Score Two Touchdowns for Chapter 11 Preference Defendants

Jan 15, 2020

Written By: David Conaway, Partner, Shumaker Attorneys at Law

The “Small Business Reorganization Act of 2019” (SBRA) signed into law on August 23, 2019 contains two amendments to Chapter 11 preference laws, which are NOT limited to small business reorganizations.

1 – Debtors’ Burden of Proof.

• As creditors who have been on the wrong end of preference claims under Section 547 of the Bankruptcy Code know all too well, debtors’ burden to assert preference claims is minimal, a lay-up. The burden quickly shifts to the creditor to establish its defenses under Section 547(c) of the Bankruptcy Code.
• With SBRA, debtors now have an additional hurdle before asserting preference claims. A debtor/trustee may avoid a preference payment “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses . . ..”
• Debtors now should analyze a preference defendant’s defenses of: “subsequent new value,” “ordinary course of business,” and “contemporaneous exchange for value.”
• This should effectively eliminate the normal “shotgun” approach by debtors to file preference complaints based on all payments made to creditors within 90 days prior to the Chapter 11 filing, without regard to potential defenses. Otherwise, debtors’ claims may be subject to dismissal, and possibly claims for bad faith filing.
• No doubt, debtors will challenge the meaning of “reasonable due diligence.”
• Over the years, many Bankruptcy Courts have issued creditor-friendly rulings in preference cases, within the bounds of the current statute. This indicates a judicial dislike of the cottage industry of attacking suppliers who supported a debtor prior to the Chapter 11 filing, particularly when preference recoveries do not serve the stated purpose of materially increasing the value of the estate, for the benefit of creditors (not the under-secured lender).
  We hope this will translate to creditor-friendly rulings on the debtors’ new “due diligence” requirement.
• The impact of this amendment will be a reduction in the value of preference claims, which should alter debtors’ incentive for pursuing claims.

2 – Venue of Small Preference Claims.

• Any preference claims for $25,000 or less must be filed in the venue where the defendant is located.
• Given the impracticability of filing small claims in multiple jurisdictions, this change may effectively eliminate claims under $25,000.
• Given the trustee’s new burden of evaluating preferential defenses, preference defendants should consider a motion to dismiss or transfer venue of preference claims that are under $25,000, after application of the preference defenses.

The effective date for these changes is February 19, 2020.

We hope you found this useful and informative. Please contact us if you have any questions about this or any other matter.

© 2019 David Conaway, Partner, Bankruptcy Practice Administrator
dconaway@shumaker.com ‖ 704.945.2149
David’s experience, business acumen and creativity adds value for clients regarding a variety of issues involving corporate bankruptcy, insolvency and restructuring; commercial contracts and business transactions; commercial disputes; and cross-border transactions, disputes and insolvencies.
David has over 25 years of lead counsel experience representing both secured and unsecured creditors, including lenders, unsecured creditors (including trade creditors, bondholders or other unsecured creditor interests), and unsecured Creditors’ Committees. David also has significant experience in representing parties in the purchase and sale of assets in bankruptcy or insolvency proceedings. His experience includes handling virtually every facet of bankruptcy and insolvency matters including issues relating to relief from stay, reclamations, setoff, critical vendor, avoidance actions, executory contracts, forensic investigations, DIP financing, Creditors’ Committees, and plan confirmation.