit Intent of parties

1. Mere statement that there was no intent for exchange to be substantially contemporaneous was insufficient, for purpose of contemporaneous exchange for new value defense to preference-avoidance claim, to rebut conclusion that parties intended to create substantially contemporaneous exchange, which was made on evidence that payment was due upon delivery of machines. 28 2. Supplier failed to show that payments that it demanded as prerequisite to continuing to ship goods to Chapter 11 debtor during period of financial distress were intended by parties as contemporaneous exchange for goods shipped, as required for such payments to come within safe harbor of the contemporaneous
Sec. 547(g); Langenkamp v. Culp, U.S.Okla.1990, 111 S.Ct. 330, 498 U.S. 42, 112 L.Ed.2d 343 Sec. 547(g) 11 U.S.C. 547(c)(1) 25 In re Hechinger Inv. Co. of Delaware, Inc., 489 F.3d 568 (3d Cir. 2007). 26 In re Spada, 903 F.2d 971 (3d Cir. 1990). 27 In re Adelphia Automatic Sprinkler Co., E.D.Pa.1995, 184 B.R. 224. 28 In re Hayes Lemmerz Intern., Inc., Bkrtcy.D.Del.2005, 329 B.R. 136.
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exchange for new value exception to preference statute, given evidence that supplier's demands served merely to alert debtor to fact that orders could not be shipped unless and until debtor remitted funds to reduce its outstanding debt to supplier to point at which subsequent shipments would not put it over its credit limit. 29 3. Evidence that, in agreeing to provide a financially troubled corporate borrower with a $1 million revolving credit loan, bank had placed significantly more weight on guarantee provided by corporation's principal than on the first priority security interest that it received in borrower's assets was irrelevant to whether, in insisting on first priority security interest in borrower's assets as prerequisite to loan, bank had manifested its intent as to contemporaneous nature of grant of security interest and extension of credit, for purpose of deciding whether, when borrower later filed for bankruptcy, bank could successfully assert a substantially contemporaneous exchange for new value defense to trustee's preference claims. 30 ii. Cash/Credit Transactions. Blending transaction between debtor food processor and creditors whereby payment by third party for blend was credited against debtor's antecedent debt to creditor was not contemporaneous exchange for new value so as to be exempt from preferential transfer rule, where, at time antecedent debt was incurred, it was not consideration that repayment would be made in form of credit from blending transaction. 31 iii. Timing.

1. Twenty-five day delay between time debtor's checks to landlord for past due rent were honored and date on which lease extension agreement was signed by debtor and landlord did not preclude application of contemporaneous exchange exception to preference avoidance rule; 25-day delay was substantially contemporaneous under circumstances. 32 2. Pre-bankruptcy transfers of two post-dated checks between one and three weeks after delivery of goods did not fall within contemporaneous exchange exception to Chapter 7 trustee's avoidance powers; transfers were not substantially contemporaneous exchanges for new value. 33 B. ORDINARY COURSE OF BUSINESS DEFENSE. It is a defense to a preference claim if a transfer was made in the ordinary course of the debtors business.34 Evidence of business custom and practice is applicable to determine what is the ordinary course of business. 35 The ordinary course of business defense is summarized as follows: (1) That the obligation being paid was incurred in the ordinary course of business or
In re Hechinger Inv. Co. of Delaware, Inc., Bkrtcy.D.Del.2005, 326 B.R. 282, affirmed 339 B.R. 332, affirmed in part, vacated in part and remanded 489 F.3d 568. 30 In re J. Silver Clothing, Inc., Bkrtcy.D.Del.2011, 453 B.R. 518 31 In re Keystone Foods, Inc., Bkrtcy.W.D.Pa.1992, 145 B.R. 502. 32 In re Adelphia Automatic Sprinkler Co., E.D.Pa.1995, 184 B.R. 224. 33 Computer Personalities Systems, Inc. v. Aspect Computer, E.D.Pa.2005, 320 B.R. 812 34 11 U.S.C. 547(c)(2) 35 Logan Square East v. PECO Energy Co. 254 B.R. 850 (E.D. Pa 2000)
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financial affairs of the customer and the supplier; [PREMABLE] AND (2) that either 36 (A) the payment have been made in the ordinary course of business of both the supplier and the customer; [SUBJECTIVE TEST] OR (B) the payment was made under ordinary business terms. 37 [OBJECTIVE TEST]

(1) Preamble. Imposed by the preamble language of 547(c)(2), the first prong of the test requires that the debt to which payments relate must be incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee ... This prong does not refer to the parties' conduct with regard to the Debtor's payment history. Rather it addresses circumstances under which the debt was originated. In other words, it is not sufficient that the transfers be made in the ordinary course. The debt must also have been incurred by the debtor and the preference defendant in their respective ordinary business dealings. To evaluate whether the first prong of the test has been met, courts will look to whether the debt is typical of the debtor's and creditor's business dealings and whether the debt was incurred as a part of an arms-length transaction. 38 (2) Subjective Test.

