Curbing Abusive Preference Actions A Contrary View

Curbing Abusive Preference Actions A Contrary View

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In "Curbing Abusive Preference Actions; Rethinking Claims on Behalf of Administratively Insolvent Estates,"2 Tom Goldberg writes critically about the prosecution of preference actions "when the recoveries will have no material impact on the recovery to general unsecured creditors." With due respect to Tom, for whom I have developed sincere regard over many years, I cannot leave his discussion unchallenged. Giving voice to a perceived problem is fair, but attributing it to ethical lapses of hard-working colleagues who are almost always highly ethical advocates of their clients' rights is off base.

The article readily acknowledges that the two most common legal attacks on these "abusive" preference actions either "beg the question" (the standing objection) or have been rejected as being at odds with the statute or the case law (the argument that recoveries "do not benefit the estate"). As a result, Tom is left to argue what should not occur in his view, in many respects essentially restating the same objections he acknowledges have been held to be legally unsound.

Abuse Is in the Eye of the Beholder

The argument that so many courts are wrong is the product of the core problem with the article, namely that it cannot define what a "clearly abusive preference action" is. While the greatest emphasis in the article is on preference actions in cases where general creditors will not (are not likely to) receive a dividend, the article also criticizes preference actions that "will not materially benefit unsecured creditors." Based on the article, one can readily infer that "preference claims [that] will simply offer the prospect of enhancing a two-cent plan into a three-cent plan" do not "materially benefit" unsecured creditors. But just how we are to define "material benefit" to unsecured creditors is left entirely unclear. What of the case where the one-cent increase amounts to $1,000,000 cash in a particular creditor's pocket? What of the one where $1,000,000 in cash is collectively added to the distributions of 2,000 creditors? Just where does one find the line between "material" benefit and "immaterial" benefit? And how is one to search out that line before the preference claims are litigated? Or before the roster of allowable claims is fixed?

The article also proceeds on the assumption that knowing that a preference action will put "materially more money" in general creditors' pockets (or, presumably, at least is highly likely to) should be a required element of the decision to prosecute preference actions. This would make it nearly an element of the cause of action itself. But while enhancement of unsecured creditors' return is a worthy goal that is prominent at the outset of every case, it is not the only cornerstone of bankruptcy policy, and by the time the decision of whether to prosecute preferences has arrived, other policy factors may well have become more prominent. For example, attracting competent professionals to bankruptcy cases by increasing their assurance of payment is also a recognized policy goal of the bankruptcy system. So is discouraging creditors from dismembering a debtor by attacking it with collection actions based on debts the debtor simply cannot pay. Actions taken in furtherance of those other goals are not less worthy because one cannot then also predict that general creditors' dividends will be "materially" enhanced by those actions.

When all is said and done, the article primarily (if not entirely) blames "professionals" for the "abusive preference cases." But what is clearly at work here is that defendants with essentially indisputable legal liability simply do not want to own up to it. In this respect, Tom and his clients are like defendants everywhere, and that instinct is both reasonable and expected. It is inappropriate, however, to twist that self-interested posture into accusations of unethical conduct by others.

We do not speak, of course, of actions that are known to be without merit. The article does not stand on the premise that the challenged actions are legally deficient. Of course, actions filed without a good-faith belief in their legal viability indeed are "abusive" and should be curbed, but not for the reasons Tom puts forth. Those actions are frivolous in any environment and should not be prosecuted.

But where the claims at hand appear to satisfy the legislatively mandated elements of the right of action, the situation is very different. Take, for example, the article's effort to advance social justice by proposing to disable the statutory cause of action where intervening administrative fees will (most likely) absorb preference recoveries before they trickle down to general creditors. From this (unfortunately) common phenomenon, Tom infers that it is unethical to pursue actions that only would "satisfy administrative expense claims."

