Tactics for Defending Preference Actions

Whenever a creditor receives a benefit from a debtor shortly before the debtor files for bankruptcy, whether the payment of money or the granting of additional security, a preferential transfer may occur. Significantly, the bankruptcy law entitles a debtor's estate to recover preferential transfers, including payments on account of antecedent debts made during the 90-day period prior to the bankruptcy petition. In other words, section 547(b) of the Code permits a trustee to avoid pre-bankruptcy transfers as “preferences.” In order for a preferential transfer to exist, a trustee of a debtor's estate must establish seven elements: 1) a transfer, 2) of an interest of the debtor in property, 3) to or for the benefit of a creditor, 4) for or on account of an antecedent debt, 5) made while the debtor was insolvent, 6) made within 90 days before bankruptcy, 7) the effect of which is to give the creditor more than it would receive in the bankruptcy proceeding. Unless the trustee proves each and every element, a transfer is not avoidable as a preference under 547(b). Conversely, a trustee's establishment of all of the elements of a preferential transfer by a preponderance of the evidence, results in the recoverability of the payment for the benefit of the bankruptcy estate.

While serving a threefold purpose of facilitating equality of distribution amongst creditors, allowing a debtor an opportunity to work out of financial difficulty and helping to fund the trustee's activity, a preferential transfer action may have a devastating effect on the finances of a creditor. In particular, recoveries from a preference action are often treated as unencumbered assets. As such, creditors that may be subject to preference actions have a vested interest in vigorously defending such actions. To that end, this article will focus on the methods and strategies of defending and perhaps pre-empting a preference action.