iV._Pre-Petition_Payments_and_Transfers_by_the

IV. Pre-Petition Payments and Transfers by the Debtor

General

A fundamental precept of bankruptcy law is that unsecured creditors, unless the Code otherwise provides, share equally in the distribution of the estate. To effect this, the Code contains specific provisions permitting the trustee to “avoid,” i.e., undo, certain pre-petition payments or transfers, whether voluntary or involuntary, and recover the transferred property for the estate.

Frequently, a debtor makes a payment or attempts to transfer property shortly before filing for bankruptcy. Such payment or transfer generally falls into one of four categories: normal payment; payment made in an attempt to avoid bankruptcy by fending off a creditor; payment or transfer of property to a favored creditor; or an attempt to keep property away from creditors by transferring it to an insider.

Effects of Avoidance
1. Effect on the Transferee
When a transfer of the debtor’s property is avoided, the affected creditor must return to the trustee the money or property transferred. The creditor is entitled to a claim for the amount or value of the recovered property. For example, an unsecured creditor is owed $4,000 on the date the petition is filed, but received an avoidable preferential payment of $1,000. The creditor must surrender the $1,000 to the trustee, but the creditor’s claim is increased to $5,000.
2. Effect on the Debtor
a. Voluntary Preferential Transfer
Unless the transfer is fraudulent, generally the existence of an avoidable transfer has no impact on whether the debtor receives a discharge or the amount of property, if any, that must be surrendered to the trustee for liquidation.
b. Involuntary Preferential Transfer
The property recovered by a trustee’s avoidance of a preferential transfer may be exempted by the debtor if the transfer was not voluntary and the debtor did not conceal the property, or the debtor could have avoided the transfer because it is a lien that impairs an exemption to which the debtor is entitled.274
Preferential Transfers
1. Definition
A preferential transfer is one that:
- is of either money or property, made to or for the benefit of a creditor on an antecedent debt, i.e., pre-petition obligation, including an obligation that is not yet matured or due (e.g., future installment loan payments);
- is made while the debtor was insolvent (there is a rebuttable presumption that a debtor is insolvent during the 90-day period preceding the date the petition is filed);275
- allows the creditor to receive more than in a chapter 7 case than if the transfer were not made; and
- is more than if the creditor received only what would otherwise be received from a distribution made from the bankruptcy estate.276
The purpose of the trustee’s avoidance powers is to prevent the debtor from favoring one creditor over another, as well as to avoid a “race to the courthouse” by creditors to seize and liquidate the assets of a financially troubled debtor. By avoiding such transfers, the trustee can ensure the pro rata distribution of a debtor’s assets among the creditors. In crafting the statute, Congress determined that, as a matter of policy, a creditor should not be permitted to improve its position on the eve of bankruptcy.277
2. Classification of a Claim
Classification of the creditors’ claim on the date the petition is filed is an important initial step. In an ordinary case, the amount and priority of an unsecured creditor’s claim is fixed on the date of filing. Similarly, the amount of a secured creditor’s claim is fixed, and the value of the security ascertained as of that date. The claim may be either fully or partially secured.
a. Fully Secured Creditors
If a creditor is fully secured, a pre-petition transfer is not preferential because the secured creditor is entitled to receive 100 percent of its claim. However, it is important to note that the controlling value is that of the collateral at the time the petition is filed, not at the time of transfer. Thus, if at the time the petition is filed the value of the collateral has deteriorated to an amount less than the creditor’s claim (adding back in the amount of the transfer), the creditor is undersecured. Also, payments made during the preference period that change a creditor from being partially unsecured to fully secured may be preferential.
b. Unsecured Creditors
In general, any payment made to an unsecured creditor during the preference period is a preferential transfer unless all creditors in the same class will be paid in full through the bankruptcy proceedings. In determining the amount that the transfer enables the creditor to receive, the creditor must be charged with the value of what was transferred, plus any additional amount that the creditor would be entitled to receive from a chapter 7 liquidation. The net result is that, as long as the distribution in bankruptcy to the creditor’s class (as determined under 11 U.S.C. § 726) is less than 100 percent, any payment “on account” of a previously existing debt to an unsecured creditor during the preference period will enable that creditor to receive more than the creditor would have received in liquidation had the payment not been made.
