Assignment 19
The Trustee’s Avoiding Powers
The Avoiding Powers
• Ch. 7 trustee can avoid (invalidate) certain
transfers of property that had the effect of
diminishing the bankruptcy estate
–
–
–
–
Unperfected SIs (“strong-arm” power) [§ 544(a)]
Preferential transfers [§ 547]
Fraudulent transfers [§§ 548, 544(b)]
Unauthorized post-petition transfers [§ 549]
• The debtor-in-possession can exercise these
powers in a Chapter 11 case [§ 1107(a)]
• § 544 gives the bankruptcy
trustee special status
– § 544(a)(1): hypothetical
“lien creditor” as to all of
debtor’s personal property
– § 544(a)(3): “bona fide
purchaser” as to debtor’s land
• § 544(a) then gives trustee the
power to invalidate any
transfer that these persons
could have avoided under state
law [such as § 9-317(a)(2)(A)]
The “StrongArm” Power
• 2013: Bank financed the
purchase of a pipe organ by
Carr, took a SI in the organ
Problem 1(a)
– Bank prepared a UCC-1, but
never filed it
Trustee as
Lien Creditor
• Oct. 2015: Carr filed Ch. 7
• Oct. 31: Bank belatedly files
UCC-1 covering pipe organ
• Could Trustee set aside
Bank’s SI in the organ under
§ 544(a)(1)?
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Problem 1(a)
• Key fact: was the pipe organ “equipment” or
“consumer goods” in Carr’s hands?
– If consumer goods, Bank had an automatically
perfected PMSI [§ 9-309(1)] on petition date; not
avoidable under strong-arm clause
– If pipe organ was equipment, Bank’s SI was
unperfected on the petition date, Trustee may thus
avoid that SI [§§ 9-317(a)(2)(A), 544(a)(1)]
Problem 1(b)
• Oct. 22: Bank loans $10,000 to Tanya’s Treats
LLC, to finance its purchase of candy-making
equipment (in which PCB took a SI)
• Oct. 31: Tanya’s Treats LLC files Ch. 11 petition
• Later in the day on Oct. 31: Bank files UCC-1
covering the equipment
• Can Trustee avoid Bank’s SI in the equipment
under the “strong-arm” clause?
• If pipe organ was equipment:
– Under Article 9, a lien creditor would take
priority over an unperfected SI [§ 9317(a)(2)(A)]
– Trustee has status of lien creditor as of date of
bankruptcy petition [§ 544(a)(1)]
– Trustee can set aside Bank’s SI if it was
unperfected on petition date
– Bank’s October 31 filing UCC-1 has no effect,
b/c it violates the automatic stay [§ 362(a)(4)]
– Bank will have only an unsecured claim
Problem 1(b): Article 9 Analysis
• Under Article 9, Bank would have had
priority over an intervening lien creditor
– § 9-317(e): PMSP can file UCC-1 w/in 20 days
after debtor takes possession and get relationback priority over intervening lien creditors
– Bank filed w/in 20-day grace period, so
intervening lien creditor would be subordinate
to Bank’s perfected SI [§ 9-317(e)]
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§§ 544(a), 546(b), and the Stay
• Ordinarily, filing a UCC-1 after the petition date
would violate the automatic stay [§ 362(a)(4)]
• But Bank’s filing (act of perfection) doesn’t
violate the stay in this situation [§ 362(b)(3)]
– Code doesn’t stay an act of perfection to extent the
trustee’s avoiding power is subject to § 546(b)
– § 546(b) makes the trustee’s avoiding power
subject to state law relation-back priority rules!
• Bank’s filing thus perfected its SI, which can’t be
avoided by bankruptcy trustee [§ 9-317(e)]
• 2013: Bank loaned $12,000 to
Simpson, taking SI in her six
saxophones
– Bank filed UCC-1 covering the
saxophones in MO, where
Simpson resided
• Oct. 31, 2015: Simpson files
Ch. 7 petition in Wisconsin, to
which she has moved
• Can Bank file a UCC-1 in
Wisconsin at this point?
