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N at i o nal A ss o c i at i o n o f C r e d i t M ana g e m e nt
Deborah Thorne, Esq.
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United States Supreme Court Lends
Hand to Preference Defendants:
Trustees Need to State a Case
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e l e c t e d
efore defendants in preference cases go through
the laborious process of analyzing a plaintiff ’s
case, a quick review of the complaint to identify whether
there are any supporting facts may give them an escape
route or leverage in defending the case.
That’s the insight many have gleaned from United States
Supreme Court and several bankruptcy cases over the
last several years that have provided new pleading
requirements.
Before a discussion on the requirements, it is important
to understand the context.
Preference Defense: A Primer
Once you are served with a summons in a preference
case, creditors and attorneys naturally jump to analyzing
whether new value or ordinary course defenses can be
asserted to the claims of the trustee. While this is important to do, many preference defendants fail to examine
The principles the Supreme Court has
emphasized make clear that a court is not
required to accept as true any legal
conclusion “couched as a factual allegation.”
whether the plaintiff trustee or debtor has or can state a
case for the recovery of a preferential payment. A brief
review of the facts contained in the complaint and
whether the facts support the legal claim may allow a
defendant to cut to the chase in defending a claim.
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As anyone who has been sued by a trustee or creditors’
trust knows, the plaintiffs generally send a demand letter and file suit against anyone who received a payment
during the 90 days prior to the bankruptcy petition
date. The information relied upon to file the complaint
may only extend to the debtor’s check register. The
plaintiff has not looked to see what antecedent debt was
the basis for the transfer and may be suing to recover
transfers made when the debtor was solvent.
The complaint generally states the legal components of
Section 547 of the Bankruptcy Code that the trustee
must prove to make his case. Most often, a list of transfers is the only factual allegation supporting the complaint. The remaining components of Section 547 are
merely stated without any factual support. Under recent
decisions rendered by the U.S. Supreme Court and now
applied to preference cases, this is simply insufficient
pleading practice. Knowledge of these new pleading
requirements may help you ward off a preference judgment against your company or at least provide leverage
to assist a fair settlement.
The Supreme Court New Pleading
Requirements
During the last several years, the Supreme Court has
instructed the lower courts in non-bankruptcy cases
that a plaintiff must state a prima facie case in a complaint filed in a federal court. A prima facie case is one
that states a cause of action for all the elements that the
plaintiff is required to prove. Several bankruptcy courts
have recently applied these Supreme Court instructions
to preference cases with the result providing creditors
and potential preference defendants with assurances that
trustees no longer can just sue everyone who received a transfer during the 90 days prior to the bankruptcy petition filing
(the “Preference Period) without pleading facts to support the
legal requirements of a preference case.
The principles the Supreme Court has emphasized make clear
that a court is not required to accept as true any legal conclusion “couched as a factual allegation.” Secondly, “only a complaint that states a plausible claim for relief survives” a motion
to dismiss. The Supreme Court intended as a policy matter to
weed out meritless cases prior to the commencement of discovery so that the expenditure of the judicial system’s resources is minimized. What this really means is that a preference
complaint must contain facts which support the legal requirements of Section 547 of the Bankruptcy Code.
Preference Pleading Requirements
In the preference context this means that a complaint that
states just the legal requirements is inadequate. The Bankruptcy Code authorizes the avoidance of “any transfer of an
interest of the debtor in property” if five conditions are satisfied, subject to one of several defenses. Specifically, the trustee
(or a party stepping into the trustee’s shoes) may avoid a
transfer of the debtor’s property –
(1)to or for the benefit of a creditor;
(2)for or on account of an antecedent debt owed by the
debtor before such transfer was made;
(3)made while the debtor was insolvent;
(4)made –
(A) on or within 90 days before the date of the filing of
the petition; or
(B) between 90 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; and
(5)that enables such creditor to receive more than such
creditor would receive if –
(A) the case were a case under Chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the
extent provided by the provisions of this title.
