The ABI Preference Survey
part of the Bankruptcy Reform Study Project
Sections of the Report
The American Bankruptcy Institute (ABI) created a Task Force on Preferences. Joseph S.U. Bodoff, Esq., of the law firm of Hinckley, Allen & Snyder in Boston, Massachusetts, has chaired the Task Force, which is comprised of 27 leading insolvency professionals. [ The Task Force has diverse representation: it is comprised of 13 attorneys, 6 accountants/turnaround specialists, 7 credit managers and one banker. ]
The Task Force conducted a nationwide survey on the bankruptcy preference laws. As explained below, those surveyed are professionals who play various roles in the actual operation and implementation of the bankruptcy preference laws—credit managers, lenders, attorneys, accountants, and trustees. The Task Force believed that the results of this Survey and this Report would be a valuable resource for the National Bankruptcy Review Commission and Congress to use in considering how the preference laws are working and whether amendments should be made to the preference laws.
In conjunction with this project, Scott Blakeley, Esq., of the law firm of Blakeley & Brinkman in Los Angeles, California, has written an article entitled A History of Bankruptcy Preferences. His article, which is included with this Report, will provide the reader with a useful historical perspective.
Two surveys were prepared. ABI Preference Survey No. 1 ("Survey 1" or "S1") was designed for credit providers: credit managers, lenders, and others involved in the business of providing credit. These parties are among those most often affected by the preference laws, both in terms of (i) being a possible preference defendant and (ii) being a possible beneficiary of the "equitable redistribution" policy of the preference laws. Their perception of how the system was working thus should be of concern to Congress. ABI Preference Survey No. 2 ("Survey 2" or "S2") was designed for bankruptcy practitioners: lawyers, accountants, trustees, and turnaround consultants. Those toiling in the bankruptcy vineyard may be able to provide the most accurate information about the actual workings of the preference laws, and may have useful suggestions for modifications in the law that might better effect the intentions of the drafters of the law.
On February 3, 1997, Survey 1 was mailed to (i) all 386 members of the Commercial Finance Association and to (ii) the 1200 members of the National Association of Credit Management with Certified Credit Executive (CCE) or Certified Business Fellow (CBF) designations. On January 30, 1997, Survey 2 was mailed to 1000 randomly selected members of the American Bankruptcy Institute who are listed in the membership rolls as being an attorney, accountant, or turnaround consultant, and who have stated that at least part of their practice involves business bankruptcy.
The surveys were returned in February 1997, and the results were processed by March 1997. The statistical results of the surveys are appended as Appendix 1 (results of Survey 1) and Appendix 2 (results of Survey 2). The return rate was good: 467 for Survey 1 (29.4 percent), and 356 for Survey 2 (35.6 percent). For Survey 1, 79 percent of the respondents identified themselves as credit managers, 11 percent as lenders, and 10 percent as otherwise engaged in providing credit. See S1-19. For Survey 2, 91 percent of the respondents identified themselves as lawyers, 4.5 percent as trustees, 3.1 percent as accountants, 0.3 percent as turnaround consultants, and 1.1 percent as otherwise engaged in bankruptcy practice. See S2-31.
The survey results demonstrate that the credit providers (Survey 1) are in many respects more dissatisfied with the operation of the preference laws than are the practitioners (Survey 2). Given that the credit providers are one of the primary intended beneficiaries of the whole preference system, considerable weight arguably should be given to the concerns expressed by that group. The surveys showed considerable disagreement between the two groups over the proper outcome of many particular issues.
The practitioners have had more experience than the credit providers with the litigation of preference cases. See S1-22, S1-23, S2-35. Preference litigation is quite common, according to the practitioners, especially in business cases. See S2-6, S2-7, S2-8, Chart Seven.
Both the practitioners and the credit providers expressed skepticism as to whether the preference law is effectively achieving the two primary stated objectives of that law. See S1-1, S1-2, S2-1, S2-2, and Charts One and Two. Furthermore, both groups thought that creditors who tried to work with debtors were penalized by the preference laws, and that those laws discouraged settlements and workouts. See S1-12, S1-14, S1-15, S2-27, and Chart Three. A widely-expressed criticism focused on the perceived coercive nature of many preference actions, with the preference defendant feeling pressured by economic and logistical concerns to settle claims of dubious validity. Based on these responses, one could fairly ask whether all of this preference litigation is "worth the candle."
Yet, at the same time, there was not much support for various proposed radical revisions to the general contours of the preference law—especially from the practitioners. Credit providers, by contrast—whose money is actually on the line—were more receptive to change. The practitioners' survey suggested that preference laws might play an unintended role in funding professional fees. See S2-5. Also, practitioners expressed some confidence that net recoveries were made for the benefit of unsecured creditors, but credit providers disagreed. See Chart Four, S1-3, S2-3, S2-7, S2-8.