Would it do them any good?
Problem 1(c)
§ 546(b)(1). The rights and powers of a trustee
under sections 544, 545, and 549 of this title are
subject to any generally applicable law that—
(A) permits perfection of an interest in
property to be effective against an entity that
acquires rights in such property before the date
of perfection; or
(B) provides for the maintenance or
continuation of perfection of an interest in property
to be effective against an entity that acquires rights
in such property before the date on which action is
taken to effect such maintenance or continuation.
• Q: Was Bank’s SI perfected on petition date?
– Bank had 4 months of temporary perfection after
Simpson moved to WI [§ 9-316(a)(2)]
– If Simpson moved to WI before June 30, 4 month grace
period has lapsed, Bank’s SI was unperfected on
petition date, and Trustee could avoid its SI
– If Simpson moved on/after July 1, Bank’s SI was still
perfected on petition date; Trustee (who obtained status
of lien creditor on that date) couldn’t set aside Bank’s
perfected SI
• If Simpson moved after July 1, does Bank need to
file a new UCC-1 in WI?
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• Bank wouldn’t have to file in WI to get priority vs.
Ch. 7 trustee (no retroactive loss of priority upon
lapse vs. lien creditors like the bankruptcy trustee) [§
9-316(b)]
• But Bank would need to file if there had been other
intervening third party purchasers (i.e., other secured
parties or buyers)
• During remaining 4-month grace period, Bank can
file in WI without violating the automatic stay [§§
362(b)(3), 546(b)(1)(B)] (trustee’s avoiding power is
subject to § 9-316 re-perfection rules)
• October 1, 2015: Bank loaned
Moore $20,000 to buy a used
BMW, took SI in the BMW
• October 23, 2015: Moore
filed Ch. 7 petition
• October 25, 2015: Bank
applied to have its lien noted
on the title certificate for the
BMW (more than 20 days
after October 1)
• Can Trustee avoid Bank’s SI
in the BMW?
Problem 1(d)
§ 546(b)(1). The rights and powers of a trustee
under sections 544, 545, and 549 of this title are
subject to any generally applicable law that—
(A) permits perfection of an interest in
property to be effective against an entity that
acquires rights in such property before the date of
perfection; or
(B) provides for the maintenance or
continuation of perfection of an interest in property
to be effective against an entity that acquires rights
in such property before the date on which action is
taken to effect such maintenance or continuation.
• Note: Missouri’s certificate-of-title act allows
for a 30-day relation-back period
– “The notice of lien is perfected as of the time of
its creation if the delivery of such notice to the
director of revenue is completed within thirty
days thereafter, otherwise as of the time of the
delivery.” [RSMo. § 301.600]
– Contrast § 9-317(e) (which provides for only a
20-day grace period for purchase money secured
party to obtain relation-back priority over an
intervening lien creditor)
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• B/c Bank complied with MO’s COT act within
the 30-day grace period of § 301.600:
– Bank’s delivery of application to titling agency did
not violate automatic stay [§ 362(b)(3); Bank take
act to perfect a lien on property of the estate to the
extent done within applicable relation-back grace
period under § 546(b)]
– Bank’s delivery of application on October 25 means
Bank deemed perfected as of October 1
– Trustee thus cannot avoid Bank’s SI [§ 544(a), § 9317(a)(2)(A)]
• Suppose Debtor has assets
worth $100, but owes $100
to A and $100 to B
Preferences
Debtor
Assets =
$100
Liabilities =
$200
– Debtor is insolvent
(liabilities >> assets)
– Debtor pays A in full, pays
B nothing
• Outside of bankruptcy,
states law generally gives
no remedy to B
– Presumption: A, B are each
capable of protecting their
own interests!