Thus, the complaint must allege enough facts to put the
defendant on notice for the preference claims. The complaint
cannot be merely a “formulaic recitation of the elements.”
Factual Pleading Required in a Preference Case
Generally, a preference complaint contains factual allegations
to support the “transfer” allegations. Most complaints incorporate an exhibit that lists certain payment amounts, check
number and check clear date but few other facts that help
identify the other allegations that are required to be provided.
Complaints fitting this description cannot survive a motion
to dismiss under the new Supreme Court instructions.
In a number of recent bankruptcy court cases, preference
defendants have won motions to dismiss because the plaintiff
trustees have simply not provided factual support to make
their case. For example, in the Delphi Automotive preference
cases, the court held that all preference cases should be dismissed without prejudice (the complaints could be refiled
with better facts) because any number of facts were missing.
Specifically, the plaintiff did not list the antecedent debt that
the cases were based upon. Had the plaintiffs listed the
invoices paid or the purchase order numbers, the motions to
dismiss might not have been granted. The complaints just did
not provide a means to determine what the payments were
for. Similarly, the author recently reviewed a preference complaint that merely listed one gross amount transferred, when
there were actually many separate amounts transferred over a
course of 90 days and the plaintiff failed to list any antecedent
debt paid by the transfers.
In a number of recent bankruptcy court
cases, preference defendants have won
motions to dismiss because the plaintiff
trustees have simply not provided factual
support to make their case.
Furthermore, as many experienced credit professionals know,
all too often plaintiffs/trustees sue to recover payments that
were cash in advance or cash on delivery. Often, the trustee
doesn’t even know what the payments were for or doesn’t
want to spend the time and money to figure this out. Yet
under the Supreme Court standards, the fact that there was a
transfer is not enough and the trustee or plaintiff must link
this transfer to the other requirements of Section 547.
Another allegation that must be supported by facts is that the
debtor was insolvent when the transfer was made. Although
the debtor is presumed to be insolvent during the 90 days
prior to the petition date, occasionally debtors are actually solvent during the 90-day period. Defendants should review the
debtor’s schedules to see whether the debtor listed more assets
than liabilities or whether other evidence would rebut the presumption. In such cases, the plaintiff must provide factual
support in the complaint to factually rebut the presumption.
The final most common pleading deficiency relates to whether
the creditor/defendant received more than it would have in a
Chapter 7 case. Simply stated, transfers received on account of
assumed executory contracts do not equate to the creditor
receiving more than it would have in a Chapter 7. Thus, simple
allegations stating that the creditor received more than it would
in a Chapter 7 without factual support should be dismissed.
Lessons Learned
Before expending time and resources to develop an ordinary
course or new value defense in response to a preference complaint, review the plaintiff ’s allegations to determine whether
they are only a “formulaic recitation of the elements.” The
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plaintiff may not actually have the factual knowledge to plead
these facts. This may be your best first defense because bankruptcy courts are increasingly granting motions to dismiss
due to the trustee’s failure to adequately plead under the new
Supreme Court standards. Even if you do not pursue a motion
to dismiss, you may want to discuss with counsel the assertion
of the failure to state a cause of action against your company
as an affirmative defense in the answer to the complaint. ●
Deborah Thorne, Esq. is a partner and the administrator of the
Financial Insolvency and Restructuring Department for the Chicago
office of Barnes & Thornburg LLP. She has practiced for many years,
representing creditors and others in financial restructurings and
workout situations. Thorne serves on the American Bankruptcy
Institute’s Board of Directors and is a former chair of the ABI’s
Unsecured Trade Creditors Committee. She is a frequent contributor
to Business Credit and other publications. She can be reached at
[email protected] or 312-214-8307.
*This is reprinted from Business Credit magazine, a publication of the
National Association of Credit Management. This article may not be
forwarded electronically or reproduced in any way without written
permission from the Editor of Business Credit magazine.
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