Two Transfers for the Price of One When a Preferential Transfer Is Made According to 547

Two Transfers for the Price of One When a Preferential Transfer Is Made According to 547

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Payments made by a debtor within 90 days of its bankruptcy filing are "preferential," in bankruptcy parlance, and with few exceptions are recoverable from the recipient by the bankruptcy estate.[1] Since defining the parameters of the 90-day period can be critical to determining whether particular transfers are within the sweep of the estate's preference recovery power, it is necessary to determine when a transfer is "made" within the meaning of Bankruptcy Code §547.

Section 547 appears to address this question in §547(e).[2] However, the byzantine language of the provision is not particularly helpful in the case of trade creditors, who receive payments primarily by check or wire transfer. Few courts or litigants have been satisfied that subsection (e) addresses those types of transfers clearly.

Since wire transfers are relatively instantaneous, there is little confusion as to when a particular transfer by wire is made for preference purposes. The transfer is made when it is made. However, with checks, the answer is not so clear. A typical check transaction involves: (i) deposit of the check in the mail, (ii) receipt of the check by the creditor, (iii) deposit of the check at the creditor's bank, (iv) presentment of the check to the debtor's bank and (v) honor (or dishonor) of the check by the debtor's bank. Courts have adopted varying views as to when in this series of events the transfer was actually made, for preference purposes.

Cases tended to find either that the transfer was made upon the delivery of the check (what constituted "delivery" in this context giving rise to a subsidiary question discussed below), or upon the honoring of the check by the drawer's bank.

The Supreme Court resolved this split in 1992 in Barnhill v. Johnson, 503 U.S. 393. In Barnhill, the court was faced with the question of whether a check delivered outside the 90-day preference period, but honored within that period, was a recoverable preferential transfer within the meaning of §547(b). The court held that the payment was a recoverable preferential transfer, since a transfer by check is made when the drawer's bank honors the check.

It is unclear whether a creditor can unilaterally gerrymander the date a transfer is deemed made by purposefully delaying the negotiation of a check, to take better advantage of preference defenses.

Although the court considered several factors bearing on its decision, including the definition of "transfer" in the general definition section of the Bankruptcy Code, the language of §547(e) and the legislative history of §547, the court's decision ultimately rested on what might be termed "commercial reality." Recognizing that "myriad events can intervene between delivery and presentment of the check that would result in the check being dishonored," the court concluded that no transfer takes place until a check is honored, when the transfer becomes irrevocable.

Barnhill was greeted with relief by the bankruptcy bar and business community, as it appeared to resolve a regularly contested issue in preference law. However, a question remained as to the applicability of Barnhill's date-of-honor rule to all subsections of §547, particularly the defenses to the estate's avoidance powers set forth in §547(c). Although §547 by its terms contemplates a single transfer date for all of §547, parties questioned whether Barnhill's date-of-honor rule applied to §547(c), in light of the pre-Barnhill jurisprudence following a date-of-delivery rule for that subsection. Indeed, Barnhill encouraged this uncertainty by acknowledging the existence of the date-of-delivery cases and specifically declining to express an opinion thereon.

Seizing upon this opportunity, litigants subsequent to Barnhill continued to argue that a transfer was made on the date of delivery, notwithstanding Barnhill's date-of-honor rule, in the context of asserting defenses to preference avoidance pursuant to §547(c). Virtually all published cases stuck with the date-of-delivery rule for §547(c). See, e.g.,In re Lee, 108 F.3d 239 (9th Cir. 1997); In re M & L Business Machine Co. Inc., 198 B.R. 800 (D.Colo. 1996); In re National Enterprises Inc., 174 B.R. 429 (Bankr. E.D. Va. 1994); In re Ladera Heights Community Hospital Inc., 152 B.R. 964 (Bankr. C.D. Cal. 1993).

Ironically, the date-of-delivery cases purport to rely on commercial practicality to support their reasoning, much the same as did Barnhill in reaching the opposite conclusion. In the date-of-delivery cases under §547(c), the purported commercial reality is that the date-of-delivery rule encourages creditors to extend credit to financially-troubled debtors. See, e.g.,In re Kroh Brothers Development Co., 930 F.2d 648, 650-651 (8th Cir. 1991); In re National Enterprises, 174 B.R. at 433.

The date-of-delivery cases theorize that creditors are more likely to extend additional credit upon receipt of a check payment if that payment will be protected from preference avoidance in a subsequent bankruptcy case. The date-of-delivery rule makes the application of defenses more likely since it moves forward the date a transfer is made. This benefits the creditor because any goods or services supplied between the date of the delivery of the check and the honoring thereof will be excepted from recovery as contemporaneous exchanges or subsequent provisions of new value, pursuant to §§547(c)(1) and (c)(4), respectively. If the date-of-honor rule applied, those transfers would not be excepted from avoidance.

However, the premise that creditors will alter their behavior in response to the adoption of the date-of-delivery rule is flawed in several respects. While it may be true that a creditor might extend new credit upon receipt of a check, it is a stretch to think it is because of the realization that if the debtor were to file for bankruptcy, an exception from preference avoidance would be more likely to apply. Indeed, it is more likely that if a creditor had any hint that a bankruptcy loomed in the next 90 days, there would be no further credit extended, regardless of preference avoidance rules.

