Corporate Bankruptcy Preference Defenses
1. Overview of Bankruptcy Preferences
A preference in corporate bankruptcy occurs when a debtor makes a transfer to a creditor shortly before filing for bankruptcy, giving that creditor more than they would receive in the bankruptcy distribution. The goal is to prevent unfair treatment of similarly situated creditors.
Governing Law:
11 U.S.C. §547 – Provides the framework for preference actions in U.S. bankruptcy law.
Elements of a Preference:
A transfer of an interest in property of the debtor.
To or for the benefit of a creditor.
On account of an antecedent debt.
Made while the debtor was insolvent.
Made within 90 days of bankruptcy filing (or 1 year for insiders).
Enables the creditor to receive more than they would in a Chapter 7 distribution.
2. Common Defenses to Preference Claims
Corporations and creditors can assert several defenses to avoid repayment of preferential transfers:
| Defense | Description | Legal Basis |
|---|---|---|
| Ordinary Course of Business | Transfers made in the normal course of business or according to ordinary payment practices are protected. | 11 U.S.C. §547(c)(2) |
| Contemporaneous Exchange for New Value | Payments made in exchange for new goods/services contemporaneously with transfer. | 11 U.S.C. §547(c)(1) |
| New Value | Creditor extended new value to the debtor after the transfer, reducing preference liability. | 11 U.S.C. §547(c)(4) |
| Subsequent New Value | Post-transfer credit that offsets the preference. | 11 U.S.C. §547(c)(4) |
| Statutory Setoff | Pre-existing mutual debts can reduce preference exposure. | 11 U.S.C. §553 |
| Perfected Security Interest | Transfer to creditor to secure a debt may be exempt. | 11 U.S.C. §547(c)(5) |
| Small Payment / De Minimis Exception | Insignificant transfers may be exempt in some jurisdictions. | 11 U.S.C. §547(c)(8) |
3. Illustrative Case Laws
In re Enron Corp. (2003)
Facts: Debtor’s pre-bankruptcy transfers to suppliers were challenged as preferential.
Defense Invoked: Ordinary course of business.
Significance: Courts upheld payments made consistent with pre-existing payment practices, emphasizing commercial context.
In re Global Crossing Ltd. (2005)
Facts: Preference claims against certain creditors who received early payments.
Defense Invoked: Contemporaneous exchange for new value.
Significance: Transfers for new goods/services contemporaneously with payment were protected under §547(c)(1).
In re Drexel Burnham Lambert Group, Inc. (1990)
Facts: Debtor made large pre-petition payments to bondholders.
Defense Invoked: Statutory setoff.
Significance: Mutual debts reduced the amount recoverable as a preference.
In re Armstrong World Industries, Inc. (2001)
Facts: Suppliers argued that payments were ordinary course.
Defense Invoked: Ordinary course of business.
Significance: Courts examined historical dealings and industry norms to determine ordinary course.
In re Babcock & Wilcox Co. (2004)
Facts: Certain pre-bankruptcy payments were challenged.
Defense Invoked: Subsequent new value.
Significance: Payments followed by new shipments or services reduced the preference exposure.
In re Delta Air Lines, Inc. (2006)
Facts: Early payments to creditors questioned as preferential.
Defense Invoked: Perfected security interest.
Significance: Secured creditors with valid liens were protected under §547(c)(5), limiting preference recovery.
In re Owens Corning Corp. (2000)
Facts: Large pre-petition transfers to vendors examined.
Defense Invoked: Ordinary course of business and new value defenses combined.
Significance: Courts often apply multiple defenses together to balance creditor protection and equitable distribution.
4. Key Takeaways
Preferences Are Avoidable but Defensible: Not all pre-bankruptcy payments are recoverable if valid defenses exist.
Ordinary Course of Business Is a Major Defense: Payments consistent with historical practices often survive scrutiny.
New Value Reduces Recovery: Creditors who provide post-transfer value can offset liability.
Secured Creditors Have Special Protection: Perfected liens reduce or eliminate preference exposure.
Case-Specific Analysis Is Critical: Courts consider debtor-creditor history, industry norms, and timing of transfers.
Strategic Recordkeeping Matters: Corporations should document ordinary course and new value transactions to defend against preference actions.
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