Trustee’s Burden for Preference Transfers: “Getting More Than in a 7”
Robert S. Bernstein, Esquire
The fifth and final element that a trustee must prove in order to avoid a preference transfer is set forth in Section 547(b)(5) of the Code. Under this section, the trustee must prove that the creditor received more than it would if the case were a Chapter 7 liquidation case, the transfer had not been made, and the creditor received payment of the debt provided by the provisions of the Code.
Initially, the trustee must determine the creditor’s appropriate class and then assess the distribution that the class would have received if the transfer had not been made. The classification of claims and their allowance is provided for under the Bankruptcy Code. See 11 U.S.C. Section 101(5), Sections 501 through 510.
Most preference actions filed are against general unsecured creditors or insiders who made loans to the debtor. Fully secured creditors generally are not be subject to a preference action because they would not receive more than in a Chapter 7 liquidation. Undersecured creditors may be subject to a preference action if the transfer from the debtor was from property not covered by the secured creditor’s liens. In this instance, a preference may exist because in a Chapter 7 liquidation, the undersecured creditor would receive the distribution for the full value of its secured claim plus the transfer not covered by its lien.
Establishing and determining what distribution a class would receive if the alleged preference transfer had not been made can be a more difficult task for the trustee. In a vacuum, this Code formula is uncomplicated if the value of the Chapter 7 estate is fixed. The trustee need only add the alleged preference transfer to the estate value and then determine how much each creditor would receive in order of priority for their respective class.
When determining the amount that an alleged preference transfer allows the creditor to receive, the Code requires that the creditor be assessed the value of the transfer plus any additional amount that the creditor would be entitled to receive in a Chapter 7 liquidation. Generally, if the distribution is less than 100%, any payment to an unsecured creditor during the preference period will allow the creditor to receive more than it would have received in a liquidation if the payment had not been made.
Problems arise for trustees in asset cases when the value of the estate is nebulous, thereby making a distribution determination arduous, for example, if a Chapter 7 estate owns real estate in a volatile market or the estate assets are comprised of questionable accounts receivable or unusual equipment. Under these scenarios it may be difficult to determine what a creditor, in particular an undersecured one, will receive in a hypothetical Chapter 7 distribution.
In most instances the trustee’s burden with respect to the fifth element in proving a preference is uncomplicated. It is, however, more difficult if the preference action is against an undersecured creditor and there is significant divergence of opinion as to the value of the estate and in turn the distribution made to creditors. Assuming the trustee can prove this final element of a preference, the battle is not over if the creditor can establish one of the defenses set forth in Section 547 of the Code. These defenses will be discussed in our forthcoming articles.