Some alterations in current practice were endorsed by both groups (and, as noted, the credit providers supported broader changes). There was considerable backing in both groups for requiring a floor amount to be in issue before a preference action could be brought. Over half favor a minimum of $5,000. See S1-13, S2-28, and Chart Five. Similar widespread support existed for immunizing a creditor from preference liability in cases where the debtor returns goods sold by the creditor. See S1-8, S2-23. About half of the respondents in each survey thought that requiring the losing party in preference litigation to pay the other party's counsel fees would be beneficial or at least would do no harm. See S1-17, S2-29. Credit providers endorsed a proposal to shorten the preference period for non-insiders to 30 or 60 days, see S1-6, but practitioners favored the status quo. See S2-21.
The responses also support the view that Congress should consider amendments to encourage creditors to work with debtors during the preference period. For example, respondents took the position that a creditor who is granted additional collateral during the preference period in exchange for new loans, or favorable concessions, should not have those new liens set aside as preferences. See S1-9, S2-24. Also, creditors who are paid pursuant to an out-of-court settlement, see S1-15, or who accept late payments at the debtor's request, see S1-14, S1-7e, S2-22e, possibly should be protected from preference liability, according to the respondents.
Many respondents in both surveys suggested that the ordinary course of business defense in §547(c)(2) needs revision. The concerns most often expressed were with the lack of clarity in the definition and the lack of consistency in application. In short, as the statute is currently written, many of those surveyed find the ordinary course defense to be unworkable. The reaction to this state of affairs generally was not to abolish the defense altogether (although that view did garner some backing), but rather to clarify the statute to make the defense easier to apply.
Discussion of responses
The purposes of the preference law: intended and unintended
The preference law has been justified normatively on a number of grounds. The two preference law policies most commonly cited are (1) promoting equality of distribution among similarly situated creditors and (2) deterring creditors from racing to dismember a financially distressed debtor, thereby helping the debtor work out its financial problems. See H.R Rep. No. 595, 95th Cong., 1st Sess. 177-78 (1977). The surveys suggest that the people who deal with preference issues are less than sanguine about how well those goals are being met.
The first goal, promoting inter-creditor equality, was examined in question 1 in both surveys, which asked:
To what extent do the preference laws accomplish the objective of equitably redistributing monies paid to creditors by an insolvent debtor shortly before a bankruptcy filing?
The two surveys sharply disagree; sounding a common theme, the credit providers were much more negative than the practitioners. See Chart One. Over half (52.1 percent) of the credit providers in Survey 1 answered that equitable redistribution occurred not at all or only a little, and another third (34.5 percent) answered "somewhat"; only 13.3 percent were fully persuaded that this objective was being met. The practitioners in Survey 2 were more positive about the extent to which the equitable redistribution policy was being met. More than 70 percent answered that this policy was being achieved more than a little.
Realization of the second objective was found wanting to a much greater degree in both surveys. Question 2 asked:
To what extent do the preference laws accomplish the objective of helping a debtor deal with its creditors prior to a bankruptcy filing?
The responses are indicated in Chart Two. In Survey 1, almost three-fourths (73.7 percent) of the credit providers said that this objective was being met either not at all or only a little, and another 19.6 percent were only willing to concede that this objective was being met "somewhat." The practitioners were only slightly less pessimistic about the realization of this second policy: well over half (59.3 percent) answered not at all or a little, and another quarter (26.4 percent) thought this policy was being satisfied only "somewhat." Furthermore, the vast majority of respondents expressed the view that the preference laws actually penalize creditors who attempt to work with a debtor. See Chart Three: S1-12 (84.3 percent said does penalize), S2-27 (61.3 percent said does penalize).
The responses to the first two questions are strongly correlated. Almost all of the respondents in Survey 1 who did not think that the equitable redistribution policy (S1-1) was being met also answered that the second policy, to help a debtor deal with its problems (S1-2), was not being satisfied. The converse proposition is somewhat less forceful, i.e., some of those who expressed pessimism about the realization of the second policy expressed a bit more optimism about the accomplishment of the first. This result is consistent with the fact that the respondents in both surveys were much more skeptical about the achievement of the second goal. The correlation for practitioners for questions 1 and 2 is not quite as strong as for credit providers, but still is significant.
It appears, however, that the preference laws may be achieving other ends, such as estate maximization and the funding of professional fees. The two surveys showed a great difference of opinion with respect to Question 3a, regarding the fruits of preference litigation, which asked how often distributions to unsecured creditors in bankruptcy cases are increased as a result of recoveries in preference actions.
Here again the responses from the two surveys were at polar extremes. See Chart Four. Nearly three-fourths (74.8 percent) of the credit providers responded that preference recoveries increase distributions to unsecured creditors never or rarely. And, of those who thought recoveries were increased, almost 90 percent (89.8 percent) thought that the increase was only minimal. See S1-3b. In Survey 2, by contrast, over 60 percent (62.6 percent) of the practitioners thought that distributions were increased sometimes, frequently, or always. Furthermore, about 40 percent of the Survey 2 responses answered that recoveries were either increased moderately or a great deal. See S2-3b. One wonders where the truth lies; if recoveries are not being increased (as the credit providers believe), that is an indictment of the system.