Offsetting a potential preference is simply a silly reason to ship goods. It is therefore naive to think that creditors are encouraged to engage in the practice because preference exceptions might be more favorable under the date-of-delivery rule. That the date-of-delivery rule can reward creditors is true. Encouraging desired behavior based upon reliance of the rule, however, is a different story.

Moreover, in light of the fact that a check can be cancelled at any time before it is honored, or other events can take place to render the check worthless (i.e., the very "commercial reality" underlying the Barnhill date-of-honor rule), it is unlikely that a sophisticated creditor with knowledge of a debtor's financial difficulties would extend credit based just upon the receipt of the check. Perhaps the receipt of a check, as evidence of good faith, is an inducement to continue to ship new goods, even before the check clears. However, that is totally independent of the potentially applicable preference defenses.

Nevertheless, courts continue to follow the date-of-delivery rule, virtually without exception, in determining the date a preference is made for purposes of §547(c). Therefore, a single preferential transfer can, in fact, be made twice—once under §547(b) and once under §547(c).

Trade creditors should be aware of the disparate treatment concerning when a transfer is deemed made under §547 for two reasons. First, in the event of a preferential transfer claim by the estate of a bankrupt customer, the creditor should realize that the applicability of the date-of-delivery rule can substantially affect, usually positively, applicable defenses. Moreover, since the cases are unclear, with respect to checks sent by mail, as to whether "delivery" is the date of mailing or the date of receipt, the creditor should argue that the date of mailing, which will usually be more favorable to the creditor, is the date the transfer was made for purposes of §547(c).[3]

Second, the potential applicability of the date-of-delivery rule underscores the importance of promptly negotiating checks received. That is because the date-of-delivery rule contains the limitation that the check must be negotiated within a reasonable time from receipt in order for the check to be deemed made upon delivery. Most cases construe a "reasonable time" to mean 10 days. See, e.g.,In re Wadsworth Building Components Inc., 711 F.2d 122 (9th Cir, 1983). One case, however, has suggested that for purposes of subsection (c)(1) and (c)(2) only, 30 days from receipt is a reasonable time. In re Wolf & Vine, 825 F.2d 197 (9th Cir. 1987). If the check is not negotiated within the reasonable period, the transfer reverts back to the Barnhill date-of-honor rule. Accordingly, creditors should exercise diligence in ensuring that checks are negotiated promptly.[4]

It is unclear whether a creditor can unilaterally gerrymander the date a transfer is deemed made by purposefully delaying the negotiation of a check, to take better advantage of preference defenses. For example, where it is clear that a bankruptcy will be filed and the creditor has no new value defenses that will be made more favorable by the date-of-delivery rule, can a creditor hold the check beyond the reasonable time period under §547(c), so that the date-of-honor rule will apply instead of the date-of-delivery rule? Deeming the transfer made on the date of honor might render the timing of the transfer more in line with the parties' historical payment pattern, thereby increasing the chances that the payment will be found to have been made in the ordinary course of business within the meaning of §547(c)(2).

No published decision appears to have addressed this question. It should be recognized that this strategy may pose risks disproportionate to its potential benefits, since every day a check is uncashed increases the chances that it will be dishonored,particularly in the case of a check from a financially troubled debtor. In addition, the practice of delaying the negotiation of a check for an unusually lengthy period may be found to render the transfer outside the ordinary course of business by definition, resulting in the defeat of the very defense that the creditor attempted to enhance.

Due to these risks, whether a creditor can influence the date a transfer is made for §547(c) purposes by delaying negotiation of a check is likely to remain a question of academic interest. Generally creditors do, and indeed should, follow the time-honored "deposit first, ask 'preference' questions later" approach.


[1]11 U.S.C §547 et seq.[RETURN TO TEXT]

[2] Section 547 provides, in part:

For the purposes of this section...a transfer is made—
(A) at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 10 days after, such time, except as provided in subsection (c)(3)(B);
(B) at the time such transfer is perfected, if such transfer is perfected after such 10 days; or
(C) immediately before the date of the filing of the petition, if such transfer is not perfected at the later of—
(i) the commencement of the case; or
(ii) 10 days after such transfer takes effect between the transferor and the transferee.
11 U.S.C. §547(e)(2).[RETURN TO TEXT] <>/BLOCKQUOTE>

[3] The Uniform Commercial Code supports the argument that delivery occurs on the date a check is mailed, rather than upon receipt. Furthermore, since the date of mailing is likely to be the same date as the date of the check, proof problems are minimized by adopting the date of mailing. Therefore, creditors have valid arguments supporting assertions that the date of mailing should control.[RETURN TO TEXT]

[4] While this may seem to go without saying, the case law is replete with cases where the creditor failed to negotiate checks in a reasonable period of time. See, e.g.,In re Wolf & Vine, 825 F.2d 197 (9th Cir. 1987).[RETURN TO TEXT]

Journal Date: 
Wednesday, October 1, 1997