A
B
Preference Avoiding Power
• Bankruptcy [§ 547] allows trustee (or debtor in
possession in Chapter 11 case) to set aside certain
pre-bankruptcy transfers that were “preferential”
– Rationale: preserves integrity of collective bankruptcy
process, preserves bankruptcy distribution scheme
– Discourages creditors from making “last minute grabs”
at the debtor’s assets to detriment of other creditors
$100 (preference)
A
$50 bankruptcyTrustee $50 bankruptcy
distribution
distribution
B
Problem 2
• Bank loaned Daddy Day Care, Inc. (DDC)
$100K on an unsecured basis; earlier this year,
DDC went into default
• Bank agreed to give DDC an extension of due
date on loan; in exchange, DDC granted Bank
a SI in its play equipment
– Bank immediately filed a proper UCC-1
• Nov. 1, 2015: DDC filed Ch. 7 petition
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Elements of a Preference
Problem 2
(1) Transfer of property of the debtor [§ 547(b)]
(2) To/for benefit of a creditor [§ 547(b)(1)]
(3) On account of antecedent debt [§ 547(b)(2)]
(4) Made while debtor insolvent [§ 547(b)(3)]
(5) Made w/in 90 days prior to bankruptcy (or 1 year,
if creditor was an “insider”) [§ 547(b)(4)]
• (6) Creditor better off than if it had instead been paid
only in a Ch. 7 liquidation proceeding [§ 547(b)(5)]
• By obtaining a SI to secure a previously unsecured
debt, Bank is made better off than it would’ve
been in a Chapter 7 liquidation
•
•
•
•
•
Problem 2
Transfer by Debtor?
To/for Creditor?
Antecedent Debt?
W/in Period?
Debtor Insolvent?
Creditor Better Off?
☑ SI in play equipment
☑ SI granted to Bank
☑ Debt had been unsecured
– In Ch. 7, as an unsecured creditor, Bank would’ve
gotten only a pro rata dividend (<< 100%)
– If it had valid SI, Bank would get 100% repayment
on the debt (up to the value of the collateral)
– SI gives Bank a “last minute grab” at DDC’s
assets, to satisfy an already-existing debt
Insolvency [§ 547(b)(3)]
• If debtor isn’t insolvent at time of transfer, transfer
isn’t preferential (b/c there are still enough assets
to pay all other creditors)
– “Insolvent” [§ 101(32)] means liabilities >>> assets
• Debtor is presumed insolvent during 90 days prior
to petition date [§ 547(f)]
☑ Otherwise unsecured!
– Burden on recipient of transfer to prove that debtor
was solvent at time transfer occurred
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Presumption of Insolvency
• Debtor is presumed insolvent during 90 days prior
to petition date [§ 547(f)]
– Burden on recipient of transfer to prove debtor was
solvent at time transfer occurred
– Rationale: Debtors usually are insolvent in run-up
to bankruptcy filing; would be bad policy to require
trustee to incur expense necessary to reconstruct
debtor’s balance sheet to prove insolvency (would
eat up funds that could otherwise pay creditors)
“Insider” Preference
• If the creditor receiving the transfer was an
“insider” of the debtor (e.g., an officer,
director, partner, spouse, etc.), preference
period is extended to 1 year [§ 547(b)(4)]
– Rationale: creditor that is “insider” of debtor could
manipulate timing of transfers and timing of
bankruptcy petition to avoid 90-day claw-back
period
• Result thus depends on timing: when did the
transfer of the SI occur relative to petition date?
• If SI was granted to Bank less than 90 days prior
to bankruptcy petition, Bank’s SI = preferential
transfer
– DDC presumed to have been insolvent in that time [§
547(f); burden would be on Bank to prove that DDC
was not insolvent at the time SI was granted to Bank]
• If SI was granted more than 90 days prior to petition
date, then the trustee cannot set aside the SI as a
preference
Problem 2(b)
• Bank also loaned DDC $10,000 to buy a giant
screen TV and a theater system
– Bank prepared a UCC-1, but it was returned for lack of
a proper filing fee
– Bank properly filed the UCC-1 the following month
• Nov. 1, 2015: DDC files Ch. 7 petition
• Is Bank’s SI in the TV/theater a preferential
transfer avoidable by the Trustee?
