A bankruptcy trustee’s pursuit of preference claims causes heartburn for trade creditors. It’s one thing to be owed a potentially uncollectable receivable from a financially distressed customer that is heading toward
or has filed bankruptcy; it’s quite another to have to turn over payments that were made in the period leading up to the customer’s bankruptcy filing, which the creditor likely spent significant time and effort collecting. While Congress might have intended the Bankruptcy Code’s preference statute to promote fairness among creditors (by permitting the bankruptcy estate to recover payments to certain creditors and then redistribute such payments to all similarly situated creditors), the way preference claims are often weaponized in bankruptcy cases is anything but fair. Debtors and trustees have made it a practice to go through the debtor’s payment register and assert preference claims en masse, and indiscriminately, against virtually every creditor that received a payment during the 90 days before the bankruptcy filing. They often do this without investigating the merits of or defenses to the claims, instead seeking nuisance value settlements of weak preference claims. Even worse, debtors and trustees often engage in this practice for the purpose of funding the administrative expenses of the case—not for distributions to the unsecured creditors that were targeted.

In 2019, Congress amended the Bankruptcy Code to attempt to curb this widespread abuse of the preference statute. Specifically, Congress amended section 547(b) to add a requirement that a plaintiff must have conducted some diligence of the validity of and defenses to a preference claim prior to commencing a preference action. While Congress might have intended this new “due diligence” requirement to impose an extra burden on potential plaintiffs and deter them from asserting specious or weak preference claims, it is unclear whether the amendment imposes any additional burden on plaintiffs as a practical matter.

Click here to view the full article