(i) The determination of whether a creditor has met its burden under 547(c)(2)(B) is a subjective test which considers the consistency of transactions between the debtor and creditor before and during the preference period. 39 Determination of what has been ordinary course of conduct between debtor and transferee, for purposes of determining whether transfer will not be avoided as preferential because the transfer was made in ordinary course of business, will require that court look at factors such as length of time parties have engaged in type of dealing at issue, whether transfer was in amount more than usually paid, whether payments were tendered in manner different from previous payments, whether there appeared any unusual action by either debtor or transferee to collect or pay on the debt, and whether transferee did anything to gain advantage in light of debtor's deteriorating financial condition. 40 To meet this requirement, the transaction need not have been common, it need only be ordinary. 41

Take notice that the second element is an either/or test. Before November 2005, the test was an AND test and both elements had to be proven. 37 See In re Molded Acoustical Products, Inc., 18 F.3d 217, 219 (3d Cir.1994); In re Frey Mech. Group, Inc., 446 B.R. 208, 215 (Bankr. E.D. Pa. 2011); In re Quad Sys. Corp., 00-35667F, 2003 WL 25947345 (Bankr. E.D. Pa. July 15, 2003). 38 In re Frey Mech. Group, Inc., 446 B.R. 208, 215 (Bankr. E.D. Pa. 2011) 39 In re First Jersey Sec., 180 F.3d 504, 512 (3d Cir.1999). 40 In re Richardson, 94 B.R. 56 (Bankr. E.D. Pa. 1988). 41 In re Forklift LP Corp., 340 B.R. 735, 738 (D. Del. 2006).
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(ii) Among factors that courts consider in deciding whether a preference period transaction is consistent with pre-preference period transactions between parties, so that the former comes within ordinary course of business exception to trustee's avoidance power, are the following: (1) length of time that parties have engaged in type of dealing at issue, (2) whether subject transfer was in an amount more than usually paid; (3) whether payments were tendered in manner different from previous payments; (4) whether there appears any unusual action by either debtor or creditor to collect or pay on debt; and (5) whether creditor did anything to gain an advantage in light of debtor's deteriorating financial condition. 42 By itself, lateness of payment does not preclude a finding that the payment was made in the ordinary course; a pattern of late payments can establish an ordinary course between the parties. 43 Extraordinary collection efforts can bring payment efforts outside the ordinary course of business even when a differing payment interval alone is not enough to do so. 44 (3) Objective Test. The third prong of 547(c)(2), involves an objective test regarding the billing practices generally within the relevant industry as opposed to the subjective test relating solely to the dealing between the parties set forth in the previous discussion of subpart A. 45 The phrase according to ordinary business terms, as used in final prong of ordinary-course-of-business exception to preference statute, refers to range of terms that encompasses practices in which firms similar in some general way to transferee engage, and only dealings so unusual as to fall outside that broad range should be deemed extraordinary. 46 The creditor can prove ordinary business terms by using industry data from sources such as the Credit Research Foundation, an industry credit group, etc in order to show that the payment terms were consistent with the range of terms in the industry. (4) Specific examples inside the 3rd Circuit (i) Pressure exerted by creditor for payment

a. Prepetition letters from automotive parts supplier to Chapter 11 debtor, in which supplier expressed its dissatisfaction with parties' existing credit arrangement and mentioned the posting of letter of credit as possible solution, but without dunning debtor or insisting upon any specific change in timing or method of payment of outstanding invoices, did not prevent debtor's subsequent payments, which were made in manner consistent with parties' practices before letters were written, from qualifying as payments made in ordinary course of business or financial affairs of debtor and supplier, as required for supplier to successfully assert ordinary course of business defense in preference proceeding. 47

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In re Richardson, 94 B.R. 56, 60 (Bankr.E.D.Pa.1988) (also quoted in In re R.M.L., Inc., 195 B.R. 602, 613 (Bankr.M.D.Pa.1996). In re Allegheny Health, Educ. & Research Found., 292 B.R. 68 (Bankr. W.D. Pa. 2003); In re J. Allan Steel Co., W.D.Pa.2005, 336 B.R. 226. In re Big Wheel Holding Co., 223 B.R. 669, 674 (Bankr.D.Del.1998). In re Molded Acoustical Products, Inc., 18 F.3d at 228.

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In re Sacred Heart Hospital of Norristown, 200 B.R. 114, 116 (Bankr.E.D.Pa.1996) In re CCI Const. Co., Inc., 371 B.R. 83 (Bankr. M.D. Pa. 2007). 47 In re Hayes Lemmerz Intern., Inc., Bkrtcy.D.Del.2006, 339 B.R. 97

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b. Extreme change in terms on which supplier provided credit to Chapter 11 debtor commencing roughly one-month prior to start of 90-day preference period, the suppliers first time imposition of limit on debtor's credit, requirement of lump sum wire transfers as debtor approached the credit limit, and shortened time that debtor had to pay its invoices, prevented payments that debtor made during preference period from qualifying as payments made in the ordinary course of business or financial affairs of the debtor and the transferee. 48 c. Payments made by Chapter 11 debtor to supplier were not made in the ordinary course of business where debtor was pressured by supplier to make accelerated payments during the 90-day preference period because of supplier's vigorous enforcement of its credit limit, and for the first time in their business relationship, the supplier required lump sum wire transfers as debtor approached this limit, and it shortened the time that debtor had to pay its invoices. 49 d. Activity between creditors and debtor during 90-day preference period generally showed tightening of credit terms throughout the period and modification of parties' pre-preference communications and method of delivering payments, establishing that creditors were providing more and more pressure on debtor to accelerate its payments, and therefore challenged payments were not protected from avoidance as preferential transfers by ordinary course of business defense. 50 e. Payments that debtor made to utility less than 90 days prior to commencement of its Chapter 11 case were not made in the ordinary course of business of debtor and utility, and were not insulated from avoidance as preferences on that basis, given that these payments were the only payments that debtor had made to utility, in timely fashion, during ten-month period preceding its bankruptcy petition, and that these payments were made in timely fashion only in response to unusual collection activity by utility in threatening, for first time in parties' relationship, to seek appointment of receiver.
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(ii)

