What Are The Defenses That Can Be Used Against Preference Avoidance Actions?

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A preference avoidance action is a lawsuit filed against the recipient of a preferential payment. That recipient undoubtedly doesn’t want to disgorge the money, so it will need to appeal to one or more of the nine affirmative defenses listed in subsection 547(c) of the Bankruptcy Code. Here are the three most commonly used ones.

One defense is that the transfer was in a contemporaneous exchange for reasonably equivalent new value. For example, if the debtor is a business that buys some merchandise to resell, and the debtor pays the vendor for that merchandise, then that may be considered a contemporaneous exchange for reasonably equivalent value.

Another defense is that the transfer was in the ordinary course of the business of the debtor, or of the daily life of the debtor. For example, if an individual debtor makes mortgage payments of $3,000 per month, then the debtor will pay $9,000 to the mortgage company within the 90 days leading up to the filing. These payments are not a preference because they were made in the ordinary course of the debtor’s life. However, payments that are in excess of ordinary payments may not be defensible. For example, if a debtor made 10 car payments of $500 each, all at once, rather than once each month, the excess payment would be a preference.

Yet another defense is the new value defense. A simple example will illustrate the concept. Suppose a business sells goods to the debtor and has a floating lien against the merchandise. The debtor then sells the merchandise and pays the vendor out of the proceeds. The steady stream of merchandise to the debtor adds new value to the debtor, that is given in exchange for the money the debtor pays to the vendor. As a consequence, when the debtor makes the payment back to the vendor, the payment is not a preference.

Why did Congress include the new value defense in the Bankruptcy Code? Looking at the change in the debtor’s financial life as a result of filing a bankruptcy petition helps to answer the question:

Prior to filing a bankruptcy petition, the debtor has debts and assets. The act of filing the petition creates a bankruptcy estate. The debtor’s assets go into the estate, and the debts become claims against that estate. In essence, a preference depletes the bankruptcy estate, thus reducing the funds available to pay the claims.

However, if reasonably equivalent new value is added back to the estate, then the estate hasn’t actually been depleted at all, and the claimants haven’t been harmed. Hence we have the new value defense.

For more information on Defenses Used Against Preference Avoidance Actions, a free 20 Minute Phone Strategy is your next best step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.