How respondents felt about the achievement of the equitable redistribution policy (question 1) correlated very strongly with their views about whether distributions to unsecured creditors were increased, and by how much (questions 3a and 3b). This correlation exists for both surveys. In other words, respondents who do not think that equitable redistribution is being accomplished also do not believe that recoveries are being increased to any significant degree, while those who do think redistribution is occurring also believe that recoveries are being increased. A correlation between the responses to the second general policy question and questions 3a and 3b also exists, but is much weaker than for the equitable redistribution policy. Whether people thought the preference laws helped a debtor deal with its creditors did not necessarily dictate whether the same respondent believed that distributions to unsecured creditors were increased; the correlation there was weak.
Responses to other questions in Survey 2 were consistent with the practitioners' view that preference litigation often did produce net recoveries, which thereby increased payments to unsecured creditors, especially in business debtor cases. See S2-7b & 7c, S2-8b & 8c. Indeed, a strong correlation exists between the answers to S2-3a and S2-7b and 7c. In business cases, over 80 percent of practitioners responded that sums are sometimes or frequently recovered from preferences, net of collection costs. See S2-7b. And in those cases, about 60 percent of practitioners answered that preference recoveries sometimes or frequently result in increased payments to unsecured creditors. See S2-7c. In individual cases, by contrast, practitioners perceived that net recoveries occur more than "rarely" only 37.6 percent of the time, and payments to unsecured creditors are increased only 31.2 percent of the time.
Survey 2 also asked whether the preference laws promoted ends other than those directly cited by Congress. S2-4 asked how often preference causes of action are utilized as a means of obtaining working capital, and S2-5 probed whether the existence of preference causes of action might influence a practitioner to accept or pursue employment in the bankruptcy case. The credit providers were not asked these questions. The short answer is that practitioners did not believe that preferences usually offered a source of working capital, but did think that preferences sometimes supported the employment of professionals. Less than a quarter of the respondents to S2-4 replied that preferences supplied working capital more than rarely, either directly via cash recoveries (only 22.6 percent) or indirectly as collateral for post-petition financing (22.2 percent).
With regard to the role of preferences as a means of influencing practitioners to accept or pursue employment in a bankruptcy case, the positive response rate was much higher, assuming that the employment was not by the debtor. See Chart Six. For employment by the debtor, only 17.1 percent of practitioners responded that they were influenced to seek employment more than rarely. However, 41 percent stated that they were sometimes or frequently influenced by the existence of potential preference litigation to accept or pursue employment by a creditors' committee, and over half (54.1 percent) said that such potential litigation influenced them to represent a trustee. Stating that the prospect of preference recovery might influence professionals to work on a bankruptcy case does not legitimize the practice, of course, although it might help to explain one reason why practitioners were less negative about the preference laws than were the credit providers. Indeed, it is worth noting that the credit providers strongly condemned allowing professionals' fees to be paid out of preference recoveries. See S1-4c (discussed in the next part).
Who should get the recovery?
An area of some debate in the framing of preference policy has been over who may use the proceeds of preference actions. Questions S1-4 and S2-19 probed this issue with six possible recipients identified: the debtor for operations or for funding a plan; secured creditors, pursuant to court order; retained professionals for allowed fees and expenses; only to creditors similarly situated to the creditor from which recovery was received; to creditors in the order of priority of their claims; or in any manner provided by the plan.
Here again the responses of the practitioners and credit providers differed enormously, depending on the proposed recipient. For example, the proposal to channel recoveries to creditors in the "same class" as the creditor from whom the recovery was made was approved by 61 percent of credit providers, but only by a third of practitioners. Interestingly, there was only a weak correlation between the answers to the equitable redistribution policy question and the "channeling" question; one might have expected a stronger showing that credit provider respondents who were displeased with the achievement of equitable redistribution would favor "channeling" as a means of rectifying the redistributive failure.
By contrast, paying professional fees was favored by almost 85 percent of practitioners, but only by 15.5 percent of credit providers. Perhaps in no other place in the surveys were the disparate interests of the two groups surveyed more dramatically highlighted. Note, though, that those credit providers who classified themselves as "lenders" were much less opposed to allowing the payment of professional fees than were credit managers.
Over four-fifths (83.1 percent) of credit providers did not want the debtor to get the money, whereas less than a third (30.5 percent) of practitioners felt the same way. Two-thirds (67.3 percent) of practitioners would allow recoveries to be distributed in any manner provided by the plan, but only one-third (32.3 percent) of credit providers agreed. Survey 2 showed a very strong correlation as to whether respondents would let the debtor keep the money and whether they would allow the money to be distributed in any manner provided by the plan. In addition, a strong correlation exists in Survey 2 between the answers to letting the debtor keep the money and permitting professionals to be paid out of the proceeds.
The two groups largely concurred that preference recoveries could (or should) be distributed to creditors in accordance with the priority of their claims: 84.5 percent of practitioners and 70.6 percent of credit providers answered yes. Whether secured creditors should be able to claim preference recoveries split each group roughly down the middle; 48.6 percent of credit providers thought such a distribution was acceptable, and 40.3 percent of practitioners approved such a distribution. Within the credit provider category, lenders were more willing to allow such a distribution to secured creditors than were credit managers, as one might expect.
