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 creditors 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 debtors 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
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 estates 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.
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.