 1st -- the trustee must prove a prima facie
case for avoidance under 547(b)

2nd -- the burden then shifts to the creditordefendant to prove any of the defenses (or
safe harbors, or exceptions) to preference
liability under 547(c)
 See 547(g) for burdens of proof










contemporaneous exchanges of new value, (c)(1)
ordinary course transfers, (c)(2)
enabling loans, (c)(3)
subsequent advances of new value, (c)(4)
floating liens, (c)(5)
statutory liens, (c)(6)
domestic relations debts, (c)(7)
transfers of less than $600 by an individual debtor
whose debts are primarily consumer debts, (c)(8)
transfers of less than $5,475 by non-consumer debtors,
(c)(9).
transfers made as part of an alternative repayment
schedule created by an approved nonprofit budgeting
and credit counseling agency, § 547(h)

1st – no preference liability if transfer < $5475
 Business Dr ((c)(9))
 floor = $600 for consumer Dr

For unsecured creditors:





$5475 immunity, of course
“ordinary course”, (c)(2)
New value, (c)(4)
Contemporaneous exchange, (c)(1)
For secured creditors:
 Enabling loans, (c)(3)
 Floating liens, (c)(5)

Until the addition of the $5475 floor for business
preferences in 2005, the most important preference
exception – by far – was “ordinary course” exception
under (c)(2)

A 1997 national preference survey conducted by the
American Bankruptcy Institute found that the
ordinary course defense was raised in 73.4% of all
preference cases.
 http://www.abiworld.org/Content/NavigationMenu/News
Room/BankruptcyResearchCenter/BankruptcyReportsRes
earchandTestimony/ABI/Report_on_the_ABI_P1.htm

Practical reality was that even if “equality”
was perverted by an eve-of-bankruptcy
transfer, was not avoidable if payment was in
the ordinary course

And fact-intensive nature of divining what =
“ordinary” made preference litigation very
uncertain, and put pressure to settle on both
trustee and creditor-defendants

Original hypo, where Dr has $6K in assets and
owes $6K each to creditors A, B, and C
 Assume all are regular business creditors, debts
arose in normal business operations
 And, debts all coming due in normal time period



Day before bankruptcy, Dr chooses to use last
assets to pay A in full, and nothing to B or C
Payment to A was in standard manner & time
A gets to keep the $ -- not avoidable

As this simple example shows, the “ordinary
course” exception completely eviscerates any
serious notion that “equality” is a meaningful
norm supporting preference avoidance

On very eve of bankruptcy, one Cr gets paid
in full, and all other creditors get nothing

Given the evisceration of equality, what
policy supports the ordinary course defense?

Congress said “deterrence”:
 “The purpose of the exception is to leave
undisturbed normal financial relations, because
it does not detract from the general policy of the
preference section to discourage unusual action
by either the debtor or his creditors during the
debtor's slide into bankruptcy.”

The statement in the legislative history
suggests that an eve-of-bankruptcy transfer
is voidable as a preference ONLY if it is
motivated by “bad” intentions – i.e., only if
the transfer was made due to “unusual action
by either the debtor or his creditors during the
debtor's slide into bankruptcy.”

This policy harkens back to the ancient
notion that a preference was “bad” only if,
variously over time:
 Dr had an intent to prefer, or
 Cr had an intent to obtain a preference, or
 Cr had (1898 Act) “reasonable cause to believe the
Dr was insolvent”
Whereas nothing ‘wrong” when no one was
motivated by “unusual action”, instead, as
legislative history said, should
“leave undisturbed normal financial relations”

-> trade creditors feel VERY strongly that they
should be immunized from preference attack
if they didn’t exert unusual pressure on the Dr
to get paid – and now that’s the law!

1st, debt had to be incurred in ordinary course
 Almost never an issue

2nd, the payment must be ordinary
 Ordinary as to what? Here is where the pre-2005 and
post-2005 versions of the law differ importantly
 Pre-2005: Cr must prove BOTH
▪ the transfer was made in the ordinary course of the business
or financial affairs of the debtor and the transferee;
and
▪ the transfer was made according to ordinary business terms.

