Preference Actions, Part 5: Preference Transfers Made While Debtor was Insolvent

Part 5: Trustee’s Burden for Preference Transfers Made While Debtor Was Insolvent

Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.
Creditworthy News

The third of five elements the Trustee must prove in order to avoid a preference transfer is set forth in Section 547(b)(3) of the Code. This Code Section requires that transfers within 90 days of a bankruptcy petition must be “made while the debtor was insolvent.”

The Trustee’s case is buttressed by Section 547(f), which provides that “the debtor is presumed to have been insolvent on and during the 90 days immediately preceding the date of the filing of the petition.” Although the Trustee must still establish the other four elements for an avoidable preference claim, Section 547(f) shifts the burden to the creditor to come forward with evidence to rebut the insolvency presumption.

A balance sheet test is used to determine insolvency. A debtor is considered insolvent when its debts are greater than its assets, at fair valuation, exclusive of property exempted or fraudulently transferred. “Fair valuation” is recognized by most courts to mean fair market value of the debtor’s assets and liabilities at the time of the alleged preference transfer. Section 101(32) separately defines partnership insolvency as: a financial condition such that the sum of such partnership’s debts is greater than the aggregate of, at fair valuation, all of such partnership’s property, and the sum of the excess of the value of each of the general partner’s non-partnership property, exclusive of property, over such partner’s non-partnership debts.

The insolvency presumption in the Code makes the Trustee’s job much easier and leaves creditors with a difficult task. Because of this, Trustees often will pay little attention to this element of their case. However, for creditors there is information and evidence at their disposal which may assist in rebutting the presumption. Some debtors file bankruptcy because they cannot pay their debts as they come due, but have assets in excess of their debts. Bankruptcy schedules filed by all debtors list the amount of assets and liabilities. If the assets on the schedules exceed liabilities, then creditors have a sworn admission of solvency by the debtor.

In Chapter 11 cases, debtors are required to file periodic financial statements, such as balance sheets, which should reveal the debtor’s solvency or insolvency just before bankruptcy. If this information does not help, then creditors might consider hiring an expert to value the Debtor’s estate so a more accurate balance sheet analysis can be done. Secured creditors may have appraisals of certain property and these appraisals can be obtained by asking the secured creditor or by subpoena.

Next – Part 6: Preference Time Periods: The Beginning and the End

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