Timing of Payments

a. Chapter 11 debtor-shoe distributor's preference period payments to manufacturer's leather supplier were not made in ordinary course of parties' business, though supplier never held up any shipment to secure payment, never instituted legal proceedings to recover debts, and did not alter its credit terms for materials, and preference period payments were no larger than previous payments, where before preference period, debtor paid supplier's invoices average of 30-32 days after due date on invoice, and during preference period, debtor paid invoices average of 94 days late. 52

In re Hechinger Inv. Co. of Delaware Inc., D.Del.2006, 339 B.R. 332, affirmed in part, vacated in part and remanded, 489 F.3d 568. In re Hechinger Inv. Co. of Delaware, Inc., 489 F.3d 568 (3d Cir. 2007) 50 In re Sierra Concrete Design, Inc., Bkrtcy.D.Del.2012, 2012 WL 12734 51 In re Logan Square East, Bkrtcy.E.D.Pa.2000, 254 B.R. 850 52 In re R.M.L., Inc., Bkrtcy.M.D.Pa.1996, 195 B.R. 602
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b. Lateness of payment does not preclude finding that payment was in ordinary course of business, for purposes of ordinary course of business exception to preference avoidance. 53 c. Payments which debtor made to supplier between 88 and 110 days late were not made in ordinary course of business, within meaning of statutory exception to trustee's preference-avoiding powers, given evidence of average delay by debtor of only 45 days in making payment on invoice. 54 d. Mere fact that only 8% of Chapter 11 debtor's payments to supplier during 90-day preference period were more than 60 days late, as opposed to 20% of payments made during pre-preference period, was insufficient to prevent court from finding that preference-period payments were made in ordinary course of business or financial affairs of the debtor and the transferee, as required for supplier to prevail on ordinary course of business defense to preference claims, where there was no change in credit terms on which parties conducted business during preference period, where there were no letters, telephone calls, or any attempts whatsoever on part of supplier to apply pressure or to dun debtor, where there were no attempts by supplier to change credit, delivery or other terms or conditions of relationship, and where late payments during pre-preference period were apparently due, at least in major part, to pricing disputes. 55 e. Chapter 7 debtors' payments to supplier were made in the ordinary course of business, and so were not avoidable; supplier was in the business of producing plastic trays for use in the food industry and debtors purchased the trays for such use, the parties' business relationship lasted over two years and involved 117 transactions, and transactions made in historical period were sufficiently similar to those made in preference period, as there was no evidence that amounts paid by debtor during preference period were inconsistent with historical practices, all 117 payments were made by check, 107 transfers that occurred during historical period were made between 21 and 177 days after issuance of invoices, with average days-to-pay of 42.3 days, while ten transfers made in preference period ranged from 41 to 64 days after issuance of invoice, with average of 47.2 days-to-pay, and supplier's practices of pressuring debtors into payment were consistent with their historical dealings. 56 f. Evidence that debtor and trade creditor had been involved in longstanding relationship of nearly three years, that debtor's payments to creditor outside preference period had consistently been from 15 to 72 days after invoice dates, and that this prior course of dealing corresponded with debtor's payments during preference period, which were made from 22 to 47 days after invoices, was itself sufficient, even in absence of any rigorous comparison of credit terms utilized by debtor and trade creditor with credit terms generally used in relevant industry, to establish ordinary course of business defense to preference claims asserted by unsecured creditors' committee, absent evidence that creditor exerted any economic pressure on debtor to make payments. 57
In re Parkline Corp., Bkrtcy.D.N.J.1994, 185 B.R. 164 Samar Fashions, Inc. v. Private Line, Inc., E.D.Pa.1990, 116 B.R. 417 In re Hechinger Inv. Co. of Del., Inc., Bkrtcy.D.Del.2004, 320 B.R. 541 56 In re Archway Cookies, Bkrtcy.D.Del.2010, 435 B.R. 234. 57 In re Color Tile, Inc., Bkrtcy.D.Del.1999, 239 B.R. 872.
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g. Bankruptcy court's finding that debtor's payments to pulp supplier during 90-day preference period were made in ordinary course of business between parties was not clearly erroneous, even though payments during preference period were made on slightly more accelerated basis than debtor's pre-preference-period payments, where payments, while slightly accelerated, were made within range established by parties' prior dealings.58 (iii) Replacement checks, check payments. Transfer that occurred when Chapter 7 debtor gave supplier a replacement check for insufficient funds check previously tendered at time of delivery of materials was not in ordinary course of business, within meaning of statutory exception to trustee's preference-avoiding power, given complete lack of evidence that debtor had routinely or ever previously tendered a bad check to supplier. 59 (iv) Other Circumstances.

a. Set Off. Blending transaction between creditors and debtor food processor whereby creditor off set price paid by third party for blend against debtor's antecedent debt was not in ordinary course of business so as to be exempt from preferential transfer rule, where parties had not previously entered into this type of transaction and transaction was designed as a vehicle to repay debtor's antecedent debt. 60 b. Guarantees. For preference avoidance purposes, guaranty obligations paid by Chapter 11 debtor-shoe distributor within 90-day preference period were within ordinary course of business between debtor and supplier of leather to shoe manufacturer; guaranty by principal, such as debtor, of payment owed by its purchasing agent is sufficiently ordinary business practice, debtor guarantied payments to other suppliers of raw materials, and guaranty is standard commercial device. 61 c. Partnership Payments. Payments made to individual partner by corporate partner in connection with agreement for purchase of individual partner's partnership interest were not excepted from avoidance as preferential transfers in corporate partner's bankruptcy case under ordinary course of business exception; debt for purchase of partnership interest was incurred under extraordinary circumstances, not in ordinary course of corporate partner's floral business or in ordinary course of its participation in partnership which involved acquisition, development, and sale of real estate.62 d. Rent Payments. Chapter 11 debtor's rent payments to lessor pursuant to arrangement under which rent for September, October, November were