c. Undersecured Creditor
Treatment of the undersecured creditor depends on the claim to which the payment is applied and the source of the payment. In bankruptcy, an undersecured creditor holds two different claims, each of which receives different treatment in bankruptcy: (1) its claim against the collateral and (2) the amount that the debt exceeds the value of that property, which is by definition “unsecured.” If payment is applied to the unsecured claim, the creditor typically will have received more than the creditor would receive in a chapter 7 liquidation, satisfying the trustee’s burden on that element. Conversely, if the source of the payment is the creditor’s own collateral, the creditor will have received no more than it would receive in chapter 7 anyway, and the trustee will have failed to sustain his burden on that element. Even a payment that has been applied to the unsecured claim of an undersecured creditor will not trigger the liquidation analysis if the source of the payment is the creditor’s own collateral.
3. Exceptions to Avoidance
Certain preferential transfers are specifically excepted from avoidance. These exceptions are generally of two classes: (1) the transaction does not result in a diminution of the debtor’s assets to the detriment of other creditors; or (2) for public policy reasons, Congress deemed the transfers entitled to exception. The following discussion does not include all of the exceptions; some (e.g., “running” or “open” accounts, reclamation rights and “floating liens”) rarely, if ever, arise in the consumer context.
a. Contemporaneous Exchange for New Value
A transfer may not be avoided if it was a voluntary and a substantially contemporaneous exchange for new value given to the debtor.278 “New value” means money or money’s worth in goods, services or new credit, or a release of property previously transferred to the transferee, including proceeds of the property, but does not include an obligation substituted for an existing obligation.279 This defense is grounded on the principle that new value given by the creditor to the debtor will offset the payments made to the creditor. Thus, the debtor’s estate was not depleted to the detriment of other creditors by the transfer.
i. The otherwise-preferential transfer is insulated from avoidance only to the extent of the new value given. The transferee must prove the specific new value, measured as of the date of the transfer. Thus, a transfer of $100,000 in exchange for goods having a value of $50,000 at the time of transfer would be protected from avoidance only to the extent of the $50,000 in “new value” actually received by the debtor.
ii. To be excepted from avoidance, the transfer of the debtor’s property must be substantially contemporaneous with the new value given in return.
- The Bankruptcy Code does not define “contemporaneous,” and case law provides no bright-line test. Clearly, if A hands B a $20 bill and B hands A a widget worth $20, there is a contemporaneous exchange. However, if A pays B with a $20 check for a transaction that is ordinarily on credit, the determination depends on whether the check is honored in due course. If the check is presented to and honored by the bank upon presentment, the exchange is substantially contemporaneous. However, if the check is not honored, the transaction becomes a credit transaction, and subsequent payment or honoring of the check does not constitute a contemporaneous exchange.
- Delay in the transfer is not invariably fatal. Most courts examine whether an exchange is substantially contemporaneous on a fact-intensive, case-by-case basis.
b. Ordinary Course of Business
Payments made on a debt incurred in the ordinary course of business or in accordance with ordinary business terms are not preferential transfers.280 The primary policy underlying this exception is to encourage creditors to continue to deal with troubled debtors by leaving undisturbed ordinary business transactions.
i. To qualify for this exception to avoidance, a creditor must establish that the payment of a debt incurred in the ordinary course of business was ordinary in relation to the past practices between the debtor and this particular creditor, or prevailing business practices in the trade or industry.
ii. The principal factors considered in determining whether transfers are ordinary in relation to past practices between the debtor and the creditor are:
- the length of time the parties were engaged in transactions at issue;
- whether the amount or form of the tender differed from past practices;
- whether the debtor or creditor engaged in any unusual collection or payment activity;281 and
- the circumstances under which the payment was made.