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• At first blush, DDC’s granting of SI doesn’t
appear to have the practical effect of
preferring Bank vs. other creditors of DDC
– Here, Bank extended credit to DDC to enable
DDC to acquire the TV/theater (which it didn’t
have otherwise), e.g., an “enabling” loan
– Thus, Bank was extending purchase money
credit (a new debt), not taking a SI to secure a
pre-existing (antecedent) debt
“Late” Perfection
• Concern: by not perfecting in a timely
fashion, Bank may have misled third parties
dealing with near-bankrupt debtor DDC
– Third parties dealing with DDC during delay in
perfection wouldn’t have known the TV/home
theater were subject to a SI in favor of Bank
– Ostensible ownership/constructive fraud
§ 547(e) “Timing” Rules
Timing of Transfers
• To apply § 547 (which applies to transfers w/in
90 days prior to bankruptcy), court must
determine the date a transfer took place
• For a payment of money, this is easy
• For the granting of a security interest,
however, there are two possibilities:
– Date SI was granted (attachment), or
– Date SI was perfected (notice to 3rd parties)
• Under § 547, a transfer of SI is deemed “made”:
– At time of attachment, if SI is perfected at that
time or w/in next 30 days [§ 547(e)(2)(A)]
– At time of perfection, if SI is perfected >> 30 days
after attachment [§ 547(e)(2)(B)]
– On the petition date, if not perfected on/before
petition date [§ 547(e)(2)(C)]
• SI is “perfected” for purposes of § 547 when a
judicial lien creditor can’t acquire a superior
interest [§ 547(e)(1)(A)] (thus, “perfected” under
Article 9 = “perfected” under § 547(e))
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Problem 2(b): Timing Rule
• If Bank filed UCC-1 w/in 30 days of attachment, SI
deemed to have been granted at time of attachment
– Thus, Bank’s SI would NOT have been on account of
an antecedent debt → no preference!
• If Bank filed its UCC-1 >> 30 days after attachment
of SI, SI is deemed granted on date of perfection!
– Thus, Bank’s SI would be deemed to have been
granted on account of an antecedent debt!
– If that date was << 90 days prior to bankruptcy, then
Bank’s SI would be subject to avoidance under §
547(b)!
Problem 3
• Carter’s Café (Carter’s) borrowed $50K from
Atlantic Commercial Finance (ACF), which
has perfected SI in Carter’s kitchen equipment
• Oct. 15: Carter’s makes $10K payment on
loan (balance of loan reduced to $40K)
• Nov. 1: Carter’s files Ch. 7 petition
• Can the Trustee make ACF disgorge the $10K
loan payment as a preferential transfer?
Problem 2(b): Rationale?
• Delay in perfection created ostensible ownership
problem; 3d parties could have been misled into
dealing with DDC in the interim
– Concern isn’t really that Bank got preferred, but
that delayed perfection created the potential for
constructive fraud on other creditors
– § 547 timing rule makes this a “preference,” to deal
most effectively w/the “secret lien” problem
Problem 3
Transfer by Debtor? ☑
☑
To/for Creditor?
☑
Antecedent Debt?
☑
W/in Period?
☑
Debtor Insolvent?
Creditor Better Off?
$10,000 payment
Paid to PCB
Debt repayment
Yes, 15 days pre-petition
Presumed insolvent
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• If ACF was oversecured (if collateral’s value is
>> $50,000), ACF was NOT made better off
by receiving the payment
– In Ch. 7 liquidation, ACF would’ve been paid in
full from proceeds of foreclosure sale anyway!
• If ACF was undersecured (if collateral’s value
was = $20,000), ACF was made better off
– In Ch. 7, ACF would’ve gotten < 100% payment
on the unsecured portion of its bifurcated claim
Problem 4: After-Acquired Property
• ACF has a perfected SI in all of Carter’s present
and after-acquired equipment
• Oct. 25: Carter’s buys a dishwasher for $5K
• Nov. 1: Carter’s files Ch. 7 bankruptcy petition
• Can Trustee invalidate ACF’s SI in the
dishwasher as a preferential transfer?