In re Global Tissue L.L.C., C.A.3 (Del.) 2004, 106 Fed.Appx. 99, 2004 WL 1510091. In re Old Electralloy Corp., Bkrtcy.W.D.Pa.1994, 164 B.R. 501 60 In re Keystone Foods, Inc., Bkrtcy.W.D.Pa.1992, 145 B.R. 502. 61 In re R.M.L., Inc., Bkrtcy.M.D.Pa.1996, 195 B.R. 602 62 In re Pittsburgh Cut Flower Co., Inc., Bkrtcy.W.D.Pa.1991, 124 B.R. 451
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not billed until November were not within ordinary course of business, and thus, payments could be avoided as preference.63 e. Severance Payments. Multimillion dollar severance payment which was neither recurring nor customary, pursuant to severance package that was not negotiated until five years after its former CEO's employment agreement, at time when debtor was already suffering from severe financial distress, did not come within ordinary course of business exception to avoidability of insider payments as constructively fraudulent. 64 f. Wages. Prepetition transfers made by Chapter 7 debtor to its founder-former chief executive officer (CEO) for wages and reimbursements were payments in the ordinary course of business, and thus could not be avoided as preferential transfers by trustee. 65 C. SUBSEQUENT ADVANCES OF NEW VALUE DEFENSE

(1) Section 547(c)(4) provides a defense where the creditor provided new value to the Debtor subsequent to the transfers. The Third Circuit has recognized that 547(c)(4) has two interrelated purposes: (1) to encourage trade creditors to continue dealing with troubled businesses; and (2) to guarantee the fair treatment of a creditor who has replenished the estate after having received a preference. 66 The application of the subsequent advance approach to protect the Advances is consistent with both purposes. 67 (2) U.S.C.A. 547(a)(2) defines new value as money or money's worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation. The provision of new value constitutes an affirmative defense to an otherwise voidable preference. Pursuant to the defense, a transfer is not avoidable to the extent the creditor can establish that the transfer was followed by an advance of new value to the debtor on an unsecured basis. 68 (3) To successfully assert subsequent new value defense to preference claim, transferee must establish the following: (1) that new value was extended after preferential transfer sought to be avoided; (2) that this new value is not secured by otherwise unavoidable security interest; and (3) that new 11 U.S.C.A. 547(c)(4). 69 (4) The Third Circuit has stated that a creditor asserting the new value defense must prove: (1) the creditor must have received a transfer that is otherwise
In re Allegheny Intern., Inc., W.D.Pa.1992, 145 B.R. 823 In re TSIC, Inc., Bkrtcy.D.Del.2010, 428 B.R. 103 65 In re Bernard Technologies, Inc., Bkrtcy.D.Del.2008, 398 B.R. 526 66 New York City Shoes, 880 F.2d at 68081 67 See, e.g., Holder v. Dolchin Slotkin & Todd, P.C. et al. (In re American Rehab & Physical Therapy, Inc.), 2006 WL 1997431, at 14 (Bankr.E.D.Pa. May 18, 2006) (offsetting amount of new value against amount of avoidable preferences to determine net amount of avoidable preference payment). 68 In re LeaseAFleet, Inc., 155 B.R. 666, 684 (Bankr.E.D.Pa.1993). 69 In re Pillowtex Corp., 416 B.R. 123 (Bankr. D. Del. 2009)
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voidable as a preference under 547(b); (2) after receiving the preferential transfer, the preferred creditor must advance new value to the debtor on an unsecured basis; and (3) the debtor must not have fully compensated the creditor for the new value as of the date that it filed its bankruptcy petition. 70 (4) There is a recognized split in the Courts of Appeals in how the various courts interpret and apply 547(c)(4)(B), which has been described as follows: Of the seven Circuits that have dealt with this provision of the Code, three (the Third, Seventh, and Eleventh) have concluded that 547(c)(4)(B) should be read to mean that new value must remain unpaid at the end of the preference period in order to be effectively used by the creditor to offset his preference liability.... conversely, three Circuits (the Fourth, Fifth, and Ninth) have determined that 547(c)(4)(B) does not mandate a remains unpaid requirement, and that rather, the statute must be interpreted in accordance with its plain albeit complexmeaning. This method of interpretation has been dubbed the subsequent advance approach, and is both the emerging and more doctrinally sophisticated view. The issue is seemingly unresolved in the Eighth Circuit, where the Court has come down with conflicting opinions at once acknowledging the doctrinal advantages of the subsequent advance approach, while upholding results it reached employing the remains unpaid approach. (5) In New York City Shoes, Inc. v. Bentley Int'l, Inc. (In re New York 71 City Shoes, Inc.), the Third Circuit Court of Appeals wrote: The three requirements of section 547(c)(4) are well established. First, the creditor must have received a transfer that is otherwise voidable as a preference under 547(b). Second, after receiving the preferential transfer, the preferred creditor must advance new value to the debtor on an unsecured basis. Third, the debtor must not have fully compensated the creditor for the new value as of the date that it filed its bankruptcy petition. More recently, the Third Circuit considered the subsequent new value defense in Schubert v. Lucent Technologies, Inc. (In re Winstar Commc'n., Inc.)72, In Winstar, the Court cited to the three-element test of New York City Shoes, then concluded that the defendant failed to prove that it provided equipment to the debtor as new value on an unsecured or undersecured basis.73. Again, the Court was not required to consider directly the third element ( 547(c)(4)(B)) of the subsequent new value defense. (5) Example: Consider the following payment history inside the 90 day preference period where the transferee/creditor seeks to avail itself of the New Value Defense. As a result of application of this rule, results in an avoidable preference against the Defendants in the amount of $400,000. 74
Date 20Jan09 20Jan09 From Debtor Debtor To Defendants Defendants Amount ($150,000.00) ($ 50,000.00) Net Amount ($150,000.00) ($200,000.00)

