This article explains what "receiving a preference" means to a creditor and provides tools to aid creditors to analyze possible defenses to preference claims in bankruptcy cases.




Since the early nineteenth century, the trustee possessed the ability to avoid a preferential transfer of an insolvent debtor's assets. The Bankruptcy Act of 1841 recognized preferential transfers as those transfers of the debtor's assets made "in contemplation of bankruptcy . . . for the purpose of giving any creditor . . . priority over the general creditors.[1] The evidentiary burden placed upon the trustee was a heavy one. The trustee was required to demonstrate the creditor knew the debtor was insolvent and the debtor transferred assets with fraudulent intent.[2]Additionally, the trustee had to demonstrate the debtor consciously intended to prefer one creditor over another. Not surprisingly, preference avoidance actions were not favored by most trustees.

The Bankruptcy Act of 1898 did away with the requirement for the trustee to demonstrate the debtor intended to give a preference.[3] The 1898 Act required the trustee to bear the burden of proving the debtor was insolvent at the time of transfer and the creditor receiving the preferential transfer had reason to believe the debtor was insolvent at the time of the transfer. The 1898 Act did not contain any exceptions to the avoidable preferences rule. Rather, the judiciary throughout this period expressed the opinion the requirement for the trustee to demonstrate the creditor had reason to believe the debtor was insolvent protected most of the ordinary business transactions engaged in between debtor and creditor.[4] Notwithstanding this fact, litigation under the 1898 Act was not infrequent. The trustee's burden was a heavy one because the trustee bore the burden of demonstrating the subjective intent of the debtor, a difficult burden under the best of circumstances.

In 1978, after considerable prodding by trustees frustrated by the demands set forth in the 1898 Act, Congress enacted the Bankruptcy Reform Act. The 1978 Act created the first set of statutory exceptions to the preference avoidance provisions contained in the Bankruptcy Code, 11 U.S.C. § 101, et. seq., (the "Code") but also eliminated the trustee's burden to prove the subjective intent of the debtor. In essence, the trustee's role and that of the creditor were reversed. After passage of the 1978 Act, the creditor had to demonstrate the debtor's transfer of assets fit within one of the specifically enumerated exceptions to the preference provisions found in § 547 (c) of the Code.

On July 10, 1984, President Reagan signed into law the Bankruptcy Amendments and Federal Judgeship Act of 1984.[5] With a stroke of his pen, President Reagan endorsed widespread changes in both the substantive and procedural elements of bankruptcy law. Significantly, the 1984 Act eliminated the 45-day limit in which an otherwise avoidable preferential transfer of the debtor's assets could not be reached by the trustee's avoidance powers.[6]

The scope of this outline is necessarily limited to a discussion of a general unsecured creditor's ability to defend a voidable preference action through the use of the "contemporaneous exchange for new value" exception to the trustee's avoiding powers. The discussion set forth below summarizes some of the more important recent developments in preference avoidance and will review the current case law to reconcile the posture taken by the various Circuit Courts that have dealt with the issue of the contemporaneous exchange for new value defense to preference avoidance under § 547(c)(2) of the Bankruptcy Code.

    1. The Trustee's Avoiding Powers
      Under the Bankruptcy Code, both the trustee and a debtor-in-possession ("DIP")[7] have the power to avoid certain transfers of the debtor's property to secured creditors made within 90 days of the filing of the debtor's bankruptcy petition.[8] The focus of the trustee's avoidance powers is to ensure similarly situated creditors receive an equal distribution of the debtor's assets. This avoids the inequity that could result if two creditors supply goods or services to an insolvent debtor at the same time and only one of the two creditors, aware of an impending bankruptcy, demands payment in full prior to the filing of bankruptcy, thereby leaving the other creditor with greatly diminished prospects of recovery as a result of the debtor's bankruptcy.
    2. Preferences
      Preferences may be defined as those pre-petition transfers of the debtor's assets to a creditor that result in the creditor receiving a greater share of the bankruptcy estate than the creditor would otherwise receive through an orderly bankruptcy distribution. 11 U.S.C. § 547(b)(5). To avoid unfair distributions to favored creditors, the preference provisions of the Code enable the trustee to recover those preferential transfers made on the eve of bankruptcy. The trustee must, however, take affirmative steps in the bankruptcy proceeding to avoid the preferential transfer. Federal Deposit Insurance Corp. v. Davis, 733 F.2d 1083, 1084 (4th Cir. 1984). The trustee also bears the burden of proving the subject transfer falls within the definition of a preference. Mazer v. AETNA Finance Co., (In re Zuni), 6 B. R. 449, 451 (D.N.M. 1980). The trustee's avoiding powers thus enable the trustee to recapture the preferential transfer and distribute the property recovered along with the remainder of the debtor's property. 11 U.S.C. §§ 550, 551

