To assure equality of distribution among similarly situated creditors, the trustee is authorized to avoid certain transfers made within 90 days of bankruptcy that would otherwise benefit one or more creditors at the expense of other creditors. Such transfers are termed “preferences.” All of the following elements must be present to avoid a transfer as a preference there must be:
•A transfer;
•Of property of the debtor;
•To or for the benefit of a creditor;
•On account of an antecedent debt;
•Made while the debtor was insolvent;
•Within 90 days prior to filing of the petition (or within one year if the transferee was an “insider”);
•Which prefers the creditor receiving the transfer;
•Certain minimums apply.
A “preference” may occur if the Bank “shored up” its loan by obtaining a security interest in additional collateral within 90 days of the Bankruptcy filing. The Bank may lose its security interest as to the additional collateral because the creation and perfection of a contractual lien (e.g., taking and recording a trust deed on real estate, or a security interest in personal property) is a “transfer.” Judicial liens and transfers are “transfers” even though not consensual.
A transfer is made for preference purposes on the date it takes effect between the transferor and transferee if the transfer is perfected within 10 days thereafter. If the transfer is perfected more than 10 days after it takes effect, it is made for preference purposes at the time of perfection.
Certain transfers that would otherwise be preferential (above) are not avoidable by the trustee or DIP and thus are defensible. For example, the trustee may not avoid a transfer to the extent it was intended by the parties to be a substantially contemporaneous exchange for new value given by the debtor; and was in fact, a substantially contemporaneous exchange.
The most important exception to the preference rule shelters “ordinary course” transactions from preference attack. The trustee may not avoid a transfer that was made in payment of a debt incurred by the debtor in the “ordinary course of business” or financial affairs of the debtor and transferee, and such transfer was (i) in the ordinary course of business or financial affairs of the debtor and transferee, or (ii) according to ordinary business terms.
Also shielded from preference attack are certain transfers that create a security interest similar to a purchase money security interest. The security interest must secure new value that was given to enable the debtor to acquire particular property, and in fact used to acquire such property.
Finally, a transfer may be protected from preference attack to the extent the creditor gave new value to the debtor after the transfer.
Some creditors have “floating” perfected liens in the debtor’s inventory and/or receivables and the proceeds therefrom. To the extent such creditors do not improve their net positions in the collateral during the avoidance period, perfected liens on new inventory and/or receivables (and their proceeds) are not avoidable as preferences.