Pleading the Preference Claim
Is it getting easier for the bankruptcy Trustee?
By Scott E. Blakeley
Credit professionals are finding ever more frequently
that the bankruptcy trustee (in Chapter 7) or litigation trustee
(often in Chapter 11) view preference claims as a significant asset
of the bankruptcy estate. The credit professional is finding that
no matter the bankruptcy chapter a customer files, they are a preference
target if they received payment within 90 days of the bankruptcy
filing. Indeed, USA Today stated: It is a phenomenon that is sweeping
the nation. As bankruptcy filings continue to increase, debtors
and trustees are becoming much more aggressive in demanding that
creditors return payments received prior to the bankruptcy filing.�
In response to the ever growing preference problem,
the credit professional, and their counsel, are looking for new
angles to defeat the preference claims. Beyond raising the traditional
547 �(c)� defenses (contemporaneous exchange, ordinary course of
business and new value), the vendor is challenging the very basis
of the preference complaint by seeking dismissal of the suit at
the pleading stage contending that the trustee has failed to plead
sufficient facts to support the preference suit.
In light of a vendor attacking the preference action
at the pleading stage, what is the minimum pleading requirement the
trustee must meet in setting forth a preference claim, especially
given the uncertain books and records of the debtor? Must a trustee
plead the nature and amount of each debt, identify each transfer,
including date, name of debtor and the amount of the transfer to
sustain a preference action? Or, rather, may a trustee merely make
a short and plain statement of the preference claim, and a showing
that the trustee is entitled to relief.
In In re Webvan Group Inc. (Webvan Group Inc. v. Cor
Karaffa) Adv. 03-54365 (CGC)(Delaware 2004), the court found that
the Federal Rules of Bankruptcy Procedure does not impose a heightened
pleading requirement on a preference claim, and expressly rejected
the heightened pleading standard enunciated in recent cases. The
case is discussed below.
What Is A Preference
The Bankruptcy Code vests the debtor (or trustee if
one is appointed) with farreaching powers to avoid transfers of assets
and monetary transactions prior to a bankruptcy filing. The power
to avoid preferential transfers is one of the most powerful weapons
a trustee has. The Bankruptcy Code defines a preference expansively
to include nearly every transfer by an insolvent debtor 90 days prior
to bankruptcy.
The purpose of the preference provision is two-fold.
First, unsecured creditors (or undersecured creditors, e.g. those
creditors whose collateral is valued at less than their debt) are
discouraged from racing to the courthouse to dismember a debtor,
thereby hastening its slide into bankruptcy. Second, debtors are
deterred from preferring certain unsecured creditors by the requirement
that any unsecured creditor that receives a greater payment than
similarly situated unsecured creditors disgorge the payment so that
like creditors receive an equal distribution of the debtor's assets.
Attacking The Preference At The Pleading Stage
In Webvan, the preference defendant sought dismissal
of the preference on the grounds that the trustee failed to state
a claim. The defendant claimed that the trustee had merely recited
the preference statute and had not provided factual information regarding:
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the date of the transfers;
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the number of transfers;
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what property was transferred;
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the means of conveyance;
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the amount of each individual transfer; and
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the alleged antecedent debt on acount of which the transfers
were made.
In the alternative, the defendant sought an order requiring the
trustee to provide a more definite statement of its preference claim
pursuant to Federal Rule of Civil Procedure 12, as made applicable
by Bankruptcy Rule 7012.
The trustee objected to the motion to dismiss on the grounds that
all facts pertinent to the preference claim had been stated as required
by FRCP 12, and that leave to file an amended preference complaint
should be granted.
The complaint alleged the facts that the defendant had an employment
agreement with the debtor, and had been paid by the debtor during
the one year preference period.
The Webvan court noted that dismissal of a preference complaint
for failure to state a claim is a drastic remedy. The court observed
that it is required to accept all of the allegations in the complaint
as true, and draw all reasonable inferences in the light most favorable
to the plaintiff trustee. Further, the court must take the facts
alleged in the complaint as true, and that the transfers made to
the defendant, are transfers to a creditor, on account of an antecedent
debt, while the company was insolvent, within one year prior to the
petition date, and received more than it would have under Chapter
7.
The Webvan court found that the trustee had set forth a claim upon
which relief may be granted. In reviewing Federal Rules of Civil
Procedure 8(a)(2), the court found that FRCP does not impose a heightened
pleading standard on a preference claim, only that it requires a
short and plain statement of the claim showing that the pleader is
entitled to relief.
The Webvan court expressly rejected the heightened pleading standard
imposed on the bankruptcy trustee in preference cases set forth in
TWA v. Marsh USA, Inc., 2004 WL 180421 (Bankr. D.Del. 2004) and Valley
Media Inv. v. Borders, Inc. (In re Valley Media, Inc.), 288 B.R.
189 (Bankr. D.Del. 2003). The TWA and Valley Media courts imposed
the following pleading threshold for a preference claim: (1) plead
the nature and amount of each debt; and (2) identify each transfer,
including date, name of debtor and transferee and the amount of the
transfer.
Although the trustee should provide specific facts at the pleading
stage when available, the Webvan court observed that requiring such
information at the pleading stage is a heavy burden given the time
constraints for filing preference actions and the uncertain condition
of the debtor's books and records. The Webvan court was also concerned
that by imposing a higher pleading standard the valuable claims of
the estate could be lost, resulting in the estate losing preference
recoveries. The creditor�s motion to dismiss the preference action
was denied.
While the creditor was unsuccessful in the Webvan case in having
the preference action dismissed, the credit professional should consider
attacking the preference suit at the pleading stage. Perhaps the
credit professional may find a court adopt a heightened pleading
standard as set forth in the TWA and Valley Media decisions.
Reprinted by permission from The Trade Vendor Quarterly, Summer
04 |