Schubert v. Lucent Technologies, Inc. (In re Winstar Communications, Inc.), 554 F.3d 382, 402 (3d Cir.2009) citing New York City Shoes, Inc. v. Bentley Int'l, Inc. (In re New York City Shoes, Inc.), 880 F.2d 679, 680 (3d Cir.1989); In re Frey Mech. Group, Inc., 446 B.R. 208, 217 (Bankr. E.D. Pa. 2011). 71 880 F.2d 679 (3d Cir.1989), 72 554 F.3d 382 (3d Cir.2009). 73 Winstar, 554 F.3d at 403 74 Case data taken from In re Frey Mech. Group, Inc., 446 B.R. 208, 219 (Bankr. E.D. Pa. 2011)
70

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30Jan09 4Feb09 6Feb09 9Feb09 25Mar09 30Mar09 7Apr09 15Apr09 23Apr09 27Apr09 28Apr09 1May09 18May09 28May09

Defendants Defendants Defendants Debtor Defendants Debtor Defendants Debtor Defendants Defendants Debtor Debtor Defendants Debtor

Debtor Debtor Debtor Defendants Debtor Defendants Debtor Defendants Debtor Debtor Defendants Defendants Debtor Defendants

$ 75,000.00 $ 25,000.00 $ 20,000.00 ($ 40,000.00) $ 20,000.00 ($ 80,000.00) $100,000.00 ($ 20,000.00) $ 60,000.00 $ 20,000.00 ($ 50,000.00) ($ 50,000.00 $ 20,000.00 ($300,000.00)

($125,000.00) ($100,000.00) ($ 80,000.00) ($120,000.00) ($100,000.00) ($180,000.00) ($ 80,000.00) ($100,000.00) ($ 40,000.00) ($ 20,000.00) ($ 70,000.00) ($120,000.00) ($100,000.00) ($400,000.00)

(5) The Delaware Bankruptcy Courts recent decision in Wahoski v. Efrid, Inc. (In re Pillowtex Corp.) has expanded the scope of the subsequent new value defense. 75 Until the bankruptcy courts decision in Pillowtex, many bankruptcy courts located in the Third Circuit relied on what they believed was binding Third Circuit Court of Appeals precedent, strictly limited the use of the new value defense to those situations where that new value was unpaid as of the date of bankruptcy, even though the debtors payment for the new value was itself subject to avoidance and recovery as a preference. In contrast to these decisions, the Pillowtex court determined that new value that was paid with a preferential payment would still qualify for the defense. The court explained that the Third Circuit opinion at issue had not directly addressed the question of paid new value, and, consequently, lower Third Circuit courts applying the strict new value rule had been improperly construing Third Circuit precedent.76 The difference between the remains unpaid approach and the subsequent advance (or plain language) approach to the defense can be illustrated in the following hypothetical example:
Preference Alleged Preference Date 1. 1/10/09 2. 1/20/09 3. 1/30/09 4. 2/10/09 5. 2/20/09 6. 3/1/09 $1,000 $1,000 $1,000 $1,000 Payment $1,000 $1,000 New Value Given exposure (subsequent adv) $1,000 $0 $1,000 $0 $1,000 $0 Preference exposure (remains unpaid) $1,000 $0 $2,000 $1,000 $3,000 $2,000

(6) The foregoing hypothetical assumes that other defenses are not available to the preference payments in lines 1, 3, and 5, so that they are not otherwise unavoidable, (or, stated in the positive, that the trustee can avoid all three transfers). Under the remains unpaid approach, the result of the analysis is that $2,000 of the transfers are
75

In re Pillowtex Corp., 416 B.R. 123 (Bankr. D. Del. 2009) Id.

76

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avoidable because the debtor paid the creditor for two of the extensions of new value (i.e., the transfer in line 3 paid the new value given in line 2, and the transfer in line 5 paid the new value given in line 4). Only the new value extended in line 6 remains unpaid and is available as a 547(c)(4)(B) defense against the three preference payments. In the subsequent advance approach, each extension of new value can be used as a defense against the $3,000 total payments in the preference period, even if the extensions of new value were paid by the transfers in lines 3 and 5, so long as those transfers are not otherwise unavoidable. 77 (7) Since Pilotex was decided, at least one other court in the Third Circuit has agreed with Judge Carey's analysis in Pillowtex and finds that the plain language of 547(c)(4)(B) permits a defendant to assert as a defense new value, even if paid, so long as the payment was not otherwise unavoidable. 78 D. THE LESSER KNOWN DEFENSES (1) De Minimus Exception. A trustee may not avoid in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $600.79 The majority view of the cases to construe Section 547(c)(8), including the 3rd Circuit, is to hold that the transfers may be aggregated for purposes of meeting the monetary floor provided in Section 547(c)(8). 80 (2) Earmarking Defense [Third Party Debtor Defendant] i. Concept: This defense asserts that the transfer was not property in which the debtor had an interest. Generally speaking, this involves a situation where a third party transfers property to the Debtor, who then in turn transfers the same property to the alleged preferential payment recipient. The earmarking doctrine is not an affirmative defense under Fed.R.Civ.P. 8, but rather a challenge to the trustee's claim that particular funds are part of the bankruptcy estate. 81 ii. The earmarking doctrine is entirely a court-made interpretation of the statutory requirement that a voidable preference must involve a transfer of an interest of the debtor in property. Under this doctrine, [w]hen ... funds are provided by [a] new creditor to or for the benefit of the debtor for the purpose of paying the obligation owed to [an existing] creditor, the funds are said to be earmarked and the payment is held not to be a voidable preference. 82 iii. Three requirements must be met in order for earmarking doctrine to apply and to prevent trustee from avoiding payment as preference: (1) there must exist an agreement between new lender and debtor that funds will be used to pay a
In re Pillowtex Corp., 416 B.R. 123, 130 (Bankr. D. Del. 2009) 446 B.R. 208, 218 (Bankr. E.D. Pa. 2011) 79 11 U.S.C. 547(c) 80 In re Transcon. Refrigerated Lines, Inc., 438 B.R. 520, 522 (M.D. Pa. 2010)(J. Thomas). 81 In re Winstar Communications, Inc., 554 F.3d 382, 400 (3d Cir. 2009) 82 In re Winstar Communications, Inc., 554 F.3d 382, 400 (3d Cir. 2009) citing McCuskey v. Nat'l Bank of Waterloo (In re Bohlen Enters., Ltd.), 859 F.2d 561, 565 (8th Cir.1988) (quoting 11 U.S.C. 547(b)).
77 78