iii. Regular payments made on long-term debt may qualify for the ordinary-business exception.
c. Purchase Money Security Interest (PMSI)
The creation of a purchase money security interest is not avoidable if:
- it is perfected within 30 days after the debtor receives possession of the property;
- the interest secures new value that is given at or after the signing of the security agreement;
- the agreement describes the property as collateral;
- the new value was given by or on behalf of the secured party under the agreement; and
- the new value was given to enable the debtor to acquire the new property, and the debtor actually used the new value to acquire the property.282
State law relation-back statutes allowing a longer perfection period are inapplicable to an avoidance analysis. A creditor must perfect its security interest within 30 days to invoke this exception. In cases involving a non-PMSI, the more flexible new value exception may apply. Moreover, while the trustee may avoid the security interest, payments made to the creditor during the preference period on the obligation may be excepted from avoidance under the new value or ordinary course of business exceptions if they otherwise qualify.
d. Subsequent New Value
The defense usually applies to an open or running account relationship between the debtor and the creditor. A transfer to the creditor is not avoidable to the extent that the creditor thereafter gave new value to the debtor. In the consumer context, a credit card account is a common example wherein the debtor makes payments to the creditor but thereafter incurs new debt on the account.283
e. Statutory Liens
i. The fixing of a statutory lien that is not avoidable under 11 U.S.C. § 545 is not avoidable as a preferential transfer.284 Under 11 U.S.C. § 545, statutory liens that are avoidable are those that are effective solely due to the debtor’s financial distress, unperfected or unenforceable at the commencement of the case against a bona fide purchaser, or for rent or distress of rent.
ii. Payments in satisfaction of, or transfers to a creditor that preclude the imposition of, an unavoidable statutory lien may also be excepted from avoidance. These transactions could fall under either the new value exception (contemporaneous surrender of lien rights) or as transfers to a secured creditor. If the statutory lien right had no value, either because the property to which it attached had no value or the lien right had expired at the time the payment was made, the payment would be avoidable.
f. De Minimis Transfers
Transfers by an individual consumer debtor to any single creditor that in the aggregate do not exceed $600 are not avoidable preferential transfers.285
g. Payments Under Alternative Repayment Plan
Payments by a debtor to a creditor pursuant to an alternative repayment plan created by an approved credit counseling agency are not avoidable as preferential transfers.286
h. Domestic Support Payments
Payments made on account of domestic support obligations are not avoidable as preferential transfers.287
4. Limitations on Avoidance Powers
a. Exceptions to Avoidance Powers
There is one exception of general application to the avoidance powers of a trustee that may apply to consumer cases: perfection of an unperfected lien that relates back in time or the continuation of perfection of a lien.288 Section 546(b) protects the holders of certain liens, unperfected as of the date the bankruptcy petition is filed, the subsequent perfection of which relates back in time (e.g., material and labor liens on real property or the holder of a PMSI) and the action necessary to continue perfection of a lien might otherwise expire (e.g., the filing of a UCC-3 continuation statement). The critical issue is whether perfection relates back in time to defeat the intervening rights of the trustee that arise at the time the bankruptcy petition is filed. If the subsequent perfection, under otherwise applicable nonbankruptcy law, relates back, the transaction is not avoidable, nor does post-petition perfection violate the automatic stay.289 If perfection requires seizure or the commencement of an action, perfection may be accomplished post-petition by giving notice.