A follow-up question in each survey asked which entities should be able to obtain a lien on preference actions or recoveries. See S1-5, S2-20. The practitioners and credit providers again disagreed across the board. Credit providers overwhelmingly opposed allowing either a post-petition lender (81.8 percent) or a post-confirmation lender (83.7 percent) to obtain a lien on preference recoveries. It is worth noting that the universe of "credit providers" split sharply on this question by profession: the vast majority of credit managers opposed allowing liens, while about half of Survey 1 lenders were willing to allow liens on preference recoveries to be granted. Approximately 60 percent of practitioners had no problem with allowing such liens (64.1 percent for a post-petition lender, and 58.2 percent for a post-confirmation lender). Credit providers did not mind if a prepetition creditor received a lien on preference recoveries as part of adequate protection (73.8 percent approved), but over half of practitioners (56.8 percent) did not like that result.
The shape of preference litigation
A number of questions in Survey 2 for practitioners explored what preference litigation looks like in practice. Questions S2-6, S2-7a, and S2-8a asked how often preference litigation is commenced. The short answer is—a lot, especially in business cases. See Chart Seven. In chapter 7 cases (71.1 percent) and chapter 11 cases post-confirmation (72.3 percent), over 70 percent of the practitioners said preference litigation was commenced either sometimes or frequently; in chapter 11 cases pre-confirmation, about half (51.7 percent) responded in like fashion. Chapter 13 preference litigation is perceived to be rare, by contrast: only 3.7 percent thought such litigation occurred more than rarely. In weighing this last response, it should be noted that the respondents as a group had relatively little chapter 13 experience.
Interestingly, the results demonstrated a strong correlation between the answers to the question about the frequency of preference litigation in chapter 11 cases pre-confirmation and the question whether the loser of a preference lawsuit should have to pay the other side's counsel fees. Perhaps those who perceive a high frequency think that a "loser pays" system might be a warranted remedy. A similar correlation was not found with regard to post-confirmation preference litigation.
The respondents also noted a substantial difference in frequency between business and individual cases, with a much higher rate in the business cases. Whereas 85.9 percent replied that preference litigation was commenced sometimes or frequently in business cases, see S2-7a, the same question for individual cases drew only a 36.8 percent response. See S2-8a. The business cases also produced a much higher percentage of recoveries, according to the respondents. As explained in an earlier section, 80.2 percent replied that net recoveries are made more than rarely in business cases, and 59.9 percent thought that payments to unsecured creditors are increased sometimes or frequently. See S2-7b & 7c. For individual cases, by comparison, net recoveries are seen to occur more than rarely only in 37.6 percent of the cases, and unsecured creditors recover more only 31.2 percent of the time.
Question S2-9 asked how often preference claims are disposed of at different points in the process. About two-thirds found that a precomplaint demand letter might lead either to a payment settlement (66.5 percent) or to abandonment of the claim (65.7 percent). Once a complaint is filed, settlement is extremely common (97.1 percent said this happened sometimes or frequently), and trial to judgment is concomitantly much less common, with barely a third (35.7 percent) answering that trial occurred sometimes or frequently. Dismissal of the action is slightly less likely to happen once a complaint has been filed; only half (55 percent) replied that dismissal at such a stage never or rarely transpires.
With the settlement of preference claims so common, the question of how much a settlement is for assumes importance. Question S2-17 provides an average figure of 58.5 percent of the claim. Note that the respondents were asked to provide the typical settlement percentage regardless of whether there were valid defenses.
Much of the focus in preference litigation is on the defenses to liability under §547(c). Question S2-11 asked the frequency with which preference defenses are raised (part a) and have some merit (part b). The most commonly raised defense by far, to the surprise of no one, is the ordinary course of business defense under §547(c)(2) (73.4 percent), with subsequent new value under §547(c)(4) (49.2 percent) and contemporaneous exchange under §547(c)(1) (46.9 percent) next. The primary defenses for secured lenders, the enabling loan (§547(c)(3)) and floating lien (§547(c)(5)) provisions, are raised much less often (16.3 percent and 14.9 percent, respectively).
The percentage of preference cases in which defenses for unsecured creditor defendants are perceived to have some merit is somewhat lower than the frequency with which those defenses are raised, but not alarmingly so. Indeed, the numbers are sufficiently close that one can infer little perception of abuse in raising frivolous defenses. The ordinary course defense is found to have some merit over half the time (57.8 percent), with subsequent new value (40.6 percent) and contemporaneous exchange (34.6 percent) following.
The secured creditor defenses are actually seen as having some merit slightly more often than they are raised, which either can be taken as an indictment of the consistency of the respondent's answers or as a suggestion that secured creditors should be more diligent in raising certain defenses. The enabling loan defense, raised 16.2 percent of the time, is considered to have some merit in 20.2 percent of the cases. Similarly, the floating lien exception is found to be of merit 16.1 percent of the time, although raised in only 14.9 percent of the cases.