Courts struggled to figure out what those two
tests meant

Tolona Pizza leading case announcing that
they state both a
 SUBJECTIVE test – what is “ordinary” as between
this Dr and this CR
AND
 OBJECTIVE (the “ordinary business terms”) – i.e.,
what is ordinary in the industry

payment terms: “net 7 days” – no one did that

Actual practice between Dr and Rose (sausage
supplier) – for 34 months before, Dr paid from 26
to 46 days late

As to others Rose sold to – norm paid in 21 days,
if paid > 28-30 days, Rose withheld
 So Dr one of “exceptional” customers

8 payments to Rose in preference period – from
12 to 32 days, average = 22 days

Did Rose have to prove only that the 8
payments made to it during the preference
period were “ordinary” as compared with the
prior practice as between Dr and Rose, or
ALSO that the payments conformed to the
industry norm?

Court held: BOTH required

1st, need “subjective” ordinariness –
 The “discourage unusual action,” not race point

2nd – need “objective” confirmation of same:
 b/c is evidentiary of actual subjective ordinariness – if
≠ objectively ordinary, raises doubts as to credibility
of claim of subjective ordinariness
 AND allay concerns of other Crs that this Cr cut a
“special deal” with Dr that will favor this Cr in times of
financial distress

1st, Subjective – clearly okay – Rose was paid well
within (indeed, slightly better than) previously –
12 to 32 days, average 22, versus prior practice
Rose-Tolona of 26-46

2nd – Objective – ends up being a VERY lenient
test: “that "ordinary business terms" refers to the
range of terms that encompasses the practices in
which firms similar in some general way to the
creditor in question engage, and that only
dealings so idiosyncratic as to fall outside that
broad range should be deemed extraordinary”

On these facts, met objective too
 21 days a goal, but up to 30 days is fine
 And average here was 22 days
 No “single set of terms”

1997 ABI Preference study found that trade
creditors believed vehemently that the
ordinary course exception did not work well
in practice – was both vague and
inconsistently applied, and gave insufficient
protection

Creditors felt was unfair and hard to prove
compliance with unknown “industry” norms –
even under a lenient Tolona approach

Accordingly, 1997 Commission Report
recommended changing the requirement
that Cr prove compliance with BOTH
subjective & objective tests, to need to prove
compliance with EITHER

Intent was for “subjective” to control if was
provable

“the conduct between the parties should prevail to
the extent that there was sufficient prepetition
conduct to establish a course of dealing”

only “[i]n the event there is not sufficient prepetition
conduct to establish a course of dealing, then industry
standards should supply the ordinary course
benchmark.”

this approach would eliminate need for a preference
defendant to prove elusive industry standards, and it
is “more accurate to rely on the relationship between
the parties.”

BAPCPA – changed the “and” to an “or”

now Cr need prove ONLY compliance with
EITHER the subjective or objective tests

Means that Cr will be safe if simply stays
consistent with its established practices with
Dr

Hypo:
 invoices require payment in 20 days
 Creditor and Debtor have a longstanding practice
of 40-45 days for payment -- [subjective]
 Industry standard (which we will assume is easily
established) requires strict compliance with the
20-day invoice terms -- [objective]
 Creditor, however, gets paid at days 43, 40, and 45
during the preference period.
 What result?

Cr wins
 Payments at days 43, 40 and 45 fell squarely
within the parties’ subjective practice
 Totally irrelevant that industry norm was 20 days

Facts:
 Supplier & Dr had unusual but longstanding practice –
Dr would send check with the P.O., but Supplier would
hold check for several weeks before presented to
bank for honor
 In 90-day preference period, Dr delivered $72K of
checks to Supplier, which were honored by bank
within 40-45 days after goods delivered
▪ Consistent with prior subjective practice
▪ Also within industry time-to-payment norm
▪ But no one else in industry had a “hold-the-check-from-thestart” sort of safeguard
 What result?

BEFORE 2005:
 Supplier faced a serious risk of losing the ordinary
course defense, because their deal (getting checks in
hand in advance of the normal time for payment, as a
form of payment security) was not ordinary for the
industry – even if, as it happened, Supplier did not
actually present the “security” checks early
 As a matter of policy (remember Posner’s 2nd
justification for objective test in Tolona), why should
this Supplier be allowed to put in place such a special
deal that gave it the option to get a jump on other
creditors if the Dr’s financial affairs turned ugly?

