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Trustee Beware The Defenses to the Preference Claim - Part IV

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Section 546(a) of the Code currently provides that a preference action (among others) may not be commenced after the earlier of:

(1) the later of—
(a) 2 years after the entry of the order for relief; or
(b) 1 year after the appointment or election of the first trustee under §702, 1104, 1163, 1202 or 1302 of this title if such appointment occurs before the expiration of the period specified in subparagraph (a); or
(2) the time the case is closed or dismissed.

Section 546(a) of the Code makes it clear that a limitation of two years begins to run upon the chapter 7, 13 or 11 filing. If a trustee is appointed, then it begins anew with the appointment of the first trustee under §702 (election of a trustee by creditors in chapter 7 cases), §1104 (appointment of a trustee in chapter 11 cases), §1163 (appointment of a trustee in a railroad reorganization), §1202 (appointment of a trustee in family-farmer chapter 12 cases), or §1302 (appointment of a trustee in chapter 13 cases). See §546(a)(1)(b). The closing or dismissal of a bankruptcy case bars any preference adversary proceeding. §546(a)(2).

Before the 1994 amendment of §546(a), the Ninth Circuit held, in In re Software Centre. Intern. Inc., 994 F.2d 682 (9th Cir. 1993), that this subsection, which provides that a trustee may not commence a preference action after the running of the statute of limitations, applies to an adversary proceeding filed by a debtor-in-possession. The Fifth Circuit, in In re CompuAdd Corp., 137 F.3d 880, 881-882 (5th Cir. 1998), also held that the two-year statute of limitations applies to debtors-in-possession in the same manner that §546(a) applies to trustees. (The Fifth Circuit in CompuAdd had to apply the pre-1994 version of §546(a), since the chapter 11 petition had been filed in 1993.)

The appointment of an estate representative under §1123(b)(3) to retain and enforce any claim or interest belonging to the debtor or to the estate does not restart the running of the two-year statute of limitations; the limitation period begins running on the date a chapter 11 petition is filed. See In re DeLaurentiis Entertainment Group Inc., 87 F.3d 1061, 1064 (9th Cir. 1996); Starzynski v. Sequoia Forest Industries, 72 F.3d 816, 822 (10th Cir. 1995).

Earmarking Doctrine

On occasion, a third party lends money to a debtor for the purpose of paying a specific creditor. Under the earmarking doctrine, the loan is not a preferential transfer because the third party is simply substituted for the original creditor. See In re Heitkamp, 137 F.3d 1087, 1089 (8th Cir. 1998); In re Interior & Wood Products Co., 986 F.2d 228, 231 (8th Cir. 1993); In re Kelton Motors Inc., 97 F.3d 22, 28 (2nd Cir. 1996).

In Heitkamp, the preference action defendant was a bank that had advanced money to the debtor to pay the debtor's obligations to certain subcontractors who had furnished labor and material in the construction of a house. The debtor, in consideration of the loan, granted the bank a second mortgage to secure the loan. The subcontractors released their mechanic's liens after they received payment from the debtor. The trustee sought to have the second mortgage voided as a preferential transfer; however, the Eighth Circuit stated that under the earmarking doctrine, there is no avoidable transfer when (1) a new lender and debtor agree to use the loaned funds to pay a specific antecedent debt; (2) the agreement terms are actually performed; and (3) the transaction viewed as a whole does not diminish the debtor's estate. Heitkamp at 1088-1089. The court held there was no preference in such a situation because the loan funds had never become property of the estate; instead, a new creditor had simply stepped into the shoes of an old creditor. Heitkamp at 1089. The earmarking doctrine does not apply when a new creditor is not substituted for an old creditor. In re Interior Wood Products Co., 986 F.2d at 232. Nor is it limited to the protection of guarantors. In re Kemp Pac. Fisheries Inc., 16 F.3d 313, 316, n.2 (9th Cir. 1994).

Bad Checks

The "contemporaneous exchange" defense is not available to a creditor who had been given a bad check by the debtor pre-petition but to whom the debtor subsequently paid the debt; the dishonor of the check creates an antecedent debt. See In re Barefoot, 952 F.2d 795, 800 (4th Cir. 1991); In re Car Renovators, 946 F.2d 780, 782 (11th Cir. 1991); In re Standard Food Services Inc., 723 F.2d 820, 821 (11th Cir. 1984). Payment by a bad check and subsequent payment by the debtor to the creditor also strips the creditor of the ordinary-course-of-business defense. See In re Barefoot at 801; In re Federated Marketing Inc., 123 B.R. 265, 270 (Bankr. S.D. Ohio 1991); In re Kroh Bros. Development Co., 115 B.R. 1011, 1020 (Bankr. W.D. Mo. 1990). Some courts hold that a replacement check does not relate back to the date of the bad check. See In re So Good Potato Chip Co., 137 B.R. 330, 331 (Bankr. E.D. Mo. 1992). Other courts, however, hold that if the debtor honors the bad check within a reasonable time, then the transfer date will relate back to the delivery date of the dishonored check. In re Kenitra Inc., 797 F.2d 790, 791 (9th Cir. 1986).

Journal Date: 
Friday, June 1, 2001

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