The preference period
Preferential transfers are only avoidable for a limited period of time—90 days for non-insiders, and one year for insiders. 11 U.S.C. §547(b)(4). The period was shortened from four months to 90 days in 1978, in conjunction with the elimination of the requirement that the trustee prove that the creditor had reasonable cause to believe that the debtor was insolvent at the time of the transfer. Reform proposals have suggested changing the preference period, either to make it longer or, more often, to shorten the time of vulnerability. Question S1-6S2-21 asked what the preference period should be for insiders (part a) and for non-insiders (part b). Respondents could choose a period of 30 days, 60 days, 90 days, 120 days, 180 days, one year, or anytime after the debtor becomes insolvent (yet another reform proposal).
As might be expected, both groups favored a much longer reachback period for insiders than non-insiders. Also, the practitioners favored longer reachback periods than did credit providers, and were more wedded to the status quo. Of the credit providers, 42.4 percent favored the current one year period for insiders, and only 28.1 percent thought the period should be 90 days or less. However, 87.3 percent of credit providers thought the non-insider period should be 90 days or less. Indeed, over half of the credit providers favored reducing the non-insider period either to 30 days (42 percent) or 60 days (16.5 percent).
About half of the practitioners (49.7 percent) wanted to keep the current one-year period for insiders. Over a quarter (26 percent) preferred adopting a rule that insider preferences should be avoidable anytime after the debtor becomes insolvent; for credit providers, 15.6 percent favored the same rule. About a sixth of practitioners (16.4 percent) would shorten the insider period to 180 days. For non-insiders, a majority of the practitioners (55.6 percent) favor the present 90-day period. About a fifth (20.1 percent) would shorten the period to 30 or 60 days, and roughly the same number (18.9 percent) would increase the period to 120 or 180 days. There was little support in either group for making non-insiders vulnerable for one year or anytime after insolvency.
In considering reform proposals regarding the length of the preference period, the drafters should note that a substantial percentage of practitioners responded that the 90-day period often affects the decision on when to file a bankruptcy case. See S2-10. In cases where the practitioner was representing the debtor, 73.9 percent answered that the 90-day period sometimes or frequently affected the decision on when to file. S2-10aS2-10b.
Another question asked what the preference period should be if all defenses were abolished. S1-10b, S2-25b. One proposal that has been aired is to eliminate all defenses, but at the same time to shorten the preference period—i.e., to move to a short but absolute preference law. However, there was not much support for the predicate, viz, dispensing with all defenses (although the credit providers were a bit more favorably disposed to the idea (18.4 percent said yes) than were the practitioners (only 5.6 percent said yes)). See S1-10a, S2-25a. With that caveat, the favored period for an absolute preference rule was 30 days in each survey, garnering 44.2 percent of practitioners and 39.8 percent of credit providers. Fairly equivalent levels of support existed for periods of one week (19.1 percent of practitioners, 18.4 percent of credit providers), 60 days (16.8 percent and 15.4 percent, respectively), and 90 days (15 percent and 17.5 percent).
For both surveys, very strong correlations existed in the responses to the various questions addressing the proper length of the preference period. Those who tended to favor longer periods for insiders likewise favored longer periods for non-insiders, and vice versa. Those who wanted a shorter period for non-insiders generally similarly favored a shorter period in the event all defenses were abolished, and the converse also was true.
The floor amount
The current preference law does not specify a minimum amount that must be in controversy before a preference action may be maintained, except that a $600 safe harbor is carved out in §547(c)(8) for individual consumer debtor cases. According to the surveys, the time may be ripe to impose a floor amount on preference actions, without distinction between business and consumer cases. See Chart Five. The status quo—that a preference action may be brought for any amount—garnered very little support in either survey. See S1-13, S2-28. Only 16.1 percent of credit providers and 11 percent of practitioners prefer the current system; stated otherwise, well over 80 percent of the respondents favor imposing a dollar floor.
That result leads to the question of what the floor amount should be. The credit providers as a whole wanted higher floors than the practitioners. Respondents could choose floor amounts of $600, $1,000, $5,000, $10,000, $25,000, or specify another amount. The highest vote-getter was the $5,000 amount, favored by 35.4 percent of practitioners and 23.3 percent of credit providers. Another 14.7 percent of practitioners and 14.4 percent of credit providers favored the $10,000 amount, while the $25,000 figure drew votes from only 4.2 percent of practitioners, but 17.9 percent of credit providers. Looking at these responses cumulatively, over half of the respondents in each survey support a floor amount of at least $5,000. For practitioners, at least 54.3 percent favor a $5,000 minimum or higher (not counting any of the "other" responses, totaling 4.2 percent), while 55.6 percent of credit providers likewise support at least a $5,000 minimum (and another 12 percent voted for "other"). The lower floor amount of $1,000 drew the second highest number of practitioner votes (27.8 percent), but less support (14.6 percent) from credit providers.
