The power of a debtor or trustee to avoid preferential transfers that benefit certain creditors over others is critical to achieving one of the primary tenets of the Bankruptcy Code – the equality of treatment among all creditors. This ability to recover preferences prevents a debtor from favoring certain creditors over others by transferring property in the time leading up to a bankruptcy filing. Although these preference powers are broad, they are restrained by certain conditions, including a minimum threshold on amounts that can be avoided. A recent Third Circuit decision, In re Net Pay Solutions, Inc. v. IRS, affirmed a District Court’s ruling holding that amounts cannot be aggregated across creditors to satisfy the minimum threshold amounts of 547(c)(9).
Prior to filing for protection under Chapter 7 of the Bankruptcy Code, debtor Net Play Solutions managed its clients’ payrolls and handled their employment taxes. Net Play would often transfer funds from its clients’ bank accounts into its own accounts and then remit those funds to the clients’ employees, the IRS, and other taxing authorities.
At issue in this case were certain transfers Net Play made on behalf of its clients to the IRS approximately three months before it filed its Chapter 7 petition. Included in these transfers were four payments made to the IRS on behalf of four different clients in the amounts of $5,338, $1,143, $352.13, and $281.13. The day after these transfers were made, Net Play informed its clients that it was ceasing business operations including all payroll processing.
The trustee appointed in Net Play’s Chapter 7 case sought to recover the funds transferred to the IRS, arguing that they were avoidable preferences. Recognizing that the four payments were below the threshold established by section 547(c)(9), the trustee argued that because the payments exceed the threshold in the aggregate, the threshold did not apply. The trustee and the IRS filed cross-motions for summary judgment and the District Court granted the IRS judgment as a matter of law.
The 547(c)(9) Threshold
Section 547(c)(9) provides, in relevant part, that the “trustee may not avoid . . . a transfer if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $6,425.” Effectively, section 547(c)(9) provides a minimum threshold that must be satisfied before a preference can be avoided. The provision was introduced as part of the 2005 Bankruptcy Code amendments and was intended to benefit creditors who had to decide whether small-value preference actions were worth defending. Prior to the enactment of the threshold, creditors often had to decide for example, whether or not to spend over $10,000 in legal fees to defeat a $5,000 preference claim. As a result of this economic inefficiency, many creditors with otherwise defendable preference claims often chose to settle their claims.
The Third Circuit acknowledged that the less than “pellucid” drafting of section 547(c)(9) left open the question whether small-value transfers for the benefit of different creditors based on distinct debts can be aggregated and avoided as preferential. After first exploring the policies underlying preference actions, including the equality of treatment of all creditors, the court then examined the legislative history of 547(c)(9), and concluded that the trustee’s aggregation argument must fail. The Third Circuit, taking the trustee’s position to its logical conclusion, offered the following hypothetical. Assume a debtor has 1,000 creditors to whom it paid $5,000 each during the preference period. If the trustee’s argument carried the day, the debtor’s estate would be able to recover this $5,000,000 and none of the creditors would be able to invoke the minimum threshold defense. This would essentially render section 547(c)(9) moot. Said another way, the only time the threshold would come into play was when all creditors were paid, in the aggregate, less than the $5,850 threshold.
The Court dismissed all of the trustee’s arguments and ultimately found that the only logical reading of 547(c)(9) is that each creditor and transaction must be considered independently. A creditor who has received the benefit of a prepetition transfer less than the threshold may invoke the defense regardless of what other creditors have received.
Interestingly, the Third Circuit cautioned that courts must not apply the threshold mindlessly in a way that would permit a less than scrupulous debtor from structuring multiple transactions in amounts less than the threshold. Notwithstanding the creditor-by-creditor and transaction-by-transaction application of 547(c)(9), a court may nonetheless aggregate amounts if they do in fact constitute a single transfer on account of the same debt.
Although the bankruptcy code provides the debtor with broad powers to avoid preferences, these powers are limited by certain exceptions, including the minimum threshold exception – which stands up for the little (less than $6,425) guys’ rights.
Kevin Bostel is an Associate at Weil Gotshal & Manges, LLP in New York.