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 #2: Venue

28 U.S.C. § 1409 should be amended to require that a preference recovery action against a noninsider seeking less than $10,000 must be brought in the bankruptcy court in the district where the creditor has its principal place of business. The Proposal applies to nonconsumer debts only.

Reasons for the Change

The increased cost of defending a small preference action in a distant forum has encouraged reform of the preference venue rules. The working group concluded that in keeping with its efforts to protect smaller trade creditors from certain preference litigation tactics, actions against noninsiders seeking below $10,000 should be commenced in the district where the creditor has its principal place of business. The purpose of this venue provision is to protect parties from "noneconomic" actions brought by trustees seeking to take advantage of the likelihood that it will cost the creditors more to litigate the action than the action itself seeks to recover.

The Proposal raises the floor for nonconsumer debts in 28 U.S.C. § 1409(b), which currently provides: "Except as provided in subsection (d) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,000 or a consumer debt of less than $5,000 only in the district court for the district in which the defendant resides." [ FN: 28 U.S.C. §1409(d) will not apply to preference actions, as subsection (d) applies only to claims "arising after " the commencement of the case. Preference actions arise before the case was commenced (when the transfer is made).] Increasing the $1,000 limit for nonconsumer debts to $10,000 will force debtors in possession and trustees to examine the meritsmore closely before commencing an avoidance action. Section 1409(b) generally was designed to deter "noneconomic" actions that cost more to defend than the action itself seeks. Creditor protection against blanket preference actions is furthered by raising the limit for invoking this provision.

Competing Considerations

When a preference action is litigated, a trustee has to hire counsel to litigate it. Currently, only one venue applies to the vast majority of preference actions, enabling a trustee to hire one counsel to file one complaint against multiple preference recipients. Thus, the current system greatly reduces costs to the estate created by having to litigate multiple actions in multiple jurisdictions. It is also beneficial to the estate for the judge who is most familiar with the debtor and the case to hear the preference actions. This venue issue is one of balancing the harm of increased costs to the estate with the harm suffered by creditors who have to litigate in the debtor’s forum. The positive effect of the Proposal, however, is that if a trustee or debtor in possession has to litigate in the creditor’s forum for all amounts between $5,000 and $10,000, more attention may be paid to possible affirmative defenses, thus reducing abusive preference actions.