But under the new law, since Supplier put its special
deal in place well before the actual onset of the
debtor’s insolvency and then bankruptcy, and the
parties then adhered to that special deal so as to
create a course of dealing, Supplier likely will prevail
by proving conformity to subjective ordinary course,
under § 547(c)(2)(A).

The fact of non-conformity to objective industry
standards supposedly would be irrelevant

But this means we allow Crs to set up “special deals”
well in advance as “bankruptcy protectors”

Subsequent advances of new value from CR to Dr are
credited against prior preferential transfers

In effect, Cr’s preference liability is reduced to the extent Cr
returns value to DR after receiving a preference.

Justified:
 Dr’s estate has been replenished to the extent of the new value,
and thus other creditors have not been harmed.
 Encourages creditors to continue doing business with a
financially troubled debtor.

In practice, 547(c)(4) has been applied most often in a trade credit
situation, involving ongoing extensions of credit on open account

1) after a preferential transfer, Cr gives new
value to or for the benefit of Dr, 547(c)(4);

2) that new value is not secured by an
otherwise unavoidable security interest,
547(c)(4)(A); and

3) Dr does not make an otherwise
unavoidable transfer to or for the benefit of
Cr on account of that new value, 547(c)(4)(B)




Cr a trade supplier of Dr, sells on open
account, & owed $10K on April 1
April 1 – Dr pay $8,500 to Cr
April 15: Cr ships $4K in goods to Dr on credit
May 1: bankruptcy
How much, if any, is preference liability?

$4,500 preference liability:
 $8500 payment April 1 (assuming n other defenses,
such as ordinary course, and meets 547(b) elements)
 MINUS $4k in “new value” – the credit for new goods
shipped by Cr on April 15
Note that Cr’s bk “claim” is thus = $10K –> the $4500
repays as preference + $4k unpaid on April 15
shipment + $1,500 never was paid on original $10K
* makes sense – Cr never intended to be > $10K exposure

Easy to justify this defense – 1st, Cr likely
never would have shipped more goods on
credit on April 15 if it had not gotten the
payment on account on April 1
 Recall, Cr never wanted to be exposed > $10K …
but if not have new value defense, Cr debt = $14K

Encourages trade creditors to keep doing
business on credit with Dr even if Dr may be
in financial trouble

Now reverse times, i.e, Cr ships $4k credit new
goods April 1, then April 15 Dr pays $8,500

Now the preference = $8,500

No new value defense – only applies if new value
given AFTER the Dr’s preferential transfer
 Makes sense – neither the “replenishment” nor the
“incentive” rationale applies where Cr ships 1st



PREFERENCE
April 1: Dr pay $8,500
$8,500
April 15: Cr ship $4K credit goods
4,500
April 20: Dr pay $3K
7,500

Now preference = $7,500

Only get credit for $1k in new value, b/c of
547(c)(4)(B) – Dr made “an otherwise
unavoidable transfer to ... such Cr” – the $3K is
protected under (c)(9)’s $5475 safe harbor
PREFERENCE
 April 1: : Dr pay $8,500
8,500
 April 15: Cr ship $4K credit goods
4,500
 April 20: Dr pay $3K
7,500
 April 25: Cr ship $7500 credit goods
0

Zero preference

Final credit shipment of new value on April 25
canceled out the remaining $7,500 in thenexisting preference liability
 Shows can apply new value to all prior transfers by Dr


April 1: Dr pays Cr $5k
April 5: Dr pays Cr another $5k

Issue is whether (c)(9) safe harbor works

Turns on question of whether or not
aggregate all the transfers by Dr to Cr during
preference period
 If so, no (c)(9) defense, b/c total = $10K > $5475
 If not, good (c)(9) defense - both transfers < $5475

Statutory language:
 “such transfer” in (c)(9) – against aggregation?
▪ but 102(7) says “singular includes plural”
 Avoid “any transfer”, (b) – same?
 “aggregate value” in (c)(9) – for aggregation
▪ But does this work across different transfers?