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specific antecedent debt; (2) agreement must be performed according to its terms; and (3) transaction, viewed as whole, must not result in any diminution of debtor's estate.83 iv. 3rd Circuit Specific Examples of Earmarking Doctrine

1. Payments made by user lessees of computer equipment, although made directly to creditor of debtor, were not loans by user lessees to debtor which had been specifically designated to satisfy debts owed by debtor to creditor, but rather, payments were made for rental of computer equipment leased from debtor, and thus, earmarking rule was inapplicable to prevent avoidance of transfers as preferences. 84 2. Prepetition loan to Chapter 7 debtor was sufficiently earmarked for payment to second creditor, and thus such payment was not avoidable preference, where there was express, albeit verbal, understanding between debtor and lender that loan would be used to pay off second creditor. 85 3. Even though trustee of trust which lent money to debtor knew that loaned money would be used to pay creditor or that money would ultimately serve to reduce debt to creditor, funds were not earmarked so as to preclude recovery of funds from creditor as preferential transfer, where debtor had power to use funds other than to pay creditor. 86 4. Because debtor does not own equitable interest in property he holds in trust for another, that interest is not property of the estate, nor is it property of the debtor for purposes of preference provision. 87 5. To extent that funds out of which Chapter 11 debtor made alleged preferential payments to its suppliers were already impressed with statutory trust in suppliers' favor under the Packers and Stockyards Act (PASA), payments would not involve interest of the debtor in property, as required for trustee to avoid payments as preferential. 88 6. Funds in debtor's account as result of its conduct in either intentionally or accidentally depositing a misdelivered check that was made out to another payee were subject to constructive trust in favor of the named payee from the moment that debtor deposited check in its account, so that funds could not have entered bankruptcy estate, and debtor's prepetition transfer of funds to named payee was not subject to avoidance as preference, as not involving interest of the debtor in property. 89

83

In re Kumar Bavishi & Associates, 906 F.2d 942, 944 (3d Cir. 1990) citing In re Bohlen Enters., Ltd., 859 F.2d 561, 566 (8th Cir.1988).

In re Funding Systems Asset Management Corp., Bkrtcy.W.D.Pa.1990, 111 B.R. 500 Matter of Oliver's Stores, Inc., Bkrtcy.D.N.J.1989, 112 B.R. 671, affirmed. 86 New York City Shoes, Inc. v. Best Shoe Corp., E.D.Pa.1989, 106 B.R. 58 87 Begier v. I.R.S., U.S.Pa.1990, 110 S.Ct. 2258, 496 U.S. 53, 110 L.Ed.2d 46. 88 In re CFP Liquidating Estate, Bkrtcy.D.Del.2009.
84 85 89

In re Bake-Line Group, LLC, Bkrtcy.D.Del.2007, 359 B.R. 566

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7. Impression, by Pennsylvania court, of constructive trust upon realty to which Chapter 7 debtors held legal title never effected a transfer of property, and did not in any event transfer any interest of the debtors in [such] property, within meaning of preference provision; state court's decision, less than 30 days prior to debtors' bankruptcy filing, that property was impressed with constructive trust merely recognized trust beneficiary's preexisting interest in property from moment of debtor-husband's fraudulent conveyance of property to himself and his wife. 90 8. Bankruptcy trustee had established Chapter 7 debtor had interest in funds paid to Commonwealth on account of past-due retail sales taxes and employer withholding taxes by establishing the funds paid were not properly withheld, but were generated from loans made subsequent to dates of proper withholding to make up delinquency in debtor's duty to withhold, and trustee could accordingly recover the funds paid to the Commonwealth as preferential transfers. 91 9. Where there exists a true agency relationship, such as a bailment, a transfer by the agent of agency property to the principal is not a voidable preference; the reason is that the transfer is not of property of the debtor but property of the principal. 92 (3) Mere Conduit Defense [Debtor Defendant Third Party] i. The idea behind this defense is that the preference defendant was merely acting as a non-stakeholder intermediary in the transfer of property from the debtor to a third party. Using this defense, the alleged preference recipient argues that the transfer was from the Debtor to a Third party. Property that is subject to avoidance may be recovered from an initial transferee. ii. Use of this exception requires that the defendant lack dominion over the property, that is, the right to put the money to one's own use. 93(to have dominion and control means to be capable of using the funds for whatever purposes he or she wishes, be it to invest in lottery tickets or uranium stocks. To establish this defense, the defendant must show the payment merely slipped through his hands to another party. 94 For example, a debtor-employer's payments to a fiduciary that administered its employee benefit plan. 95 iii. Although the Bankruptcy Code does not define the term initial transferee, courts addressing the issue have determined that where a party is a mere conduit of funds, recovery from that party cannot be had.96 The rationale behind the mere conduit theory was first described by Justice Cardozo. The person to be charged with liability, if he has parted before the bankruptcy with title and possession, must have been
In re Aultman, Bkrtcy.W.D.Pa.1998, 223 B.R. 481 In re Miller's Auto Supplies, Inc., Bkrtcy.E.D.Pa.1988, 93 B.R. 344. 92 In re Crouthamel Potato Chip Co. Inc., Bkrtcy.E.D.Pa.1980.
90 91