      1. The Elements Of A Preference
        The general rules governing preferences are objective and technical. The intent or state of mind of the parties is immaterial as to whether a transfer is a preference.[9] Section 547(b) of the Bankruptcy Code defines the elements of a preference. Under this section, the trustee may avoid any transfer of an interest of the debtor in property

        1. to or on behalf of a creditor;[10]
        2. for or on account of an antecedent debt owed by the debtor before such transfer was made;[11]
        3. made while the debtor was insolvent;[12]

          1. on or within 90 days before the date of filing of the bankruptcy petition;[13]
          2. between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider;[14]
        4. That enables such creditor to receive more than such creditor would receive if:

          1. The case were a case under Chapter 7 of this title;[15]
          2. the transfer had not been made;[16]and
          3. such creditor received payment of such debt to extent provided by the provisions of this title.[17]
      2. Objectives Of Preference Avoidance

        1. Discouraging a race to the courthouse
        2. Equality of distribution among creditors.[18]
        3. Protection for creditors who enhance the bankruptcy estate by making advances to the debtor during the 90 days prior to the filing of the bankruptcy petition.[19]

    1. Transfer To Or For The Benefit Of Creditor
      The transfer[20] must have been to or for the benefit of a creditor. For example, in Matter of Prescott,[21]the debtor purchased a grocery store funded by a loan from a bank. The bank held a security interest in inventory and accounts receivable. A junior interest in that security was held by a trade creditor. The court found that the bank received preferential transfers resulting from offset of positive balance accounts, payment of overdrafts and taking possession of a certificate of deposit. The bankruptcy court further found those transfers resulted in an indirect benefit to the trade creditor. The trade creditor had agreed to guarantee one-half the declining balance of the debtor's note to the bank. As a junior lienholder, the position of the trade creditor was benefited by an improvement in the bank's position. As the bank's secured debt decreased, the trade creditor's security was thereby increased dollar for dollar
    2. Transfer On Account Of An Antecedent Debt
      The Bankruptcy Code does not define "antecedent debt." A debt is antecedent when the debtor becomes legally bound to pay before the transfer is made.[22]
    3. Transfer Made When The Debtor Was Insolvent
      Insolvency is determined as of the date of the transfer, not the date on which the petition was filed.[23] Insolvency is generally based on a balance sheet standard.[24] Thus, if the fair value of the debtor's liabilities exceeds the fair value of the debtor's assets, the debtor is deemed insolvent.[25]

      The trustee is aided in proving insolvency by a presumption the debtor was insolvent during the 90 day period preceding the petition date.[26] Accordingly, the initial burden is on the creditor to provide substantial evidence of solvency. Once the creditor meets this burden, the obligation then shifts to the trustee to provide sufficient evidence of insolvency.[27]

      Section 547(e) defines when a transfer is made. The general rule requires that the transfer occur within 90 days of the petition date. This time period is extended to one year in the event the transfer is to an insider.[28] To determine when the preference period begins, the court counts backward from the date of the petition.[29]

      If the payment is made by check, the transfer is deemed to have occurred on the date the check was honored rather than the date on which it was delivered to the creditor.[30] In the event the payment is a transfer by wire, the transfer occurs when the funds are received.[31]
    4. Transfer Enabled Creditor To Receive A Greater Percentage Of Its Claim Than It Would Have Received In A Chapter 7 Liquidation
      Generally, unless "the estate is sufficient to provide 100% distribution, any unsecured creditor . . . who receives payment during the preference period is in a position to receive more than it would have received under a Chapter 7 liquidation."[32] When engaging in the comparative computation, the petition date is the appropriate date to use for calculation of a hypothetical liquidation analysis and comparison.[33] It should be noted that the comparison to recovery in a Chapter 7 liquidation is irrelevant in the event a creditor is fully secured. Fully secured status precludes a finding that the creditor would receive less in a Chapter 7 liquidation of the debtor's assets.[34]
    5. Prima Facie Case.
      The trustee has the obligation to prove all of the foregoing elements. If there is no dispute regarding insolvency, no evidence would be required with regard to that element because of the statutory presumption. This is true, however, only with regard to transfers made within 90 days of the petition date. In the event the transfer challenge is to an insider and was made outside of the 90 day preference period, the presumption will not assist the trustee in proving insolvency. In the event the presumption is rebutted, the trustee must present sufficient evidence to establish insolvency.[35] The standard proof required is preponderance of the evidence.[36] Failure to meet the burden as to any element will insulate the transfer from avoidance

    The trustee may not avoid certain of the debtor's transfers of assets to creditors that would otherwise fall within the scope of § 547(b). Congress created seven specifically enumerated exceptions to the trustee's avoiding powers. Two of the exceptions creditor's counsel may use when defending preference actions involve the transfer of "new value" from the creditor to the debtor.

