Perhaps Preferential Transfer Litigation is Not Worth the Cost- two ...
12/20/19
Although the primary thrust of the Small Business Reorganization Act of 2019 which was signed by the President on August 23 is to provide relief to reorganizing small businesses, the act has two provisions that are intended to provide some relief from the threat of questionable and small dollar bankruptcy preference claims. One of the preference aspects of this new law requires bankruptcy trustees and post confirmation trustees and debtors in possession and others who initiate preference actions to: consider, before commencing suit, an alleged preference recipient’s statutory defenses based on “reasonable diligence in the circumstances; and taking into account a party’s known or reasonably knowable affirmative defenses.” (punctuation added) The second preference aspect of the new law amends a bankruptcy venue provision that, if applied to preference suits, may reduce the number of small (under $25,000) preference cases filed.
Although the avoidance of preferences has been part of US Bankruptcy law for over two hundred years and has generated considerable litigation, there is virtually no empirical research into the actual operation and impact of American preference law.
The “reasonable diligence” provision of the new law is a reflection of the critical perception that pre-litigation demands and litigation are often made or filed without sufficient consideration of the validity of the claim. Because 547 (a) generally sets forth the elements of the plaintiff’s cause of action and 547 (b) generally sets forth the defenses, existing court decisions exonerate a plaintiff that files on the basis of the 547 (a) facts with no or little review of the 547 defenses before making demand or filing suit.
A recent article of mine [2019 No. 11 Norton Bankr. L. Adviser NL 1 (or 2019 WL 4919025)] looks at preference litigation in twenty one large cases filed under chapter 11. The article was not intended to be a classic empirical study but rather to take a first small step onto the examination of this important area of the law.
In sixteen of the twenty one sample chapter 11 cases the study was able to identify the percentage of recovery to unsecured creditors. In the cases studied, the unsecured creditor class received the following returns on their allowed claims.
0 0% (Case is not complete but this is the anticipated result.)
Less than 0.1%
.6%
0.38%
1.1%
2.91%
4%
At least 5%
7.6%
At least -7.8%
21% in one of the estates 0 - 16% in the others.
30.99%
67%
67%
90%
The following percentages in the various estates: 87.4% to 88.0% 6.5% to 6.7% 5.6% to 5.9%
The study also compared the amount sought in the preference complaint with the amount of the recovery in that adversary proceeding. Although the information was available in only seven cases, the information that was available on the ratio was surprisingly constant.
12%
14 % plus claims reduction in an asset case
15%
15%
15.3%
6 - 20%
16.3%
The study noted other crucial information that was not available. For example, costs of the prosecutions was available only if the case is converted to Chapter 7 and the Chapter 7 trustee provides this information in her report; or if the court required the post confirmation entity to report its fees or seek permission to collect its fees and provide information on preference recoveries. If there is a post chapter 11 confirmation trustee, most courts do not require the trustee to provide extensive information; a few require information about the settlements or court consent. Some require reports on fees but most do not. The important data that arises from pre litigation demands of trustees is also missing and hard to capture.
Professor Brook Gotberg continues to do insightful work on surveys of other important related issues such as defendant costs and whether the existence of the avoidance law has the effects contemplated by the drafters of the statute. e.g. Conflicting Preferences in Business Bankruptcy: The Need for Different Rules in Different Chapters, 100 IOWA L. REV. 51 (2014)
The new due diligence requirement may result in a reduction of the number of preference actions particularly if defendants seek damages under Rule 9011 in a few appropriate cases.
The small dollar venue provision of the Act is a reflection of the fact that many of the preference adversary proceedings are related to large chapter 11 cases filed in Delaware and the Southern District of New York and that the costs of hiring local counsel there and other costs of defense are a considerable burden for defendants, most of which are located elsewhere. This provision amends section 1409(b) of Title 28 to require that any proceeding arising in or related to a bankruptcy case against a non-insider to recover a non-consumer debt of less than $25,000 (an increase from $13,650 currently) be commenced in the district where the defendant resides.
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