Policy:
 If not aggregate, easy to circumvent – endless series
of transfers each < $5475

Result: AGGREGATE
 So here, avoid BOTH transfers, $10K
Note – Cr WORSE off when got 2nd transfer – was
fully protected as to 1st $5k transfer – but after 2nd
transfer kicks up aggregate total to 410K, no
defense at all!
* (c)(9) is NOT a “credit” against liability – it’s an
either-or defense

for a Secured Cr, have 2 possible times when
might deem the “transfer” of the lien to be
made for preference purposes:
 1st – when effective as between the DR and the SP
▪ Only need valid transfer of lien Dr to SP, & debt
▪ i.e. = “attachment” under article 9
 2nd – when effective as against 3rd parties
▪ Need public recordation

If just use the 1st option, and say lien is
transferred when effective Dr –SP, whether or
not in public records, would allow secret liens

As long as SP record any time before
bankruptcy, would be safe –
 not avoid under strong arm clause 544(a), b/c that
focuses solely on time of bk filing
 Not avoid as preference b/c would not have an
antecedent debt –
▪ And possibly outside 90-day period as well

The preference rule for timing for transfer of a lien is a
compromise between the “only when recorded” and the
“when effective against Dr” options

1st -- the “timing” of a lien transfer for preference purposes
is when the transfer is recorded (547(e)(1))
 i.e., when effective vs 3rd parties
▪ Realty – beat bfp – (e)(1)(A)
▪ Personalty – beat lien Cr – (e)(1)(B)

HOWEVER -- subject to 30-day grace period, after transfer
effective as between Dr and SP, 547(e)(2)
 If record within 30-days, deem “transfer” to have occurred back
when effective between Dr-SP

Fixing the transfer time alone, however, may
not fully protect legitimate interests of SP

Why? b/c in some scenarios the “debt” arises
before the time the lien is transferred – and
thus have an artificial “antecedent debt”
problem
 Even if no delay in perfection, or relates back to
when 1st effective as between Dr & SP

To see this, consider a common scenario:
 May 1: Lender loans Dr $25K to enable Debtor to purchase
certain equipment, Debtor grants Lender a security interest in
that equipment, and Lender immediately perfects
 June 1: Dr purchases the equipment
▪ Under the UCC, the security interest in the equipment does not
“attach” until June 1, when the Debtor has acquired rights in the
collateral. U.C.C. § 9-203(b).
▪ Likewise, in bankruptcy, “transfer” of security interest in equipment to
Lender under 547(e)(2) would be deemed to occur on June 1, when the
security interest first became effective as between Lender and Debtor.
 The debt, though, arose on May 1, when the loan was made,
and May 1 is antecedent to June 1, when transfer deemed made

Would obviously be unfair to avoid Lender’s
security interest as a preference, b/c of
artificial construction that the lien “transfer”
occurred after the “debt” arose, when
 no one under non-bankruptcy law could ever have
possibly beaten Lender
 Lender did everything it possibly could do

Solution is in 547(c)(3)’s safe harbor for
enabling loans

Assuming meet requisites of an enabling loan

SP has a statutory grace period to perfect
(now, 30 days) after Dr receives possession

In case like our hypo, where the SP filed to
perfect on May 1 (when the loan was made),
but Dr did not get collateral and thus no
attachment until June 1, SP is fully protected
under (c)(3):
 Meets all requisites of enabling loan
 Was perfected “on or before 30 days after Dr
receives possession of such property”
▪ Perfected May 1, Dr possession June 1

As it happened, though, 547(c)(3) proved less
apt for saving the SP when it delayed
perfecting for some period of time after
security interest 1st attached

Recall, though, that non-bk law might give
the SP a grace period here as well
 Example– UCC 9-317(e) – PMSI valid against
intervening Crs if SP perfects within 20 days after
Dr receives possession of collateral

What happened over time was that 547(c)(3), as
originally enacted in 1978, did not track precisely 9317(e)’s grace period, and thus a legitimate PMSI
might be exposed

So Congress kept amending (c)(3) to try to conform it
to UCC rule
 Changed trigger date from “attachment” to when Dr
receives possession of collateral
 Expanded grace period from 10 days to 20 days (like UCC
9-317(e)), and now is 30 days
 BUT did not simply incorporate by reference valid non-bk
relation back rules

Final piece in the “time of transfer” morass re secured
creditors  547(c)(1), which has defense if a
“substantially contemporaneous exchange”
 Predicated on Dean v Davis preference prong – time of
the lien to the brother-in-law (Dean) and the loan from
Dean to farmer Jones – while loan came 1st, and thus
technically “antecedent,” Court suggested that were
intended to be and were in fact “substantially
contemporaneous” and thus should not be set aside
 So, in slightly delayed perfection cases, can SP argue (c)(1)
defense?