b. Protected Transferees
In general, the trustee may recover the transferred property, or its value, from either the initial transferee or any immediate or mediate transferee of the initial transferee, or the entity for whose benefit the transfer was made.290 The trustee is limited to a single satisfaction.291 There are, however, three significant exceptions that may protect a particular transferee:
i. If, in good faith and without knowledge of the voidability of the transfer, the transferee, other than the original transferee, takes for value, including satisfaction of or securing an antecedent debt, the trustee may not recover from that transferee or any subsequent good-faith transferee.292
ii. If the avoidance is based on a transfer made for the benefit of an insider between 90 days and one year pre-petition, the trustee may not recover from a transferee that is not an insider.293
iii. While innocence of the transferee is irrelevant to determining whether the trustee is entitled to avoid the transfer, there are protections for the good-faith transferee. A good-faith transferee who makes improvements on or to the property recovered is granted a lien on the property recovered to the extent of the lesser of the cost of the improvement to the transferee or the increase in value to the property as a result of the transferee’s improvement.294
- Improvements include physical improvements, repairs, payment of property taxes, reduction in debt securing a lien superior or equal to the rights of the trustee, or preservation of the property.295
- In a fraudulent-transfer situation, a good-faith transferee is granted a lien on the recovered property to the extent of the value given.296
5. Time Limitations on Preference Avoidance Actions
There are time limits within which the trustee must bring the action to avoid a preferential transfer and recover the property transferred, or its value. There are two elements to consider: the appropriate “reach-back” period and the time within which an action may be brought. These are separate limitations on the time to bring the action, and the running of either is fatal to the trustee’s avoidance action.
a. Reach-Back Period
The first limitation relates to the time of the transfer with respect to the date the petition is filed.
i. Generally, the reach-back period is 90 days preceding the date the petition is filed.297
ii. However, if the transferee is an insider, the reach-back period extends to one year preceding the date the petition is filed.298 For individual debtors, “insider” includes a relative; a partnership in which the debtor is a general partner; a general partner of the debtor; or a corporation of which the debtor is an officer, director or person in control.299
iii. A transfer is deemed made:
- at the time the transfer takes effect between the transferor and transferee if perfected within 30 days after the transfer;
- at the time the transfer is perfected, if perfected more than 30 days after the transfer; or
- immediately before the petition is filed if not perfected at the later of the date of filing, or 30 days after the transfer takes effect between the transferor and transferee.300
b. Time for Bringing Action
i. An action to avoid a pre-petition transfer, regardless of the legal basis, must be brought before the earlier of the time the case is closed or dismissed, or two years after entry of the order for relief, unless within that two-year period the first trustee is appointed or elected. If the first trustee is appointed within the two-year period, the time is extended for one year after her appointment or election.301 For example, if the first trustee is appointed in a chapter 11 case less than six months after the petition is filed, the trustee must bring the action within the two-year period; however, if the trustee is not appointed until 18 months after the petition is filed, the trustee has one year from the date of appointment or election to file an avoidance action. The time for bringing an action is not extended by the sale of the right to a creditor.
ii. Generally, a case may not be reopened for the purpose of avoiding a transfer.302 However, this restriction is not a bar to reopening the case to recover assets where the failure to discover or administer assets prior to original case closure was the result of ambiguity or nondisclosure in debtors’ schedules or to administer an asset that was not located or pursued through mistake, inadvertence or excusable neglect under Fed. R. Civ. P. 60(b). Moreover, this restriction is conditioned upon the case having been properly closed; therefore, if closure was due to clerical error, it may be reopened to pursue avoidance.
iii. An action to avoid an unauthorized post-petition transfer must be commenced within the earlier of two years from the date of the transfer, or before the case is closed.303 An action to recover property from a transferee must then be brought within one year of the date the transfer is avoided or the case is closed or dismissed, whichever is earlier.304
iv. The limitation periods of 11 U.S.C. §§ 546(a) and 549(d) are not necessarily absolute. The doctrine of equitable tolling, which applies where a party remains in ignorance of a wrong without any fault or want of diligence or care on her part, may apply to both. In that case, the statute of limitations does not begin to run until the wrong is discovered. Equitable tolling is especially applicable where a party has an affirmative duty to keep the other party informed and fails to so do. However, if the trustee fails to carry out diligently his statutory duties to investigate the financial affairs of the debtor, as a matter of law, the doctrine of equitable tolling cannot be invoked by the trustee.