A. Yes
B. No
C. Maybe
• ACF’s SI in new dishwasher may be a preference
– B/c dishwasher was “after-acquired” collateral, the SI
in it is deemed to have been granted when Carter’s
acquired it [§ 547(e)(3)], and thus deemed to have been
granted on account of an antecedent debt
• Question: Did SI in dishwasher make ACF better
off than it would have been in a Ch. 7 liquidation?
– This depends on the value of ACF’s other collateral,
relative to the debt
– If ACF was already fully secured, the additional
collateral didn’t make ACF better off
– However, if ACF’s claim was otherwise undersecured,
having the dishwasher as an additional item of
collateral would’ve made ACF better off (less
undersecured = greater recovery!)
• Debt = $50K
• Other equipment =
$30K
• Dishwasher = $5K
• In Ch. 7, ACF’s
unsecured claim
would’ve = $20K
• W/SI in dishwasher,
ACF’s unsecured
claim = $15K
• Debt = $50K
• Other equipment =
$60K
• Dishwasher = $5K
• In Ch. 7, ACF’s
unsecured claim = $ 0
(fully secured)
• W/SI in dishwasher,
ACF’s unsecured
claim = $ 0
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Preference Exceptions [§ 547(c)]
• Certain transfers by the debtor literally
satisfy the § 547(b) test, but would not be
preferential in their actual effect
• Congress protects these transfers through
exceptions; trustee cannot avoid a transfer
covered by one of the § 547(c) exceptions
• Technically, Seller has received a preference
– SI was not granted until Oct. 2
– Debt was incurred on Oct. 1, so SI was granted on
account of antecedent debt
– Had SI not been granted on Oct. 2, Seller would’ve
been unsecured, so getting the SI made Seller better
off than it would’ve been in Ch. 7
• But, this transfer wasn’t intended to be
preferential in its effect; Seller meant to extend
PM credit, which enabled Debtor to acquire
additional asset! (not a “last minute grab”)
Preference Hypothetical
• Oct. 1: Debtor buys computer from Seller on
installment K
– Seller intended to take PMSI in computer, but Debtor
signed “agreement” that did not describe the computer!
• Oct. 2: Seller catches the error; Debtor signs a new
installment K that properly describes the computer
• Nov. 1: Debtor files a Chapter 7 petition
• Did Seller receive a preference?
“Contemporaneous Exchange”
Exception [§ 547(c)(1)]
• A transfer that would otherwise be a preference
under § 547(b) cannot be avoided if the transfer:
– Was intended to be a contemporaneous exchange
for new value given to the debtor, and
– Was in fact substantially contemporaneous
• This would likely prevent Trustee from being able
to set aside Seller’s SI as a preference
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Enabling Loan Exception [§ 547(c)(3)]
• Trustee can’t avoid SI to extent it
– Secures “new value” given by secured party at or
after signing of security agreement
– Secures “new value” given to enable the debtor
to acquire collateral (and so used), and
– Was perfected on or before 30 days after debtor
received possession of collateral
Problem 5: The “Problem”
• If Austin is like most sellers, its inventory “turns
over” (i.e., is sold and replaced) frequently
• Thus, it’s likely that on the petition date, most if
not all of Austin’s inventory will have been
acquired by Austin during the previous 90 days
– Similar problem exists where the collateral is present
and after-acquired accounts
Problem 5
• In 2011, First Bank extended a line of credit to
Austin Auto Parts, Inc. (Austin)
– Collateral: present and after-acquired inventory of
Austin (perfected by UCC-1 filing)
• On Nov. 1, 2015, Austin filed bankruptcy
• Technically, First Bank’s SI in nearly all of
Austin’s inventory is a preference. Why?
• B/c SI in after-acquired inventory doesn’t attach
until Austin acquires “rights” in it, § 547(e)(3)
timing rule threatens First Bank’s “floating lien”
– First Bank’s SI in Austin’s “petition date” inventory is
deemed to have been granted when Austin acquired it
– If line of credit was incurred in 2011, the SI in current
inventory arose on account of an antecedent debt!
