Restructuring

Readers familiar with contract law undoubtedly know the “mailbox rule,” that an offer is accepted the moment a document goes in the mail.¹  The United States Bankruptcy Appellate Panel for the Ninth Circuit (the “BAP”) recently dealt with its own variant of the mailbox rule: does the issuance of a check constitute a transfer of estate assets on the date the check is delivered or on the date it is honored? In re Cresta Tech. holds that the defining date is the date on which the check is honored.²  Cresta Technology Corporation’s (“Cresta” or the “Debtor”) CFO, Matthew Lewis, learned this the hard way after Cresta filed a case under chapter 7 of title 11 of the United States Code (the “Bankruptcy Code”), and the court-appointed trustee pursued a claw-back action against Lewis. The action successfully targeted a check Cresta provided to Lewis prior to the petition date, which reimbursed Lewis for certain legal fees he paid on behalf of Cresta. Cresta’s bank, however, did not honor the check until after the petition date. Both the United States Bankruptcy Court of the Northern District of California (the “Bankruptcy Court”) and the BAP found that the payment to Lewis was transferred when the check was honored by the Debtor’s bank, after the petition date, and it therefore constituted an impermissible postpetition transfer.

Background

Cresta filed its chapter 7 case on March 18, 2016. The day before, Lewis paid Cresta’s bankruptcy counsel with a cashier’s check drawn from his personal account at the counsel’s request. Cresta agreed to reimburse Lewis for the amounts Lewis paid out of his personal account and issued a check to him before Cresta commenced its bankruptcy case. The check cleared Cresta’s bank account on March 22, 2016, four days after the petition date.
Subsequently, the chapter 7 trustee filed a complaint against Lewis, seeking to avoid the payment as a postpetition transfer under section 549 of the Bankruptcy Code and to recover the funds for the benefit of the Debtor’s estate under section 550(a)(1) of the Bankruptcy Code.³  Lewis argued that section 547 of the Bankruptcy Code applied instead, which would treat the check as a preferential payment and provide Lewis with certain affirmative defenses not available under section 549 of the Bankruptcy Code.⁴  Lewis’s argument relied on the date the check was delivered as the relevant date for the transfer of assets, while the trustee argued the date the check was honored was the date of the transfer. The Bankruptcy Court sided with the trustee and held that the transfer to Lewis occurred on March 22, 2016 — the date the check was honored by Cresta’s bank. Accordingly, the honoring of the check was a postpetition transfer under section 549(a) of the Bankruptcy Code and was recoverable by the Debtor’s estate. Lewis appealed the judgment of the Bankruptcy Court.

The BAP’s Decision

The BAP affirmed the Bankruptcy Court’s decision and found that, with respect to ordinary checks, a transfer occurs on the date the check is honored. In doing so, the BAP overruled Ninth Circuit precedent that conflicted with the Supreme Court’s decision in Barnhill v. Johnson.⁵  In Barnhill, the Supreme Court found that the date of honor is the date of transfer in a debate over whether a transfer via ordinary check fell within the ninety day preference period under section 547 of the Bankruptcy Code. The BAP determined that the same definition used by the Supreme Court in Barnhill with respect to transfers under section 547 applies when determining when a transfer via ordinary check occurs under section 549 of the Bankruptcy Code. More specifically, the BAP held Barnhill‘s determination that a check recipient has “no right in the funds held by the bank on the drawer’s account” because intervening events could “result in the check being dishonored” applies “with equal force” to postpetition transfers under section 549.⁶  Additionally, the BAP noted that aligning the standards for a check’s transfer date under sections 547 and 549 avoids “creat[ing] a safe harbor for certain transfers by check . . . recoverable neither as a preference nor as a postpetition transfer.”⁷
The BAP’s ruling on a check’s transfer date also determined which defenses Lewis could use against the trustee’s claw-back action. Lewis hoped to argue his payment was valid as a contemporaneous exchange for new value, which, as the BAP noted, is only available as an affirmative defense for prepetition transfers under section 547 of the Bankruptcy Code. Instead, Lewis found himself subject to the more limited exceptions set forth in section 549, which apply only to involuntary cases or good faith transfers. Therefore, the BAP found that Lewis’ argument was flawed because neither the Bankruptcy Code nor the Bankruptcy Court authorized the postpetition transfer made by the Debtor, and none of the exceptions under section 549 applied.

Conclusion

Cresta‘s holding affects any case where the debtor delivers ordinary checks prior to the petition date that are subsequently honored postpetition. For these cases, the date of transfer makes a huge difference because prepetition, preferential transfers can be defended using the affirmative defenses set forth in section 547 of the Bankruptcy Code, whereas postpetition transfers only receive the more limited defenses available under section 549 of the Bankruptcy Code. Thus, following Cresta, creditors or debtors seeking section 547’s affirmative defenses for payments via ordinary check should ensure the check is honored before the debtor files for bankruptcy or that applicable relief to authorize the postpetition transfer is requested in a chapter 11 debtor’s “first day” motions.
Weil Summer Associate Brian Morganelli contributed to this post.