Preference Update – New Take on Key Provision of Preference Statute May Provide Additional Defense to Trade Creditors by S. Jason Teele, Esq. and Nicole Stefanelli, Esq.
Bankruptcy trustees have the power to avoid and recover certain payments to creditors that were made in the 90 days (12 months for insiders) prior to the filing of a bankruptcy petition. In a majority of cases, demands and lawsuits to recover allegedly preferential transfers are a thorn in the side of trade creditors, who in good faith supply goods and services on credit to companies that are or may be in financial distress. In order to avoid a preferential transfer, the bankruptcy trustee must prove that the payment: (1) was to or for the benefit of a creditor; (2) was for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) was made while the debtor was insolvent; (4) was made on or within 90 days before the petition date; and (5) enabled the recipient to receive more than the recipient would have received if case were a case under chapter 7, the transfer had not been made, and the creditor received payment of such debt to the extent provided under the Bankruptcy Code.
With respect to the fifth element of the preference statute, the conventional wisdom holds that a trustee must show that creditors in a hypothetical chapter 7 case would receive less than full repayment of their claims. A recent ruling by the United States Bankruptcy Court for the Southern District of New York sheds new light, and may change the conventional wisdom, on the statute’s fifth element. In In re ContinuityX, Inc., the Bankruptcy Court ruled that the trustee must determine the percentage distribution a defendant would have received under the Bankruptcy Code and compare this amount to the percentage distribution that the defendant actually received on account of the transfers in order to prove that the defendant was paid more than it would have received in a chapter 7 case. In cases where the defendant received less than 100% payment, the trustee must prove that creditors in a hypothetical chapter 7 case would receive less than the percent recovered by the defendant through the preferences. A showing by the trustee that creditors in a chapter 7 case will receive less than a 100% distribution is not enough.
The Bankruptcy Court’s ruling may provide additional avenues for trade creditors to attack a complaint seeking to avoid and recover an allegedly preferential transfer.