A Matter of Time: Delaware Bankruptcy Court Considers the Proper Date to Determine Secured Status in Preference Actions

Contributed by Debra McElligott
Under section 547 of the Bankruptcy Code, trustees may avoid and recover certain “preferential” prepetition debt payments by a debtor that give recipients more than they would have received in a chapter 7 liquidation.  Bankruptcy courts are divided on whether, for the purposes of this inquiry, the secured status of the preference defendant (i.e., the extent to which the defendant was secured) should be considered as of the petition date, or alternatively, as of the date of the transfer.  In Forman v. IPFS Corp. of the South (In re Alabama Aircraft Industries), the United States Bankruptcy Court for the District of Delaware contributed to this debate, holding that a defendant’s secured status should be considered as of the date of the transfer. 
In Alabama Aircraft, the trustee filed an adversary proceeding under section 547(b)(5)(A) of the Bankruptcy Code to avoid and recover four preferential transfers made by the debtors to the defendant pursuant to an insurance premium financing agreement within the ninety days prior to the petition date.  The only dispute in the case was whether the value of the collateral should be measured as of the petition date or as of the date of the transfer.  The debtor’s transfer would fail to meet the avoidance requirement if the defendant was fully secured as of the relevant date, because secured creditors are entitled to full payment in a chapter 7 distribution.
In its analysis, the bankruptcy court considered two different approaches to the question.  The defendant argued that the court should follow two bankruptcy court decisions from the Southern District of New York and Northern District of Illinois holding that the defendant’s secured status is to be determined as of the date of the transfers.  On the other hand, the trustee argued that the United States Supreme Court’s opinion in Palmer Clay Products Co. v. Brown controls the question.  In that case, the Court considered whether a debtor’s prepetition payments to a defendant creditor had the effect of allowing the defendant to receive a greater percentage of its debt than other creditors of the same class would have received in a liquidation.  The Court held that whether a creditor has received a preference is to be determined based on the effect of the payment as of the petition date.  Declining to apply Palmer Clay, the bankruptcy court held in favor of the defendant.  The court distinguished the case on its facts, noting that the corporation in Alabama Aircraft was fully secured, while the defendant in Palmer Clay was unsecured.
Although Palmer Clay did involve a transfer to an unsecured creditor, the holding – as even the Alabama Aircraft court noted – does not explicitly apply only to unsecured creditors.  Furthermore, although some lower courts have found the Palmer Clay analysis inapplicable to secured creditors, others have gone in the opposite direction.  One such opinion, cited by the Alabama Aircraft court, is that of the United States Bankruptcy Appellate Panel for the Eighth Circuit in Falcon Creditor Trust v. First Insurance Funding (In re Falcon Products, Inc.), in which the court held that nothing in the language of Palmer Clay expresses or provides a basis for limiting the holding to unsecured creditors only.
The Alabama Aircraft opinion appears to take a moderate approach to the question, focusing on the unique nature of a premium financing agreement and arguably limiting its holding to premium finance contracts.  These narrow parameters suggest that the bankruptcy court may at least be open to finding, under different facts, that the Supreme Court’s holding in Palmer Clay is applicable despite a defendant’s status as a secured creditor.  We will be watching to see if additional courts weigh in on this issue.