Official Comm. of Unsecured Creditors v. Guardian Ins. 401 (In re Parcel Consultants, Inc.), 287 B.R. 41, 46 (Bankr.D.N.J.2002). In re U.S. Interactive, Inc., 321 B.R. 388, 395 (Bankr. D. Del. 2005) 95 In re Parcel Consultants, Inc., Bkrtcy.D.N.J.2002, 287 B.R. 41 96 See Abele v. Modern Financial Plans Services, Inc. (In re Cohen), 300 F.3d 1097 (9th Cir.2002); In re First Sec. Mortgage Co., 33 F.3d 42 (10th Cir.1994); Bonded Fin. Services, Inc. v. European American Bank, 838 F.2d 890 (7th Cir.1988).
93 94

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more than a mere custodian, an intermediary or conduit between the bankrupt and the creditor. Directly or indirectly he must have had a beneficial interest in the preference to be avoided, the thing to be reclaimed. 97 iv. While the language of 550(a) does not appear to present an exception to recovery of a preference under 547, courts have held that it does provide a defense to a preference action for parties who act as a mere conduit in receiving a transfer solely for another and not for their own benefit. 98 The rationale for finding that a mere conduit is not an initial transferee liable for a preference was articulated by the Second Circuit as follows: The statutory structure confirms that the term initial transferee references something more particular than the initial recipient.... Every Court of Appeals to consider this issue has squarely rejected a test that equates mere receipt with liability, declining to find mere conduits' to be initial transferees. 99 (5) Improvement in Position Test. A creditor fully secured by the debtors assets or paid from collateral proceeds is not subject to preference exposure. (6) Limits on Venue and Forum Selection: Strictly speaking venue is not a defense, however, initiation of a preference action where venue is not proper may serve as an additional obstacle for a trustee to resolve. i. 28 U.S.C. 1409(b) has been amended to provide that an action to avoid a non-consumer debt against a non-insider for less than $10,000 must be filed in the district in which the defendant resides (as opposed to the district where the bankruptcy case is pending). ii. The same section also requires actions to recover a money judgment of or property worth less than $1,000 or consumer debt of less than $15,000 (previously, $5,000) to be commenced in the district in which the defendant resides (again, as opposed to the district where the bankruptcy case is pending). iii. There is strong presumption in favor of maintaining venue of adversary proceeding in bankruptcy case in judicial district where bankruptcy case is pending. 28 U.S.C.A. 1412. The burden is on party seeking to transfer venue of bankruptcy proceeding to demonstrate that transfer of venue is warranted. In re Hayes Lemmerz Int'l Inc., 312 B.R. 44 (Bankr. D. Del. 2004). iv. In determining whether to transfer venue pursuant to sec. 1404 or 1412, the Third Circuit has articulated several factors: (i) plaintiff's choice of forum, (ii) defendant's forum preference, (iii) whether the claim arose elsewhere, (iv) the location of books and records and/or the possibility of viewing premises if applicable, (v) the convenience of the parties as indicated by their relative physical and financial condition, (vi) the convenience of the witnesses-but only to the extent that the witnesses may actually be
In re Parcel Consultants, Inc., 287 B.R. 41, 46 (Bankr. D.N.J. 2002) citing Carson v. Federal Reserve Bank, 254 N.Y. 218, 235236, 172 N.E. 475 (1930). 98 See, e.g., Official Comm. of Unsecured Creditors v. Guardian Ins. 401 (In re Parcel Consultants, Inc.), 287 B.R. 41, 46 (Bankr.D.N.J.2002) (finding insurance company which administered 401k plan for debtor was mere conduit for plan funds). 99 Finley, 130 F.3d at 57.
97

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unavailable for trial in one of the fora, (vii) the enforceability of the judgment, (viii) practical considerations that would make the trial easy, expeditious, or inexpensive, (ix) the relative administrative difficulty in the two fora resulting from congestion of the court's dockets, (x) the public policies of the fora, (xi) the familiarity of the judge with the applicable state law, and (xii) the local interest in deciding local controversies at home. 100 H. Maximizing the Defenses

(1). Supply new value and receive payment on a substantially contemporaneous basis. (2) Adhere to historical payment practices. (3) Supply goods only in exchange for payment. (4) Always take the payment. I V. THE USUAL PROGRESSION OF PREFERENCE CASE A. Receipt of Demand Letter

i. Tickle/calendar the Answer Deadline. The Answer deadline is typically 30 days from the date of summons. Counsel should try to obtain an extension of time to answer the complaint to provide an opportunity to identify defenses to claim and to resolve the lawsuit. Most trustees counsel will provide a reasonable extension to consider meritorious defenses to claims. Other trustees counsel may make a demand for concession of granting an extension, such as waiver of certain defenses or an admission that the transfers were actually received, etc. ii. The typical demand letter will offer a settlement if concluded within a proscribed period of time. It is important to conduct a new value and ordinary course of business defense before your client automatically accepts the settlement offer. There may be a complete defense to the claim if further analysis is done. iii. Send litigation hold letter to Client. All evidence regarding the claims must be preserved. iv. Find local counsel if needed. Many bankruptcies of large corporate debtors will be located in districts such as S.D of N.Y. or Delaware. B. Conduct Detailed Review and Analysis of Case

i. Review all available payment history for at least the last two years before the 90 day preference period; ii. Review available receipts for good delivered;
100

Hechinger, 296 B.R. at 325 (citing Jumara v. State Farm Ins. Co., 55 F.3d 873, 87980 (3d Cir.1995)).