Question 18 in Survey 2 asked practitioners related questions: what are the minimum dollar amounts that must be in controversy for it to be financially worthwhile to prosecute (part a) or defend (part b) a preference action. The responses to Question 18 were very strongly correlated to the responses to Question 28 (the floor amount question), as one would expect. Most practitioners thought that the cost-effective point was at least $2000 both for prosecuting and defending, and many thought it was much higher—$5,000 or $10,000. Only 16.3 percent thought it would be worth prosecuting a preference action for $2,000 or less, and only 15.2 percent responded that it would be worth defending with so little at stake. About a third (34.1 percent for prosecution, 32 percent for defense) identified the minimum prudent amount in controversy to be $2,001 to $5,000. Another sizable group (25.6 percent for prosecution, 31.7 percent for defense) selected an amount of $5,001 to $10,000, and still another large group (23.9 percent and 21 percent, respectively) said that only if the amount in controversy were more than $10,000 did litigating the preference make financial sense. Thus, about half of the respondents in both surveys (49.4 percent, 52.7 percent) thought the minimum amount should be at least $5,000. Another important fact to note about these results is that the responses to Question 18 are strongly correlated to the federal district in which the respondent primarily practices. As one might have expected, those in more populous (and usually expensive) districts tended to respond that higher dollar amounts need to be at issue to make the preference litigation worthwhile.
Date of transfer
Many cases have grappled with the issue of what the date of transfer should be for security interests. Two rules in §547 bear on the issue. Under §547(e)(2), the date the security interest attaches is the effective transfer date if the interest is perfected within 10 days. However, for purchase money security interests, §547(c)(3) utilizes a 20-day grace period. Courts have been reluctant to vary these dates under the aegis of other provisions, such as the contemporaneous exchange exception in §547(c)(1). Question S1-11 and S2-26 asked the respondents to select a preferred rule for identifying the transfer date for security interests. Several options were given: the date the security interest was granted, regardless of perfection date; the date the security interest was granted, but only if perfection occurred within a certain period of time (10, 20, or 30 days, or anytime prior to bankruptcy); or the date the security interest was deemed perfected under state law.
About half of the practitioners (49.4 percent) chose the date the security interest was deemed perfected under state law. Roughly a quarter (26.2 percent) of the credit providers chose that date. The differing perfection grace periods garnered varying amounts of support. The credit providers tended to favor somewhat longer grace periods than did the practitioners. The option of using the date the security interest was granted, regardless of perfection date, attracted 17.3 percent of credit providers, but only 10.5 percent of practitioners. In short, it appears that if any amendments are made to §547 on this issue, the state law deemed perfection date has the most support.
Another issue that has arisen with regard to the date of transfer is what date should be used for a transfer by check. In Barnhill v. Johnson, 503 U.S. 393 (1992), the Supreme Court held that the date the check is honored should control for purposes of determining whether the transfer occurred within the preference period, under §547(b)(4). The Court did not express an opinion as to whether the same date would govern for the preference exceptions in §547(c).
Question S1-16 asked credit providers what the date of transfer should be for check payments: the date of the check, the date the check is mailed, the date the check is received, the date the check is deposited, or the date the check clears. The responses were widely scattered, but a large percentage thought that a date earlier than the date of honor should control. The most often selected time was the date the check is deposited (34.7 percent). Following that date, in order, were the date of the check (19.8 percent), the date the check clears (17.7 percent), the date of receipt (14.7 percent), and the date of mailing (12.7 percent).
What transfers should be avoidable?
One of the most basic issues in preference law, if not the most basic, concerns what types of transfers should be avoidable. At one extreme, the preference law could require the avoidance of all transfers made by a debtor after the onset of insolvency. However, the law never has, and probably never will, take such an absolute position. In short, some post-insolvency transfers may be immune from avoidance. The challenge is sorting out the voidable from the valid. Over the centuries the law has taken different tacks, sometimes requiring proof of debtor intent to prefer, sometimes requiring creditor knowledge or action, and sometimes differentiating (as now) between ordinary and non-ordinary transactions. Today the notion still persists that a creditor should only be required to disgorge a preference if either the creditor or the debtor has done something "wrong." The credit providers in particular reflected this view.
Creditor and debtor activity
One long question (S1-7, S2-22) presented seven different factual scenarios (parts a through g), implicating different degrees of complicity or activity by the creditor or by the debtor in causing the preference to be made. Under each scenario, the respondent was asked "whether a payment made to a creditor should be repaid to the bankruptcy estate." For each situation, the question was asked in two ways—first with the assumption that the creditor was an insider (subpart (i) in each part), and then that the creditor was not an insider (subpart (ii)). The question also asked the respondents to assume that they were not a defendant to the preference action and did not represent a party to the preference action; that repayment of the preference would significantly increase the payment to unsecured creditors; and that the amount paid to the creditor as a possible preference allowed that creditor to receive a significantly higher percentage of its claim than other creditors.
The respondent could answer each question "definitely" or "probably" not or "definitely" or "probably" yes. For the sake of discussion in this Report, the totals from the two possible "not" answers and from the two "yes" answers generally are grouped together to indicate the percentage of respondents that either do or do not favor avoidance and repayment.
The responses showed, first, that both groups favored much tougher avoidance rules for insiders than for non-insiders, no matter what the factual scenario. To illustrate, under the practitioner survey, the most lenient response with regard to insiders showed that "only" 82.3 percent favored avoidance (i.e., "probably" or "definitely" yes) in the situation where the debtor requests the creditor to accept late payments within 90 days of bankruptcy (part e). For most situations presented, well over 90 percent thought that the insider creditor should be liable for a preference.
