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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:

  1. the date of the transfers;

  2. the number of transfers;

  3. what property was transferred;

  4. the means of conveyance;

  5. the amount of each individual transfer; and

  6. 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

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