Exactly why satisfying administrative expense claims is unethical is unclear, to say the least. Worse, this also ignores the source of those accrued fees, such as a creditors' committee's counsel's tireless—but ultimately fruitless—effort to develop a value slice of the debtor for general creditors, or a trustee's counsel's equally dedicated pursuit of an insider, only to have a court hold that the insider's post-petition recordation of a deed of trust is not avoidable because the debtor listed the debt and the unrecorded instrument in its bankruptcy schedules.

Both of these, and dozens of similar scenarios, are realities in this respondent's experience. On the other hand, I have yet to see a preference defendant or its counsel, while expressing exactly the same concern Tom does here for the lack of an unsecured creditors' dividend traceable to the disgorgement of his or her preference liability, take it upon themselves to object to the asserted administrative expenses for purposes of being sure the disgorgement proceeds will reach those who are worthy.

Code Protects All Creditors

With apologies for a degree of facetiousness, the analysis is real. That is, administrative creditors and taxing agencies are creditors too. Pre-petition trade creditors—who become preference defendants in many cases—are not the only worthy creditors, and what a plaintiff should or should not do with the proceeds of a defendant's liability is no concern of the defendant's, either in law or equity. Otherwise, defendants everywhere could defeat lawsuits by establishing that the plaintiff hired an inefficient lawyer, the result of which will be that the plaintiff will enjoy far fewer benefits from a judgment than the defendant judges should be the case.

Measuring administrative decisions by front-end guesstimates about what will reach pre-petition creditors puts the cart before the horse and is, ironically enough, an argument made by those who truly lack "standing" to make it, in law and logic. While it is true that in some cases it becomes indisputably clear that neither preference recoveries nor any other back-end income to the estate will flow to the bottom of the creditor food chain, in many other cases where this is suspected (or assumed), the actual outcome is much less certain. For example, a large pre-conversion administrative claim might be allocated off and deemed satisfied by the proceeds, if any, of one particular matter of speculative litigation. Or long-shot litigation might "come in" after all. Or a white knight might show up to recapitalize the debtor on the eve of conversion. Again, all these have actually happened. Not often, but they happen and it would be not only unworkable practically, but bad legal policy, to cause the rights between a plaintiff and defendant in a preference action to turn, at the front end, on guesstimates about long-shot, high-return possibilities down the road.3

To be sure, no one advocates unethical litigation, but the point here is that the boundaries of ethical litigation are no different in "preference portfolio" assignments than they are anywhere else. And more to the point, those boundaries are much broader than Tom suggests. For example, while Tom wants preference actions barred "unless an initial determination has been made that the recipient does not appear to have meritorious defenses," at least one circuit court has plainly suggested that being an effective and zealous advocate precludes making the assumption that an adversary's defenses will prevail. Golden Eagle Distributing Corp. v. Burroughs Corp., 801 F.2d 1531, 1542 (9th Cir. 1986).

The law, as written, works properly when the truly operative public policy is kept in perspective, not just the one that speaks only to a defendant's selfish interests. At the same time, there is recourse for those interests, namely with Congress. If "subjecting" defendants to such "abuses" is truly wrong when all policy factors are accounted for, the legislative branch will rewrite the law. Clearly the financial institutions, telecom giants and international industrial producers of goods who are "abused" by the current system have as strong access to the legislative process as anyone.4 In the meantime, those personal economic interests should not parade as disappointment with the ethics of other advocates.


1 Mr. Weinstein has been a bankruptcy practitioner for 25 years. All of that time has been spent in bankruptcy "boutiques," where clients regularly include all types of constituents in bankruptcy cases, large and small. Mr. Weinstein has prosecuted and defended numerous preference actions. Return to article

2 ABI Journal, On the Edge column (May 2004). Return to article

3 This, of course, does not even try to measure what return to pre-petition creditors would be worthy in the first place: 5 percent? 10? 2? Return to article

4 Congress did exactly this in 1994 when institutional defendants expressed outrage over the DePrizio decision. Return to article

Journal Date: 
Thursday, July 1, 2004