6. Venue Limitations
The trustee may bring an avoidance action on a consumer debt in an amount of less than $19,250 only in the district in which the defendant resides.305 A corporation is deemed to reside in any judicial district in which it is subject to personal jurisdiction at the time the action is commenced.306
Fraudulent Transfers
1. Definition
A fraudulent transfer is transfer of an interest of the debtor in property that was made within two years of the filing date with the actual intent to hinder, delay or defraud an existing or future creditor, or in which the debtor received less than reasonably equivalent value for the transfer and was either insolvent or became insolvent as a result of the transfer, engaged in or was about to engage in a business or transaction for which any property left with the debtor constituted unreasonably small capital, or intended to incur debts beyond the debtor’s ability to repay such debts.307
a. Timing of the Transfer
A transfer is completed when a bona fide purchaser from the debtor cannot acquire an interest in the property transferred that is superior to the interest of the transferee.308
b. Value
Value is defined as property, or satisfaction or securing of a present or antecedent debt.309
c. Good-Faith Transferee
A good-faith transferee for value is granted a lien on the transferred property to the extent that the transferee gave value to the debtor in exchange for the transfer.310
2. Intent
An intent to hinder, delay or defraud is usually inferred from the facts and circumstances surrounding the transaction. The Uniform Fraudulent Transfer Act (UFTA) is a customary source for common indicia of fraud, which include:311
- the transfer or obligation was to an insider;
- the debtor retained possession or control of the property transferred after the transfer;
- the transfer or obligation was disclosed or concealed;
- before the transfer was made or obligation was incurred, the debtor had been sued or threatened with a suit;
- the transfer was of substantially all the debtor’s assets;
- the debtor absconded;
- the debtor removed or concealed assets;
- the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
- the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
- the transfer occurred shortly before or after a substantial debt was incurred; and
- the debtor transferred the essential assets to a lienor who transferred the assets to an insider of the debtor.
Presence of a single badge may spur suspicion; the confluence of several can constitute conclusive evidence of actual intent to defraud. If indicia of fraud have been established, the burden shifts to the transferee to establish a legitimate supervening purpose for the transfer at issue.
Although conversion of nonexempt into exempt property as a pre-bankruptcy planning tool is not per se fraudulent or unlawful, it may under some circumstances constitute a fraudulent transfer and should be approached with caution. Both a debtor’s attempt to conceal a pre-bankruptcy transfer and the value of the property transferred are factors considered by the courts.
3. Protected Transfers
a. Foreclosure Sales
A noncollusive foreclosure sale regularly conducted in accordance with applicable state law or the tests in § 548(a)(1) is unlikely to be a fraudulent transfer. Further, the trustee may not avoid an unauthorized post-petition sale of real property for fair market value to a good-faith purchaser without knowledge of the bankruptcy.312
b. Charitable Contributions
A contribution made to any qualified charitable or religious organization, as defined in 26 U.S.C. § 170(c), is not a fraudulent transfer to the extent that the transfer does not exceed the greater of 15 percent of the debtor’s gross annual income or an amount consistent with the charitable giving practices of the debtor.313
4. Limitations on Avoidance Powers
The limitations on the trustee’s power to avoid fraudulent transfers are essentially identical to the limitations on the power to avoid preferential transfers.
5. Time Limits on Avoidance Actions
As with preferential transfers, there are two time limits for the trustee to bring an action: the time within which an action may be brought, and the reach-back period.
a. Reach-Back Period
In a fraudulent-conveyance action, transfers within two years prior to the petition date are subject to avoidance.314
b. Time for Bringing Action
The time for bringing an avoidance action based on a fraudulent transfer is identical to the time for bringing a preferential transfer avoidance action.
c. Actions Under State Law
i. The trustee is also cloaked with the power to use state law to avoid transfers.315 A state law reach-back period may exceed that under the Bankruptcy Code. For example, the UFTA reach-back period is four years. Thus, the trustee has the option of the Bankruptcy Code’s two-year reach-back under 11 U.S.C. § 548, or the four-year reach-back pursuant to state law under 11 U.S.C. § 549.
ii. A state statute of limitations is measured from the date the petition is filed. If the state limitation period has not expired by the time the petition is filed, the federal limitation period under 11 U.S.C. § 546(a) controls; expiration of the state limitation period post-petition is irrelevant.
iii. The “discovery rule” applies to state law actions. In the absence of a controlling state statute or judicial decision, there are two public policy considerations that may tip the scales in favor of application of the discovery rule.