– SI in new inventory acquired within past 90 days
nominally improved First Bank’s position (if Austin’s
inventory had “turned over” within 90 days, it would have
no inventory collateral without the new inventory!)
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Floating Liens in Bankruptcy
• But it doesn’t make sense to completely wipe out
First Bank’s floating lien in all of the inventory
acquired in the prior 90 days
– Use of floating lien is not by itself a “last minute grab”
by First Bank
– At same time Austin was buying new inventory, it was
also likely paying for it by borrowing more money
under its line of credit (offsetting extension of value)
• 2011: First Bank took,
perfected a SI in Austin Auto
Parts’s inventory (incl. afteracquired)
• Nov. 1, 2015: Austin Auto Parts
files bankruptcy petition
• Has Bank received a preference
where:
Date
Aug. 1
Sept. 1
Oct. 1
Nov. 1
Balance Inventory
$140,000
$100,000
$120,000
$100,000
$120,000
$120,000
$80,000
$150,000
Floating Lien Exception: § 547(c)(5)
• Trustee can only avoid floating lien on inventory/
accounts to the extent that transfers/payments
during 90 days prior to bankruptcy improved the
creditor’s secured position [§ 547(c)(5)]
• “Two point net improvement” test
– If Secured position(=petition date) > Secured
position(=90 days prior to petition), trustee can
avoid floating lien to the extent of improvement
– Intermediate fluctuations are irrelevant
Problem 5
Problem 5
• First Bank’s position 90 days prior: $120K
(inventory) - $140K (debt) = [$20K undersecured]
• Bank’s position at petition date: $150K (inventory) $100K (debt) = $50K oversecured!
• Net improvement is $70K; trustee can avoid SI as to
$70K of the $150K inventory on hand on petition date
– Amounts that otherwise would’ve paid unsecured
creditors went to buy inventory or repay debt, reducing
the unsecured portion of First Bank’s claim
• First Bank’s claim: $80K secured, $20K unsecured
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Fraudulent Transfers
• Under state law, an injured creditor can sue to
invalidate a fraudulent transfer by the debtor
– E.g., Tortfeasor (T) harms Victim
– Before Victim can get a judgment (and a lien vs.
T’s car), T gives his car to his children (who agree
to let T continue to drive it)
– Victim can invalidate this transfer, which is
intended to defraud Victim as a creditor [UFTA]
• Bankruptcy Code § 548 allows Trustee to set
aside transfers of property made by Debtor
during 2 years prior to bankruptcy, if they are
– Actually fraudulent, e.g., made w/intent to hinder,
delay, or defraud creditors [§ 548(a)(1)(A)], OR
– Constructively fraudulent [§ 548(a)(2)(B)],
meaning that:
• The debtor received less than “reasonably equivalent
value” for the transfer, and
• The transfer was made while Debtor was insolvent
or the transfer rendered Debtor insolvent
Fraudulent Transfer Hypo
• October 1: X sells $2MM worth of business
equipment to his son for $1MM cash
• November 1: X files for bankruptcy, with
assets of $100,000 and liabilities of $1MM
• Should X’s bankruptcy trustee be able to
recover the equipment from X’s son?
Fraudulent Transfer Hypo
• X’s sale to his son was for less than reasonably
equivalent value (50% of FMV)
• X’s sale to son rendered X insolvent (negative net
worth as a result of sale)
• Sale occurred within 2 years prior to bankruptcy
• Thus, trustee can recover the equipment from X’s
son, for benefit of X’s creditors
– X’s son would have a lien on the equipment to secure
repayment of the $1MM he paid [§ 548(c)]
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Fraudulent Transfer
• Often, bankruptcy trustees may try to set
aside a pre-bankruptcy foreclosure sale on
the ground that the foreclosure sale price
was less than “reasonably equivalent value”
• We’ll discuss Problem 6 more in
Assignment 21 (Tuesday/Wednesday),
when we cover foreclosure sales
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