By comparison, the responses favoring avoidance for non-insiders ranged from about 10 percent to 30 percent lower than for the parallel insider cases. For example, only half of the practitioners thought that a non-insider creditor who is asked by the debtor to accept late payments (part e) should be subject to preference liability, as compared to 82.3 percent for insiders for the same question.
Similar sentiment favoring non-insiders over insiders is reflected in the credit provider survey, but even more dramatically. Here many of the disparities in the percentage of respondents who thought an insider should be liable but not a non-insider ranged as high as almost 50 percent. For example, 80 percent of credit providers thought that an insider creditor who is paid within 90 days after filing suit against the debtor (part a) should be liable for a preference, but only 32.1 percent would impose liability on a non-insider in the same situation. The lowest percentage of credit providers favoring avoidance as against an insider for any of the situations presented was 78.4 percent. These responses suggest that the Code perhaps should differentiate between insiders and non-insiders on more than just the preference period, but on liability rules as well.
A second major generalization that may be made is that the practitioners were much less inclined to let a non-insider creditor escape avoidance under the different scenarios than were the credit providers. It is difficult to know what to do with these disparate responses in terms of framing policy. Given that the credit providers are both the possible targets and beneficiaries of preference litigation, whose own money is squarely on the line, while the practitioners are just the "hired guns" who will prosper in all cases from increased litigation, perhaps some credence should be accorded the views of the credit providers.
For all of the situations involving preferences triggered by creditor action (i.e., parts a through d), an overwhelming majority of the credit providers favored not imposing liability on non-insiders (typically by about a two-to-one ratio). Practitioners, however, favored avoidance in those creditor-initiated cases, and by even larger margins: the lowest affirmative vote was 74.3 percent, and the highest was 86 percent.
By contrast, in some of the cases involving debtor-initiated preferences (i.e., parts e through g), the practitioners were somewhat less inclined to impose liability than in the creditor-initiated cases. Here the percentage of practitioners favoring avoidance ranged from 50 percent to 79.7 percent, as compared with a range of 74.3 percent to 86 percent for the creditor-based preferences. The responses of the credit providers came out exactly the opposite (i.e., they were more willing to impose liability in cases triggered by debtor action). The credit providers ranged from 32.1 percent to 37.7 percent favoring liability in the cases involving creditor action, as compared to a range of 35.2 percent to 67.3 percent in the debtor-triggered cases. Note, though, that even in the debtor-initiated cases, a much higher total percentage of practitioners favored avoidance than did the credit providers.
Third, the correlations between the answers to the different parts of this question are incredibly high, especially in the practitioner survey. These strong correlations exist both as between the insider and non-insider questions and as between the different factual scenarios. These results suggest that most respondents tended to have consistent views towards the rigor of preference avoidance. In other words, those who favored a "hard-line" approach tended to do so across the board, while the more lenient respondents displayed such leniency consistently. Drawing the critical line of avoidability thus may not rest so much on the subtle distinctions between factual situations, but on the fundamental viewpoints of whether to have a harsh or forgiving preference law.
Looking at the particulars, consider first those hypotheticals involving a preference at the instigation of the creditor. These questions contemplate a decreasing level of creditor activity, ranging from filing suit (part a), to threatening to file suit (part b), to sending a delinquency notice (part c), to just making a phone call (part d). Under current law, any of these actions by a creditor might be sufficient to negate the defense that the payment was made in the ordinary course of business under §547(c)(2).
The percentage of practitioners answering that non-insiders probably or definitely should have to repay the alleged preference went from 84.3 percent (paid after filing suit), slightly up to 86 percent (threatened to file suit), and down a bit to 79.9 percent (sent delinquency notice), and down a bit more to 74.3 percent (made phone call). It appears that practitioners generally support maintenance of the status quo in the law, requiring creditors who get paid after engaging in collection efforts to disgorge the resulting preference.
The credit providers took a sharply different view of the creditor-initiated preferences with regard to non-insider creditors. Only 32.1 percent thought that a non-insider creditor who got paid after filing suit probably or definitely should have to repay that amount (compared to 84.3 percent of practitioners). Slightly more (37.7 percent) would impose liability on a creditor who got paid after threatening to file suit (versus 86 percent of practitioners), while only 35.8 percent would hold against a creditor who sent a delinquency notice (79.9 percent of practitioners), and a mere 34.8 percent favored avoidance when the creditor was paid after making a phone call (contrasted to 74.3 percent of practitioners).
Now, consider those hypotheticals in which the debtor initiated the preference, not the creditor. The first hypothetical (part e) is where the debtor requests the creditor to accept late payment. The second (part f) is where the creditor is paid pursuant to an out-of-court restructuring that treats certain creditors better than others, but in which that creditor did not take overt collection efforts. The final scenario (part g) is where the creditor takes no overt collection efforts, but the debtor pays the creditor because of the debtor's desire to treat that creditor more favorably than other creditors (a form of the venerable "intent to prefer" test). For non-insider creditors, the practitioners who would either probably or definitely impose liability ranged from 50 percent (request to accept late payments), to 62.6 percent (out-of-court restructuring), to 79.7 percent (debtor intent to prefer). The credit providers displayed a similar trend line, but at much lower levels. Only 35.2 percent would favor liability when the debtor had requested the creditor to accept late payments; slightly more than half (53.1 percent) voted for avoidance in the out-of-court restructuring case, and two-thirds (67.3 percent) believed that a creditor who was paid when the debtor intended to prefer that creditor should have to repay the preference.
