No Idle Preference

Amid Covid-19 economic uncertainty, Congress has continued to tinker with the Small Business Reorganization Act. How will the reworked law change bankruptcy preference litigation?

Stick figure running down an incline from a big rock

Joseph Briggett

September 25, 2020 08:00 AM

The Small Business Reorganization Act took effect in bankruptcy courts nationwide on February 19, 2020. Three weeks later, on March 11, the World Health Organization declared COVID-19 a global pandemic.

At the time, most lawyers—and even many serious bankruptcy practitioners—had not yet learned the exact contours of the SBRA. Congress, apparently realizing the excruciating relevance of small-business reorganizations at that particular moment, decided to go back and tweak the law further. Many are still watching to see how this new body of bankruptcy law will look in practice. Let’s take a look at the particular amendments to the law of bankruptcy preferences, and how we can expect preference litigation to change as a result.

A bankruptcy preference is a right that a debtor or trustee has, after filing for bankruptcy, to recover payments from certain creditors who received what the law deems a preferential payment prior to the commencement of the bankruptcy case. It’s an enforcement of the bankruptcy principle that similarly situated creditors should receive equal treatment. The elements a bankruptcy trustee has to prove to recover a preference claim are simple: The trustee must show that the debtor transferred money or property to a party within 90 days prior to the date the debtor filed bankruptcy (in most cases). The trustee must show that the payment was on account of an “antecedent debt”—in essence, a debt that was due and owing before the payment was made. The trustee must show that the debtor was insolvent at the time of the transfer, which is often not difficult to prove in the case of a debtor on the verge of filing for bankruptcy. And finally, the trustee must show that the transfer enabled the creditor to receive more than it would have had there been no transfer and had the debtor gone through a liquidation.

The SBRA amended the provisions governing preference actions in two significant ways. The first change was procedural: Under the prior iteration of the law, the debtor or trustee could file these suits in what was, in essence, their home jurisdiction, unless the amount of the transfer was less than $13,650. The SBRA raised the threshold for non-insider defendants from $13,650 to $25,000 so that claims under $25,000 must generally be filed in the district in which the defendant resides.

This might seem like a small adjustment, but it could in many instances tilt the playing field strongly in the creditor’s favor. It costs the debtor or trustee very little to generate yet another preference complaint in its home jurisdiction when it’s already planning to file tens or hundreds of suits there. Requiring the trustee to retain local counsel and file in another jurisdiction, with respect to a relatively small claim, will in some cases render litigation undesirable or even cost-prohibitive. Many of these cases simply will not be filed—which is, for the most part, good news for creditors.

Second, Congress amended Section 547 of the law, and the effects of that change are more difficult to predict. The new law requires that a trustee or debtor must exercise reasonable due diligence and must “take into account a party’s known or reasonably knowable affirmative defenses” before filing any preference lawsuit. It is unclear how this requirement will be applied, but it will likely be used by preference defendants to create leverage.

One could argue that this requirement is surplusage because a reasonable pre-suit inquiry was already part of a debtor or trustee’s duties in filing suit. Federal Rule of Bankruptcy Procedure 9011 incorporates Rule 11 of the Federal Rules of Civil Procedure, which requires that any attorney filing a pleading must have conducted an inquiry reasonable under the circumstances and concluded that the claims and defenses are warranted by both fact and law.

There are numerous pre-SBRA cases in which preference defendants alleged that trustees wrongly or maliciously filed preference actions. Bankruptcy courts have most often deferred to the trustees’ judgment in these controversies. One conceivable way in which the SBRA amendment could change the calculus is the requirement to inquire into defenses. Interestingly, the aforementioned Rule 9011 requires counsel to conduct a reasonable inquiry into the claims made in the complaint, both in law and in fact. It does not expressly require counsel to examine the merit of affirmative defenses that a defendant may assert. Indeed, some bankruptcy courts specifically adopted this view under the pre-SBRA law, in one case holding “the mere fact . . . that a plaintiff is aware that an affirmative defense may be asserted does not require it to make a pre-filing investigation into the merits of the defense.” Indeed, the law’s Subsection 547(g) gives statutory footing to this interpretation by allocating the burden of proof on the elements of the claim to the plaintiff, and the burden of proof on affirmative defenses to the defendant. The SBRA amendments to Section 547 make it clear that a debtor or trustee must take into account the preference defendant’s known (or reasonably knowable) defenses prior to filing suit.