    1. Contemporaneous Exchange
      Section 547(c)(1) of the Bankruptcy Code provides a trustee may not avoid as a preference a transfer the parties to the transfer intended to be a contemporaneous exchange for new value, provided the exchange is, in fact, substantially contemporaneous. 11 U.S.C. § 547(c)(1).[37]

      1. The contemporaneous exchange exception was first recognized in Dean v. Davis, 242 U.S. 438, 37 S.Ct. 130, 61 L.Ed.2d 419 (1917) in which the Supreme Court held that if the parties to the transaction intend for the transfer of assets from the debtor to the creditor to be a contemporaneous exchange, and the exchange itself is substantially contemporaneous, there is no preferential transfer of the debtor's assets.

        1. In Dean, the Supreme Court determined no preferential transfer took place when a mortgage, granted by a farmer who was deeply insolvent at the time he obtained the mortgage, was given to secure a substantially contemporaneous advance.
        2. The justification for this exception to the trustee's avoiding powers is that the legitimate expectations of the debtor's other creditors would not be defeated when the creditor who provides an infusion of value into the bankruptcy estate joins the pool of creditors.[38]
      2. To determine whether an exchange is, in fact, "contemporaneous," the courts look to the facts and the parties' intent.

        1. Tyler v. Swiss American Securities (In Re Lewellyn & Co., Inc.), 929 F.2d 424, 427 (8th Cir. 1991)(To establish a defense to a preference avoidance action, a securities clearing organization had to show the parties intended the transfer by debtor of shares of stock to creditor, in lieu of timely cash payment of $8 million, to be a contemporaneous exchange for new value to allow the transfer to fall within the new value exception).
        2. Pine Top Insurance Co.v. Bank of America National Trust and Savings Association, 969 F.2d 321, 323 (7th Cir. 1992)(Debtor's collateralization of its reimbursement obligation was intended by the parties to be a substantially contemporaneous exchange even though debtor did not provide the requisite security interest until three or four weeks after the creditor issued the letter of credit).
        3. Creditor's Committee v. Spada (In re Spada), 903 F.2d 971, 975 (9th Cir. 1990)(Although 11 U.S.C.§ 547(c) required only an in-fact demonstration of a contemporaneous exchange for new value, the intent element necessary must be proven by reference to the facts surrounding the transfer).
      3. The creditor may defend against the trustee's avoidance power only to the extent the transfer received is equivalent to the new value transferred to the debtor.

        1. Sulmeyer v. Suzuki (In Re Grand Chevrolet, Inc.), 25 F.3d 728, 734 (9th Cir. 1994) (Court of Appeals remands to trial court to measure the extent to which "new value" was conferred on the debtor's estate at the time of the transfers)
        2. Milchem, Inc. v. Fredman (In re Nucorp Energy, Inc.), 902 F.2d F.2d 729 (9th Cir. 1990)(The purpose behind § 547 requires the court to "measure the value given to the creditor and the new value given to the debtor in determining the extent to which the trustee may avoid a contemporaneous exchange." Id., at 733)
      4. The burden of proving value is on the creditor.

        1. Aero-Fastner, Inc v. Sierracin Corp. (In re Aero-Fastener), 177 B.R. 120 (Bankr. D.C. Mass. 1994)(Definition of ’new value’ requires the creditor to demonstrate a specific dollar valuation of the value the debtor receives. ’New value’ does not include esoteric or intangible benefits)
        2. Electronic Metal Products, Inc. v. Bittman (In re Electronic Metal Products, Inc.), 916 F.2d 1502 (10th Cir. 1990)("[T]he Bankruptcy Code's definition of the term ’new value’ implies the creditor must prove the specific valuation in ’money or money’s worth in goods, services, or new credit." Id., at 1506)
        3. Lowrey v. U.P.G., Inc (In re Robinson Brothers Drilling, Inc.), 877 F.2d 32, 34 (10th Cir. 1989)(If the creditor did not have to prove specific value given by the creditor to the debtor, nearly any transfer for or on account of an antecedent debt would be insulated from recovery as a preference under § 547(c)).
        4. Jet Florida, Inc v. American Airlines, Inc. (In re Jet Florida Systems, Inc), 861 F.2d 1555, 1558 (11th Cir. 1988)(Proof that parties intended the creditor to provide ’new value’ to debtor was insufficient to prove ’new value.’ The creditor claiming the transfer was a contemporaneous exchange for new value bears the burden of proving specific valuation).
      5. Check Transactions. Careful review must be made of transactions involving payment by check. A transfer involving a check will be considered a transfer involving a check will be considered a contemporaneous exchange if:

        1. it was "intended to be contemporaneous"; and
        2. the check was presented for payment in the normal course of affairs.[39]

          It is important to note, however, that a dishonor changes the nature of the transaction. Thus, if payment is made by check at the time goods are received but the check is subsequently dishonored, the transaction will not be considered a contemporaneous exchange.[40] Any payment made to cover the dishonored check, no matter how quickly made, will not be considered to have been made contemporaneously. This is because the dishonor of a check creates an antecedent debt owed by the debtor.[41]
    2. "New Value".

      "New Value" is money or money's worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation.[42]
    3. Legislative History.

      Congress did not explicitly state whether the laundry list of items contained within the statutory definition of new value was intended to be exclusive. Rather, "[i]nventory, new value, and receivables are defined in their ordinary senses, but are defined to avoid any confusion or uncertainty surrounding the terms." H.R. Rep. No. 595, 95th Cong., 1st Sess. 177-79 (1977) reprinted in 1978 U.S. Code Cong. & Admin. News 5963, 6328; S.Rep. No. 989, 95th Cong., 2d Sess. 87.
    4. Notes of Committee on the Judiciary.

      The Committee recognized explicitly that § 547 of the Code was a substantial modification of the then-existing law. The Committee designed § 547(b) was designed to provide the trustee with the power to avoid a transfer, provided the trustee met the conditions set forth in S 547(b). Just as important, however, was the Committee's recognition that creditors were to be protected from the trustee's avoiding powers, provided the creditor can qualify it's transaction with the debtor under one of the exceptions contained in § 547(c).

      1. There Is No Uniform Interpretation Of "New Value."

        1. There has been no consensus among the circuits over the precise meaning of "new value."
        2. The Second, Seventh, Tenth and Eleventh Circuits interpret the language of § 547(a)(2) in a restrictive fashion, limiting new value to the definitions specifically provided for in the Code.
        3. Durant's Rental Center, Inc., v. United Truck Leasing, Inc. (In re Durant's Rental Center, Inc.), 116 B.R. 362 (Bankr. D. Conn. 1990)("Since Congress used "means" rather than "includes", see 11 U.S.C. § 102(3), the definition of "new value" is exclusive.")
        4. Energy Cooperative Inc. v. SOCAP International, Ltd., (In re Energy Cooperative, Inc.), 832 F.2d 997, 1003 (7th Cir. 1987)(Oil Seller's release of a Chapter 7 debtor's liability in exchange for debtor's payment and debtor's continued good will with seller in the marketplace did not constitute "new value").
        5. Lowrey v. U.P.G., Inc. (In re Robinson Brothers Drilling, Inc), 877 F.2d 32 (10th Cir. 1989)("[T]he Bankruptcy Code's definition of the term "new value" implies that the creditor must prove the specific valuation in "money or money's worth of goods, services, or new credit." Id., at 34 citing, In re Jet Florida Systems, Inc., 861 F.2d 1555 (11th Cir. 1988)(Payments made by debtor to creditor in excess of mechanic's lien did not constitute new value); but see, Kenan v. Fort Worth Pipe Co., (In re George Rodman, Inc.), 792 F.2d 125 (10th Cir. 1986)(Payment by a debtor in exchange for a secured creditor's release of its lien on an oil well constitutes a contemporaneous exchange for new value.
        6. Nordberg v. Arab Banking Corp. (In re Chase & Sandborn Corp.), 904 F.2d 588, 595-96 (11th Cir. 1990)(Credit toward outstanding and nonavoidable account through partial satisfaction did not constitute "new value"); American Bank of Martin County v. Leasing Service Corp. (In re Air Conditioning, Inc. of Stuart), 845 F.2d 293, 298 (11th Cir. 1988)(Agreement by undersecured creditor to forego its right to foreclose on collateral cannot be treated as "new value.").
      2. The Third, Fifth, Sixth, Ninth and D.C. Circuits, on the other hand, interpret "new value" in a more expansive fashion.

