The law of preferential transfers permits the trustee of a bankruptcy estate to avoid transfers made by the debtor to a creditor on account of a prior debt in the 90 days leading up to the bankruptcy proceeding. The standard for avoiding these preferential transfers is one of strict liability, on the rationale that preference actions exist to ensure that all general creditors of the bankruptcy estate recover the same proportional amount, regardless of the debtor’s intent to favor any one creditor or the creditor’s intent to be so favored. However, preference law also permits certain exceptions to strict preference liability and gives the estate trustee discretion in pursuing preference actions. These exceptions and the use of discretion permit the continuation of preferences to certain creditors. Such practices undermine the policy of equal distribution by permitting some creditors to fare better than others in the bankruptcy distribution. However, these practices are arguably necessary to promote conflicting bankruptcy policies that seek to maximize the estate for the benefit of creditors and encourage the survival of struggling businesses.
As a result, the law of preferences is internally inconsistent and controversial, attempting unsuccessfully to serve multiple policy masters at the same time. Much of the analysis on preferences up to now has proposed amending preference law generally in an attempt to satisfy these often conflicting demands. This article recommends consideration of a more dramatic approach; returning preference law to a mechanism of equal distribution in liquidation proceedings by eliminating true exceptions to the rule, and doing away with preference law altogether in the context of bankruptcy reorganization.
The article argues that preference liability should be eliminated when a strict policy of equal distribution is not a priority, and more firmly establish preference liability when it is. As such, the article would amend the Bankruptcy Code to eliminate preference liability for creditors who do business with a debtor in the 90 days prior to a filing for Chapter 11 reorganization, thereby promoting economic activity and improving the debtor’s chances of survival. Contrariwise, the Bankruptcy Code should remove the true exceptions to preference liability in the context of bankruptcy liquidation, thereby promoting a strict equality of distribution, regardless of the creditor’s intent or motivation, and tangentially improving the prospects of estate maximization by reducing the costs of preference actions.
This article intentionally ignores both a review and policy suggestions about preference actions in Chapter 13, due to an alleged “uncertainty preference actions in chapter 13” as the Bankruptcy Code “makes no express provision permitting or prohibiting a chapter 13 trustee from exercising a trustee’s avoidance powers.” This seems an unfortunate dodge, as the interests of equal distribution and reorganization are also in tension.
Regardless of the policy proscriptions, this article is an excellent primer on preferences.
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