Like the procedural change, this requirement could impose costs on debtors and trustees for filing preference actions. Debtors and trustees were already incentivized to conduct due diligence on preference claims because filing an unwarranted claim would, at the very least, waste estate resources on a filing fee, and at worst expose the estate and counsel to sanctions. To those who, at their peril, ignored the significance of affirmative defenses, this requirement adds another layer of due diligence. Some time and resources must be devoted to analyzing affirmative defenses before filing suit.

The next question is what consequences will arise for failure to reasonably investigate affirmative defenses. Rule 9011 sanctions remain on the menu. Inevitably there will be a case in which a preference defendant asserts a counterclaim against the debtor or trustee for breach of this statutory duty to conduct a pre-suit investigation. There is no language in the statute that clearly allows a preference defendant to use this issue offensively—but context, legislative history, and other factors could certainly be used to weaponize it in that fashion.

Finally, while these changes were made in connection with the SBRA, it’s important to note that they are not limited to preference claims arising from small-business cases. They apply in preference cases arising under all chapters of the code.

Joseph P. Briggett is a shareholder and published author with Lugenbuhl, Wheaton, Peck, Rankin & Hubbard in New Orleans. His practice focuses on commercial litigation; bankruptcy, restructuring and creditors’ rights; admiralty and maritime; intellectual property; corporate and commercial law; and international and cross-border law.


Related Articles

Is It Live . . . Or Is It Virtual?

by Adrian L. Bastianelli III, Kevin J. O'Connor, Paulo Flores and Robert S. Peckar

Mediation via Zoom is just one of the legal-industry oddities the pandemic has wrought. Here’s a cheat sheet for how to make it work for you—and some thoughts on whether it’s here to stay.

Virtual Mediation

Equal to the Task

by Joyce D. Edelman

Fighting for gender equity in the law firm can seem like the very definition of a thankless task. But you just might find yourself able to make great strides.

Gender Equity in the Workplace

Protecting Small Business Owners: Trial Experts Connick Law LLC Notoriously Successful with Fire Litigation

by Justin Smulison

When small business owners become the target of insurance companies in fire-related lawsuits, hiring a firm with a reputation for understanding the science of fire suppression trials can save their livelihoods.

Gold Indoor Sprinkler Heads on Red Background

Will Recent Boeing Settlements Create Tailwinds In Corporate Law?

by Justin Smulison

Prominent litigation against Boeing is setting a precedent of accountability, professionalism and commitment among company boards as well as ushering ESG further into the courtroom to help monitor and prevent safety issues.

Recent Boeing Settlements and Corporate Law

Colorado's Best Lawyers 2022

by Best Lawyers

Our 2022 Colorado's Best Lawyers publication features top-ranked legal talent in Boulder, Denver and Western Colorado.

Colorado's Best Lawyers 2022

Newly Launched COVID-19 Litigation Project Offers Open Access To Pandemic-Related Court Judgments From Over 70 Countries

by Sara Collin

A worldwide database of COVID-19 cases is uniting more than 70 countries as judges, lawmakers and lawyers continue to navigate pandemic related litigation and the ways in which it’s evolving amid year three.

COVID-19 Worldwide Litigation Project

Road to Somewhere

by Mark LeHocky

How can attorneys take steps to improve settlement efforts and avoid unpleasant surprises as they map out a dispute resolution? One litigator-turned-general counsel-turned mediator (with some help from a distinguished rock star) points the way forward.

Improved Dispute Resolution Settlement

Look for the Zoom Label

by Anne R. Yuengert and Matthew C. Lonergan

Will the virtual platforms that got such a boost during the pandemic replace how you interact with your employees, unions, and lawyers?

Virtual Platforms Replacing Work Interactions

Discovery in the Time of COVID-19

by H. Barber Boone

The pandemic has affected the vital process of legal discovery in ways both good and bad. Which changes are likely to become widely accepted in the years ahead?

The Impact of COVID-19 on E-Discovery

Busting a Trust

by Joseph Marrs

The rules governing trusts and asset distribution are often much more flexible than many might assume. Here’s a primer.

Rules Governing Trusts and Asset Distribution

The Next Chapter

by Patrick M. Shelby

Among its uncountable other disruptions, the pandemic upended U.S. bankruptcy procedures. Congressional relief, legislative changes, amended legal provisions: What lies ahead for those looking to file?