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iii. Determine Applicability of New Value Defense. Prepare a new value analysis to determine the net exposure after deducting new value; iv. Determine Applicability of Ordinary Course of Business Defense; v. Determine Solvency of Debtor. The solvency of the Debtor may or may not be apparent from the Debtors schedules. The schedules and statement of financial affairs should be carefully review to rebut the presumption of insolvency; vi. Determine whether venue is proper vii. Review account statements showing invoicing history; viii. Review sales contracts, financial statements; ix. Review applicable court order to determine scheduling and processing of preference claims; x. Determine whether service has been proper. Beware of service of corporate entities special rules apply for serving large corporations; xi. Determine applicable statute of limitations. A complaint must be filed no greater than two years from the date of the bankruptcy filing or, if a pertinent trustee is selected before the end of the two year period, not later than the greater of the two years after the bankruptcy filing or one year after such selection. In the Third Circuit, the date of appointment of the permanent trustee under Section 702 is the controlling date for purposes of the statute of limitations. 101 C. Respond to the Demand letter. Communicate available defenses to the trustee . If needed, file an Answer to prevent default judgment, or agree on a general extension to resolve claims after consideration of defenses and evidence. If you represent a corporation, it is important to note that a corporation is not permitted to Answer to a complaint pro se, without an attorney. D. Negotiations. Negotiate with the Trustee regarding the available defenses. Present a new value and ordinary course of business defense in the form of a spreadsheet. Support the analysis with statistical analysis. Other possible opportunities to negotiate a preference claim may include: i. If the debtor wants to negotiate terms for post bankruptcy shipments; ii. Resolution of Reclamation claims; iii. Resolution of 503(b)(9) claims; and iv. Resolution of state lien law claims.
101

Singer v. Franklin Boxboard Co. (In re American Pad & Paper ), 478 F.3d 546 (3rd Cir. 2007).

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E. Settlement i. Ensure that the settlement agreement provides for a general release in favor of the Creditor, or at least waives the claims asserted in the preference complaint. ii. Consider the value of the creditors rights under 11 U.S.C. 502(h) to file an unsecured claim for the settlement amount. iii. Consideration of assignment of claim. There is a secondary market for sales of claims and it is likely that your client will be solicited by a buyer seeking to buy the claim. Proceed with caution and conduct your due diligence regarding whether sale of claim will amount to greater recovery.

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PREFERENTIAL TRANSFERS: A FOCUS ON THE 3RD CIRCUIT

Compiled By: Brent C. Diefenderfer 102 CGA Law Firm P.C. May 2012

TABLE OF CONTENTS INTRODUCTION. .......................................................................................................... 1 ELEMENTS OF A PREFERENTIAL PAYMENT. 11 U.S.C. 547(b) ..................... 1 Transfer. ......................................................................................................................... 1 Property of the Debtor. ................................................................................................. 1 To or for the Benefit of a Creditor ................................................................................ 1 For or on Account of Past Debts .................................................................................. 1 Made While the Debtor was Insolvent......................................................................... 2 Made within 90 days prior to the Bankruptcy ............................................................. 2 Allowing the Creditor to Receive More than in a Chapter 7 ...................................... 2 PREFERENCE CLAIM DEFENSES AND EXCEPTIONS ...................................... 3 CONTEMPORANEOUS EXCHANGE OF NEW VALUE ...................................................... 3 Specific Examples in the 3rd Circuit ......................................................................... 3 Intent of parties ..................................................................................................... 3 Cash/Credit Transactions .................................................................................... 4 Timing. ................................................................................................................... 4 ORDINARY COURSE OF BUSINESS DEFENSE ................................................................. 4 Preamble .................................................................................................................... 5 Subjective Test........................................................................................................... 5 Objective Test ............................................................................................................ 6 Specific examples inside the 3rd Circuit ................................................................... 6 Pressure exerted by creditor for payment ............................................................ 6 Timing of Payments .............................................................................................. 7 Replacement checks, check payments ................................................................ 9 Other Circumstances............................................................................................. 9 SUBSEQUENT ADVANCES OF NEW VALUE DEFENSE.................................................. 10 Example ................................................................................................................... 11 THE LESSER KNOWN DEFENSES ................................................................................. 13 De Minimus Exception ......................................................................................... 13 Earmarking Defense ............................................................................................... 13 Concept ................................................................................................................ 13 3rd Circuit Specific Examples of Earmarking Doctrine .................................... 14 Mere Conduit Defense .......................................................................................... 15 Improvement in Position Test................................................................................ 16 Limits on Venue and Forum Selection .................................................................. 16 Maximizing the Defenses ........................................................................................... 17 THE USUAL PROGRESSION OF PREFERENCE CASE ...................................... 17 Receipt of Demand Letter .......................................................................................... 17
102

135 N. George St., York, Pennsylvania 17401; (717) 848 4900; bdiefenderfer@cgalaw.com;, www.brentcdiefenderfer.com

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Conduct Detailed Review and Analysis of Case ....................................................... 17 Respond to the Demand letter ................................................................................... 18 Negotiations ................................................................................................................ 18 Settlement .................................................................................................................... 19

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