Under the current preference law, the transfer of an interest of the debtor in any type of property can qualify as a preference. In other words, voidable preferences are not limited to cash payments; transfers of goods in kind or of liens on collateral (voluntary or involuntary) may be voidable. One question asked the respondents whether certain types of non-cash transactions should be considered the same as the payment of money for the purposes of the preference law. See S1-8, S2-23. In other words, should these non-monetary transfers be avoidable on the same basis as monetary payments?
Both groups of respondents overwhelmingly agreed that the return of goods by the debtor to the selling creditor should not be avoidable. Four-fifths of the credit providers and two-thirds (67.5 percent) of the practitioners indicated that such a transaction should not be treated the same as the payment of money. Note, though, that slightly less than half of the lenders agreed.
In all of the other five categories, the practitioners strongly favored treating the transaction the same as the payment of money, i.e., as potentially avoidable. These transactions were:
- the debtor transfers goods to the creditor not originally sold by that creditor; only 5.1 percent of practitioners indicated that such a transaction should be treated differently from the payment of money;
- the debtor grants the creditor a security interest in debtor's assets; 7.5 percent of practitioners voted no (on whether the transaction should be treated the same as the payment of money);
- the debtor grants the creditor a mortgage on debtor's real estate; 8.3 percent of practitioners voted no;
- the court imposes a lien after a judgment is obtained; this drew the second most votes for differential treatment—27.4 percent of practitioners; and
- the court imposes a lien before judgment; 16.5 percent of practitioners voted no.
The credit providers agreed with the practitioners that the return of goods other than those sold by the creditor should generally be treated the same as the payment of money—only 11.6 percent thought otherwise. For all of the other types of transactions, however, the credit providers were much less willing than the practitioners to treat the non-cash transactions as avoidable. The credit providers strongly felt that imposition of a lien by a court after judgment should not be a preference—77.7 percent favored treating such a post-judgment lien differently from the payment of money. Almost half (49.2 percent) would extend the same protection to prejudgment liens. About two-fifths of credit providers would not treat as preferential a grant of a security interest in assets (41.4 percent) or of a mortgage on real estate (38.7 percent). In summary, a significant percentage of credit providers do not think that transfers of collateral, voluntary or (especially) involuntary, should be avoidable and treated the same as the payment of money; practitioners, however, do not share those doubts.
Increases in collateral and workout (dis)incentives
One of the biggest complaints evidenced by the survey responses is that the preference law penalize creditors who attempt to work with the debtor during the period of financial distress shortly before bankruptcy. One situation in which this might occur is where the creditor makes new loans to the debtor, or grants certain concessions, or sells goods on credit, and receives additional collateral in exchange. Upon the debtor's bankruptcy filing within 90 days, however, it is possible that the grant of additional collateral might (depending on the application of certain existing defenses) be avoidable as a preference. Accordingly, one question (S1-9, S2-24) examined whether increases in a secured creditor's collateral during the preference period should be avoidable, under three different situations.
The first is where the debtor grants the creditor additional collateral to induce the creditor to lend additional money to the debtor. The second is where the debtor grants the creditor additional collateral to induce the creditor to make favorable concessions to the debtor, such as reduction in interest rate, an extension of the maturity of the debt, and so forth. The final situation is where the amount of the creditor's collateral increases as a result of additional goods sold on credit and unpaid for as of the date of bankruptcy.
A majority of both practitioners and credit providers concluded that none of the situations should be considered preferences. The strongest vote came where the debtor grants the secured creditor additional collateral as an inducement to lend additional money. In that event, 86.3 percent of practitioners and 70.3 percent of credit providers thought the transfer should not be avoidable. The granting of additional collateral in exchange for concessions was considered non-preferential by three-quarters of practitioners (74.7 percent) and by half (50.8 percent) of credit providers. Finally, about three-fifths of each group (60.6 percent of practitioners and 60.1 percent of credit providers) opined that increases in collateral due to additional goods sold on credit should not be a preference.
Much of the action in preference litigation centers on the defenses to liability in §547(c). Many reformers have suggested eliminating some or all of these defenses, or modifying them in various ways. Several questions in the surveys asked about what should be done with preference defenses.
One question (S1-10a, S2-25a) asked whether all defenses should be abolished. In reform proposals, this suggestion typically is linked with a shortening of the preference period (to 30 days, for example). Abolition of defenses was not a popular idea with the survey respondents, to put it mildly. Over 90 percent (91.8 percent) of practitioners thought it was a bad proposal (only 5.6 percent actually approved the idea—the others expressed no opinion). The credit providers agreed, albeit not quite as vehemently—64.4 percent voted against the abolition proposal, and another 17.1 percent expressed no opinion.
If all defenses were to be abolished, part b of this question asked what the preference period should be. Given the overwhelming lack of support for the aboli