COVID-19's Impacts on Bankruptcy Procedures

Phoning It In

by Alyson M. St. Pierre, Ashley C. Pack and Crystal S. Wildeman

It’s not easy for employers to weigh requests from employees to work from afar, even in the wake of the pandemic. Considerations include COVID-19, vaccinations, the Americans with Disabilities Act and the nature of the job itself.

Employer Considerations for Teleworking

Compelled to Compete

by Ashish Mahendru

Courts and legislatures—and now the White House—are taking an increasingly dim view of noncompete employment agreements, a development the pandemic has quickened. What can employers do to protect their confidential information?

Protection for Employers Beyond Noncompetes

Meeting Halfway

by Julia B. Meister

To resolve family and business disputes including wills, trusts, estates and more, mediation is often a more effective, gentler and cheaper option than litigation.

Mediation to Resolve Wills, Trusts, Estates

Look Out Below

by Mary Jo Larson

Employee 401(k) and other pension plans that include company stock can be a financial minefield. What’s a responsible fiduciary to do to lessen the risk of a plummeting share price—and the risk of a subsequent “stock-drop” lawsuit from aggrieved workers?

Navigating Employee 401(k) and Pension Plans

High Court Merit

by Tracy Collins Ortlieb

In progressive legal circles, the name Robbie Kaplan has emerged as an omnipresent force for equal and human rights.

Q&A With Roberta Kaplan

Trending Articles

Announcing the 2023 The Best Lawyers in America Honorees

by Best Lawyers

Only the top 5.3% of all practicing lawyers in the U.S. were selected by their peers for inclusion in the 29th edition of The Best Lawyers in America®.

Gold strings and dots connecting to form US map

Could Reign Supreme End with the Queen?

by Sara Collin

Canada is revisiting the notion of abolishing the monarchy after Queen Elizabeth II’s passing, but many Canadians and lawmakers are questioning if Canada could, should and would follow through.

Teacup on saucer over image of Queen's eye

Best Lawyers: Ones to Watch in America for 2023

by Best Lawyers

The third edition of Best Lawyers: Ones to Watch in America™ highlights the legal talent of lawyers who have been in practice less than 10 years.

Three arrows made of lines and dots on blue background

The Best Lawyers in South Africa™ 2023

by Best Lawyers

Best Lawyers proudly announces lawyers recognized in South Africa for 2023.

South African flag

Famous Songs Unprotected by Copyright Could Mean Royalties for Some

by Michael B. Fein

A guide to navigating copyright claims on famous songs.

Can I Sing "Happy Birthday" in Public?

Announcing the 2023 The Best Lawyers in Canada Honorees

by Best Lawyers

The Best Lawyers in Canada™ is entering its 17th edition for 2023. We highlight the elite lawyers awarded this year.

Red map of Canada with white lines and dots

Wage and Overtime Laws for Truck Drivers

by Greg Mansell

For truck drivers nationwide, underpayment and overtime violations are just the beginning of a long list of problems. Below we explore the wages you are entitled to but may not be receiving.

Truck Driver Wage and Overtime Laws in the US

The Upcycle Conundrum

by Karen Kreider Gaunt

Laudable or litigious? What you need to know about potential copyright and trademark infringement when repurposing products.

Repurposed Products and Copyright Infringemen

What the Courts Say About Recording in the Classroom

by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?

Choosing a Title Company: What a Seller Should Expect

by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller

Thirteen Years of Excellence

by Best Lawyers

For the 13th consecutive year, “Best Law Firms” has awarded the most elite and talented law firms across the country through a thorough and trusted data review process.

Red, white and blue pipes and writing on black background


2022: Another Banner Year

by John Fields

Block O’Toole & Murphy continues to secure some of New York’s highest results for personal injury matters.

Three men in business suits standing in office

Caffeine Overload and DUI Tests

by Daniel Taylor

While it might come as a surprise, the over-consumption of caffeine could trigger a false positive on a breathalyzer test.

Can Caffeine Cause You to Fail DUI Test?

Announcing the 2022 Best Lawyers® in the United States

by Best Lawyers

The results include an elite field of top lawyers listed in the 28th Edition of The Best Lawyers in America® and in the 2nd Edition of Best Lawyers: Ones to Watch in America for 2022.

2022 Best Lawyers Listings for United States

Announcing The Best Lawyers in Australia™ 2023

by Best Lawyers

The results include an elite field of top lawyers and firms from Australia.

The Best Lawyers in Australia™ 2023

Announcing The Best Lawyers in Germany™ 2023

by Best Lawyers

The results include an elite field of top lawyers and firms from Germany.

Black, red and yellow stripes