Facts:
 April 1: Dr buy new car, gives Cr note for price,
grants Cr security interest in car, Dr takes
possession of car
 April 25: Cr perfects
 June 1: bankruptcy
 State law: Cr perfection “relates back” if perfect
within 20 days of Dr possession

When was security interest effective between Dr & Cr?
 April 1 (attachment under Art. 9 – agreement for security, SP gave value, Dr
had rights in collateral)

When was security interest perfected?
 April 25 (when SP filed financing statement)

Is date of perfection (April 25) within 30 days of date effective between Dr & SP
(April 1)?
 Yes

Since “yes,” deem time of transfer of security interest as date effective Dr & SP
(April 1) under 547(e)(2)(A)
 date of debt (April 1 loan) is not “antecedent” to date of security interest
transfer (April 1) and thus NOT preference – not satisfy 547(b)(2)

Furthermore, since the loan did enable Dr to
buy the car, and was in fact so used for that
purpose, is protected form preference
avoidance under “enabling loan” safe harbor
of 547(c)(3), since perfected within 30 days
after Dr received possession
 Even though the state law PMSI rule only gives 20
days!
 The federal time period controls, irrespective of
what the state law says

Note that under the sort of facts have in
9.13(a), for preference purposes the Cr is the
fortunate beneficiary of a bankruptcy law
“relation back” rule (547(e)(2)(A)) even
though:
 It delayed perfecting, and thus during the 90-day
preference period enjoyed a “secret lien” for some
time, and
 Did NOT qualify for a state law relation-back
grace period, since missed the 20-day state period

Same facts as (a), except not an enabling loan
 So under state law, no “grace period” whatsoever
for perfection to “relate back”

Still not a preference
 Same timing result under 547(e), since perfected
within 30 days of when effective between Dr & Cr

And thus no “antecedent debt”




Same facts as (a) (April 1 loan & security
grant, Dr takes possession, security interest
attaches)
State law gives CR 45 days to perfect with
relation back effect
Cr perfects at day 35 (May 6)
Bankruptcy June 1

PREFERENCE!
 This is the Fink case, SCOTUS
 Even though now Cr DID comply with state law!

Time of transfer security interest = May 6
 > 30 days after effective Dr-Cr

So IS = “antecedent debt”
 Debt = April 1; Security interest = May 6

Not saved by enabling loan defense, b/c > 30 days, 547(c)(3)(B)
 Purely a FEDERAL rule

Not saved by contemporaneous exchange (c)(1)
 Courts say “specific” [viz, subsec (e) and (c)(3)] control general [(c)(1)]

What? 547(c)(5) protects secured creditors with "floating
liens" in inventory and receivables

A lien is said to "float" when it attaches to collateral that
Dr acquires after the initial security transaction

(c)(5) exempts floating lien that attaches to inventory or
receivables during the preference period, EXCEPT to
extent Cr has improved its position during the 90-day
preference period.
 Thus, the fifth exception requires a comparison of the creditor's
security position at the beginning of the preference period with
its position at the time of bankruptcy.

Problem arises b/c a Cr’s security interest cannot attach to collateral until
Dr has rights in that collateral
 True under state law, U.C.C. 9-203(a), (b)(2).
 And also true in bankruptcy, see 547(e)(3)

Yet, some types of collateral (e.g., inventory, receivables) are expected to
and do “turn over” in course of Dr’s business
 Old inventory sold, but new inventory acquired
 Collect old receivables, generate new ones

Dr’s bargain with SP is that its security interest will “float” to attach to
the new inventory or receivables that Dr acquires in normal course
 Outside of bankruptcy, under Article 9, generally other Crs cannot beat a
previously perfected inventory or receivables SP

But absent a saving rule, the “new” collateral would be deemed
“transferred” to SP for the “antecedent” debt, & thus = preference

Courts knew that it was unfair to nail the SP in
these floating lien cases, but pre-Code had to do
some tricky legerdemain to escape

9th Circuit held for SP in 1969 in DuBay v.
Williams -- concluded that the "transfer" of the
security interest occurred for preference
purposes when SP perfected the security interest
by filing a financing statement, not later when
the debtor acquired the collateral
 Under current Code, reject that view in 547(e)(3)

Grain Merchants v. Union Bank, also 1969 -- 7th Circuit 2 rationales for
upholding SP’s lien:

1st: a "relaxed substitution of collateral" theory:
 Under 547(c)(1), CR is protected from preference if one item of collateral is
substituted for another; the release of the lien on the original collateral is
"new value" for the transfer of the security interest in the replacement
 However, substitution approach does not work well for floating liens b/c is
difficult to trace the replacement-item-for-released-item linkage.