        1. Reigle v. Mahajan (In re Kumar Bavishi & Associates), 906 F.2d 942, 945 (3rd. Cir. 1990)(Creditor's execution of personal guarantees of new loans in favor of secured lender enabling debtor to obtain additional credit held to constitute "new value.")
        2. Gulf Oil Corp v. Fuel Oil Supply & Terminaling, Inc. (Matter of Fuel Oil Supply & Terminaling, Inc.), 837 F.2d 224, 229 (5th Cir. 1988)(Debtor-In-Possession's attempt to recover as preferential transfer value of gasoline denied because the court found the creditor's release of letters of credit and bank's subsequent release of collateral in response to debtor's performance by transferring gasoline and money to supplier constitute "new value.")

          • LaRose v. Crosby & Son Towing, Inc (In Re Dick Henley, Inc., 38 B.R, 210, 213 (Bankr. M.D. La. 1984)("If the Congressional intent was to define 'new value' in its ordinary sense, the list of 'goods, services, or new credit' must not be exclusive.")
          • It is interesting to note that the Fifth Circuit in Matter of Fuel Supply & Terminaling, Inc, expressly rejected the holding in In re Dick Henley, Inc.: "Henley essentially held any time a debtor makes a pre-bankruptcy transfer to a creditor whose debt is guaranteed by a third party, there is no preference because the release of the debtor from contingent liability to the guarantor would constitute new value. This holding vitiates the purpose of the preference section." Matter of Fuel Supply & Terminaling, Inc., 837 F.2d at 230, note 17.
        3. Waldschmidt v. Mid-State Homes, Inc. (In re Pitman), 843 F.2 235, 237 (6th Cir. 1988)(Debtor's transfer of a home buyer's mortgage deed 30 days before filing bankruptcy petition as security for payment of house purchase price held to be "new value" where debtor's promise to pay on mortgage was conditioned upon receipt of clear title by warranty deed)
        4. O'Rourke v. Seaboard Surety Co. (In re E.R. Fegert, Inc), 887 F.2d 955, 959 (9th Cir. 1989) (Debtor's payments to subcontractors held to be contemporaneous exchange for new value where debtor simultaneously avoided it's surety's automatic equitable lien against the contract balance)
        5. Drabkin v. A.I. Credit Corp., 800 F.2d 1153, 1157-58 (D.C. Cir. 1986) (While the release of a security interest may be sufficient to satisfy new value exception, creditor's failure to cancel insurance coverage was not a release of a security interest sufficient to constitute "New Value.")

    Section 547(c) also contains an exception for payments made in the ordinary course of business. The purpose of this section was to permit normal financing relationships between parties to continue.[43] Such relations are viewed as usual and customary, and do not raise concerns regarding a change in practice such that the transfer should be avoidable.[44]

    Examination of such a defense is fact specific.[45] This defense may be available to payments on long-term, as well as short-term obligations.[46]

    1. Elements.

      1. Obligation Incurred In The Ordinary Course.[47] This section is rarely at issue in a dispute. Customarily, the obligation will have been incurred in the normal course of business of the business of the debtor.
      2. Ordinary Course Of Business Or Financial Affairs Of The Parties.[48] This element is a subjective test. It requires a comparison of the business dealings between the debtor and the transferee to other business dealings between the same parties. In essence, this requirements asks what the ordinary course of dealings has been between this debtor and this creditor.[49]

        The prior course of dealings between the parties, including the amount and timing of payments, and circumstances surrounding the payments, should be analyzed.[50] Additionally, inquiry may be made into the collection activities or practices between the parties, whether the payments were designed to give the transferee an advantage over other creditors in bankruptcy, or whether there was any change in the status of the transferee such as the ability to obtain security in the even of nonpayment.[51] If there has been any unusual pressure or collection activity by the creditor resulting in the payment, the payment would not be ordinary course of business. The transfer at issue is not required to be the type that occurs in every transaction between the parties. It is necessary only that the type of payment be somewhat consistent with prior dealings and transactions.[52]
      3. Industry Standards.[53] This requirement is an objective test. It requires proof that the transfer was within the standards prevailing in the particular industry in which the parties are engaged.

        The Seventy Circuit imposes an objective standard, but defines "ordinary business terms" in an open-ended, permissive manner:

        Ordinary business terms refers to the range of terms that encompass the practices in which firms similar in some general way to the creditor in question in gauge, and that only dealings so idiosyncratic as to fall outside that broad range should be deemed extraordinary and therefore outside the scope of subsection C.[54]

        The Seventh Circuit test has been adopted in other Circuits.[55] However, in adopting the test, the<


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