11 U.S.C. Section 547 - Preferences

What Is Section 547?

Section 547 allows the trustee to avoid and recover certain transfers made by the debtor to creditors shortly before bankruptcy. The purpose is to promote equality of distribution among similarly situated creditors by undoing pre-petition transfers that favored particular creditors at the expense of others. The provision also discourages aggressive creditor collection that might otherwise force a debtor into bankruptcy.

The preference remedy is one of the most powerful tools available to a bankruptcy trustee. It does not require any wrongdoing by the creditor; it operates on the structural fact of the transfer regardless of motive. A creditor sued for preference recovery may, however, invoke statutory defenses to limit or defeat the trustee's recovery.

The Five Elements of a Preference: Section 547(b)

Section 547(b) authorizes the trustee to avoid any transfer of an interest of the debtor in property:

1. To or for the benefit of a creditor.
2. For or on account of an antecedent debt owed by the debtor before such transfer was made.
3. Made while the debtor was insolvent. Section 547(f) creates a presumption of insolvency during the 90 days preceding the petition, shifting the burden to the creditor.
4. Made on or within 90 days before the date of the filing of the petition; or between 90 days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider. Insider is defined in Section 101(31) to include relatives of an individual debtor, directors and officers of a corporate debtor, and similar parties.
5. That enables such creditor to receive more than such creditor would receive if (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title.

The "more than it would receive" test means a payment to a fully secured creditor is generally not avoidable, because the creditor would have received full recovery from collateral in a hypothetical Chapter 7. A payment to an unsecured creditor is avoidable to the extent it exceeds the pro rata distribution the creditor would have received as a general unsecured claim.

Defenses: Section 547(c)

Section 547(c) lists several statutory defenses that, if established by the creditor, defeat avoidance:

• 547(c)(1) - Contemporaneous exchange for new value: A transfer intended by both parties to be a contemporaneous exchange for new value given to the debtor, and in fact a substantially contemporaneous exchange.
• 547(c)(2) - Ordinary course of business: A transfer made in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and either made in the ordinary course of business or financial affairs between the parties or made according to ordinary business terms.
• 547(c)(3) - Purchase-money security interest: A transfer creating a security interest in property acquired by the debtor, securing new value given by the secured party, perfected within 30 days after the debtor receives possession.
• 547(c)(4) - Subsequent new value: A transfer to or for the benefit of a creditor, to the extent that after such transfer, such creditor gave new value to or for the benefit of the debtor that is not secured by an otherwise unavoidable security interest and on account of which new value the debtor did not make an otherwise unavoidable transfer.
• 547(c)(5) - Floating lien on inventory or receivables: Protection of a perfected security interest in inventory or receivables, except to the extent the creditor improved its position during the 90-day period.
• 547(c)(6) - Statutory liens: A transfer creating a statutory lien not avoidable under Section 545.
• 547(c)(7) - Domestic-support obligations: Transfers in payment of bona fide alimony, maintenance, or support obligations.
• 547(c)(8) and (c)(9) - De minimis transfers: Transfers totaling less than the statutory threshold (currently $600 for consumer debts, with a separate $6,825 threshold for non-consumer debts as adjusted under Section 104).

The Ordinary-Course Defense in Practice

Section 547(c)(2) is the most heavily litigated preference defense. After BAPCPA, the defense applies if either of two prongs is met (rather than both as before):

• Subjective prong: The transfer was made in the ordinary course of business or financial affairs between the parties (the historical course of dealing between this debtor and this creditor).
• Objective prong: The transfer was made according to ordinary business terms (industry-wide norms for the type of debt at issue).

The subjective prong is fact-intensive and turns on baseline payment timing, communications, and any departures from established patterns. The objective prong requires expert evidence about industry norms. Creditors typically pursue both prongs in the alternative.

Procedure and Recovery

Preference actions are filed as adversary proceedings under Federal Rule of Bankruptcy Procedure 7001(1). The trustee must file within the limitations period of Section 546(a): the later of two years after the order for relief or one year after appointment of the first trustee, but in no event after the case is closed or dismissed. Venue for preference actions of $25,000 or less (currently adjusted to higher thresholds for non-consumer debt) is governed by 28 U.S.C. Section 1409(b), generally requiring filing in the district of the defendant's residence rather than the bankruptcy district.

Recovery of an avoided preference proceeds under Section 550, which permits recovery from the initial transferee, the entity for whose benefit the transfer was made, or any subsequent transferee that did not take in good faith for value.

Related Bankruptcy Code Sections

This section operates in concert with several other provisions of the Bankruptcy Code:

• Section 544 - Other trustee avoidance powers
• Section 548 - Fraudulent transfers
• Section 550 - Liability of transferees
• Section 541 - Property of the estate including recovered transfers
• Section 506 - Secured status affecting the 547(b)(5) "more than" test

Understanding how these sections interact is important for debtors, creditors, trustees, and counsel navigating a bankruptcy case.