2nd: "entity" theory, or, more colorfully, the "Mississippi River" theory:
 Cr has security interest, not in specific items of collateral, but in the "entity"
that is Dr’s “inventory” or “receivables.”
 Analogy drawn to Mississippi River: the specific molecules of water present
from time to time vary, but it is still the Mississippi River. Just so, SP’s security
interest may vary from time to time with regard to the precise items of
collateral covered, but the "collateral" viewed as an entity is still the same.
 Also put out of court by 547(e)(3)

Not only were the 9th and 7th Circuit theories
formally really strained, but, more importantly,
they posed a real preference risk

Say 90 days before bk SP is under-secured, then
demands buildup in collateral before bk arrives
 Example: 90 days before – debt = $100K, collateral =
60K (so 40 short) ; by time bk filed, collateral = 100

Even though SP obviously seems to be $40k
better off, not able to avoid under either
“transferred when perfected” or “Mississippi”

1. no “transfer” of collateral until Dr has
interest – 547(e)(3)
 Thus potentially is for “antecedent debt” and
prima facie preference under 547(b)

2. safe harbor defense = 547(c)(5) – the “2point improvement in position” test
 Compare SP’s security position 90 days before
bankruptcy and see if “improved” by time of
bankruptcy – so, in hypo, have a preference = 40

547(c)(5) uses two-point improvement-in-position test:
 security interest in inventory or receivables is only avoided to extent
that CR improves its position from point one to point two.
 Interim fluctuations are ignored.

Point One is the beginning of the preference period
 only exception is if Cr does not make loan until a later date; in that
event, the date new value is first extended will be point one

Point Two is the date of bankruptcy

Comparison between these two points: extent Cr is undersecured,
i.e., the amount that the debt exceeds the value of the collateral.

Preference: only found to extent Cr’s unsecured claim gets smaller,
i.e., its deficiency decreases, from point one to point two.

Point One deficiency
 (debt minus collateral value)
minus

Point Two deficiency
 (debt minus collateral value)
= amount avoided




Note meet requisites for application (c)(5) –
inventory financing, turned over entirely
during preference period
Dates: bankruptcy filed June 30 (point tw0),
so 90 days before (point one) = April 1
Point one: debt = $100, inventory value = 100
Point two: debt = $100, inventory value = 100

No preference

Not possible b/c NO DEFICIENCY AT POINT
ONE!

Since Cr was fully secured at point one (90
days before), it cannot “improve its position”

Point one: debt = 100, collateral = 100
Point two: debt = 100, collateral = 115

Still no preference

 Even though did “build up” inventory, not matter,
b/c since Cr was fully secured at point one, it can’t
improve its position under (c)(5)
▪ Of course, Cr IS better off b/c now can get postpetition
interest under 506(b)!

Point one: debt = 125, collateral = 100
Point two: debt = 125, collateral = 115

Now preference = 15

 The Cr was undersecured by 25 at point one, but is
only undersecured by 10 at point two
 Thus has improved its position by 15

Point one: debt = 125, collateral 100
15 days before bankruptcy: debt 125, coll = 50
Point two: debt = 125, collateral 100

NO preference


 Only compare points one and two
 Undersecured by same amount at both (25)
 Ignore interim fluctuations



Point one: debt = 125, collateral = 100
Day later: payment of 20
Point two: debt = 105, collateral = 100

BE CAREFUL!
 Simple “deficiency at pt 1 vs deficiency at pt 2”
comparison might suggest should avoid 20 of lien,
since deficiency is 20 less
 But that is b/c Dr made a payment
 What happens if Trustee avoids and recovers that $20
payment? – Cr’s claim is back to 125 at point two, so
really did NOT improve position