Pleading the preference claim: is it getting easier for the bankruptcy trustee?(Credit Column)

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 what 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. 0354365 (CGC) (Delaware 2004), the court found that the Federal Rules of Bankruptcy Procedure do 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 far-reaching 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.