- Inherent in the Code is that all creditors are treated equitably and share ratably in the distribution of a debtor’s assets. A fraudulent transfer by nature is antithetical to and tends to defeat this basic precept of bankruptcy law.
- In the federal system, the discovery rule has long been read into statutes of limitations.
Under 11 U.S.C. § 544(b), the trustee has no independent right to bring an action, but “stands in the shoes” of the creditor who holds the right. If there is no creditor with an unsecured claim that holds a right to bring the action as of the date the petition was filed, the trustee lacks standing to avoid the transfer.316 However, any property recovered under the trustee’s avoiding powers is brought into the estate for distribution to all creditors.317
6. Venue Limitations
They are the same as for preferential transfers.
7. Denial of Discharge
A transfer made within one year of the date of the petition, if made with the intent to hinder, delay or defraud a creditor, is grounds for denial of discharge.318

274 11 U.S.C. § 522(g).
275 11 U.S.C. § 547(f).
276 Id.
277 11 U.S.C. § 547(b)(4).
278 11 U.S.C. § 547(c)(1).
279 11 U.S.C. § 547(a)(2).
280 11 U.S.C. § 547(c)(2).
281 For example, if the debtor typically paid the creditor an average of 50 days after delivery or invoice, but payments during the preference period were made an average of 15 days after invoice, the payments might be found to be not in the ordinary course of business.
282 11 U.S.C. § 547(c)(3).
283 11 U.S.C. § 547(c)(4).
284 11 U.S.C. § 547(c)(6).
285 11 U.S.C. § 547(c)(8). If the case is one where the individual’s debts are not primarily consumer debts, the exception goes up to $6,425. 11 U.S.C. § 547(c)(9). The amounts in 11 U.S.C. § 547(c)(9) are adjusted every three years, whereas the amount in 11 U.S.C. § 547(c)(8) is not adjusted. The next adjustment will be on April 1, 2019.
286 11 U.S.C. § 547(h).
287 11 U.S.C. § 547(c)(7).
288 11 U.S.C. § 546(b).
289 11 U.S.C. § 362(b)(3).
290 11 U.S.C. § 550(a).
291 11 U.S.C. § 550(d).
292 11 U.S.C. § 550(b).
293 11 U.S.C. § 550(c).
294 11 U.S.C. § 550(e)(1).
295 11 U.S.C. § 550(e)(2).
296 11 U.S.C. § 548(c).
297 11 U.S.C. § 547(b).
298 Id.
299 11 U.S.C. § 101(31)(A).
300 11 U.S.C. § 547(e)(2).
301 11 U.S.C. § 546(a).
302 11 U.S.C. § 546(a)(2).
303 11 U.S.C. § 549(d).
304 11 U.S.C. § 550(f).
305 28 U.S.C. § 1409(b). The amount will be adjusted every three years; the next adjustment will be April 1, 2019.
306 28 U.S.C. § 1391(c).
307 11 U.S.C. § 548(a)(1).
308 11 U.S.C. § 548(d)(1).
309 11 U.S.C. § 548(d)(2)(A).
310 11 U.S.C. § 548(c).
311 This is a model act that has been enacted in whole or in part by many states.
312 11 U.S.C. § 549(c).
313 11 U.S.C. § 548(a)(2).
314 11 U.S.C. § 548(a)(1).
315 11 U.S.C. § 544(b).
316 Cf. 11 U.S.C. § 544(a), not requiring that a creditor have knowledge of an impermissible transfer in order for the trustee to act.
317 11 U.S.C. § 541(a)(3). This differs from a state law action, where the property recovered by voiding a transfer goes to the plaintiff.
318 11 U.S.C. § 727(a)(2).