Reforms to Preference Recovery under 11 U.S.C. § 547

Procedural preference reforms start with the premise that although the theory and substance of the preference power are sound, the practice of preference recovery is somewhat flawed. The argument is that section 547 leads to abusive preference recovery suits by bankruptcy trustees who bring actions indiscriminately, without properly analyzing the creditor’s available defenses, and to obtain settlements by creditors because of the litigation costs associated with defending these actions.

There is a dearth of authority or statistics on preference abuses. For example, the perception of certain preference actions is that a trustee (or in rare instances, a debtor in possession) sends out a blanket complaint to virtually every creditor, particularly trade creditors, who received any payment within ninety days of the petition date. The trustee would have done little to no prior investigation other than to review the debtor’s check register and would have made no effort to determine whether the creditors have any valid defenses. Given the small amount of money at stake, it is rarely cost-effective for the creditor to contest the action, especially if the creditor is located in another state. As a result, those creditors are led to settle the action regardless of its merits.

The tension, therefore, is to develop efficient procedures to restrain abusive litigation techniques by the trustee without interfering with the policy goals of the preference power itself, which can be summed up as equality of treatment of creditors.

Proposals to the Commission on preference reforms have centered on the limited area involving smaller trade creditors from whom recovery of prepetition payments were sought by debtors in possession or trustees as avoidable preferences. In these instances there is, at times, a disincentive for such creditors to defend rather than settle the actions because (i) the amount sought is relatively small (cost of defending could be greater) and (ii) the bankruptcy court is in a distant location making it more costly to defend. It has also been noted that in chapter 7 cases converted from chapter 11, a fair amount of time had elapsed from the payment and chapter 11 petition date to the date recovery was sought by the chapter 7 trustee. In such instances, the demand could come as a surprise as well as long after the transaction was considered closed.

Possible solutions to these problems include (1) placing a dollar amount below which a payment to a business creditor (trade creditor, supplier) would not be voidable; and (2) placing a dollar amount below which any action to recover a preference would have to be brought in the district where the creditor is located. The American Bankruptcy Institute provided the Commission with the results of a survey it took of attorneys as well as credit managers canvassing a variety of preference experiences. The survey results provided support for these solutions to address the problems faced by smaller trade creditors.

Preference Proposal #1: Minimum Threshold Requirement

Section 547 should provide that $5,000 is the minimum aggregate transfer to a noninsider creditor that must be sought in a nonconsumer debt preference avoidance action.

Reasons for the Change

The Proposal is an effort to protect smaller trade creditors (i) who are most prone to abusive litigation tactics, and (ii) who are also least likely to have received a significant preference that would imperil the policies underlying the preference power. Raising the minimum aggregate transfer sought to $5,000 is consistent with current preference policies. Aggregate transfers of less than that amount are unlikely to create a substantial deviation from equality of treatment for creditors and it is doubtful that such a small transfer would pose a significant threat of premature scavenging of the estate’s assets. The Proposal does not affect the recovery of any transfer to an insider during the one year preference period. By increasing the minimumaggregate transfer that must be sought in a preference recovery, the Proposal increases the likelihood that any amounts recovered will benefit creditors and not simply the trustee and his professionals.

Competing Considerations

It may be argued that in small business cases, a $5,000 preference floor would virtually eliminate any preference litigation, because there are rarely transfers of that size.