As bankruptcy attorneys who often defend clients in preference avoidance actions, we were pleased with the 547(b) amendments, effective as of February 20, 2020, requiring a trustee to conduct some level of due diligence into affirmative defenses before commencing a preference avoidance action. The amendment states “the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property. . .” (emphasis added). We had hoped the additional due diligence requirement would reduce preference demands and actions in cases where there were reasonably knowable defenses. Unfortunately, that has not turned out to be the case in most instances.
Courts have grappled with what the new 547(b) provision requires. Does a mere assertion that the trustee has reviewed the debtor’s books and records to ascertain knowable defenses suffice? See Faulkner v. Lone Star Car Brokering, LLC (In re Reagor-Dykes Motors, LP), No. 18-50214, 2021 WL 2546664 (Bankr. N.D. Tex. June 21, 2021). Or, perhaps, must a trustee engage in pre-filing due diligence, and if so, how much is required? See Husted v. Taggart (In re ECS Refining, Inc.), 625 B.R. 425 (Bankr. E.D. Cal. 2020). Is it now an element of a preference case that must be shown by the trustee, like all other elements of its prima facie preference action? See Pinktoe Liquidation Trust v. Dellal (In re Pinktoe Trantula Ltd.), No. 18-10344, 2023 WL 2960894 (Bankr. D. Del. April 14, 2023).
Since the new 547(b) provision was enacted, we have seen an assertion that the plaintiff has reviewed the debtor’s books and records and taken into account knowable defenses routinely added to complaints and demand letters. However, based on our experience, it seems unlikely that the additional due diligence requirement is being taken seriously for the most part. We have seen complaints filed to recover preference period payments made under an executory contract that was assumed and assigned, despite the fact that the assumption and assignment of an executory contract gives rise to an absolute defense to any preference claim. In re Kiwi Int’l Air Lines, Inc., 344 F.3d 311 (3d Cir. 2003). We have also seen demands and complaints in cases involving prepayment(s) for current services. Clearly, the absence of an antecedent debt means there can be no preferential transfer. In these instances, the most basic review of underlying invoices or contracts would show the customer was on prepayment terms. We have also seen demands and complaints where a simple review of the history between the parties would show a complete or near complete defense based on either new value or the ordinary course of business.
Unfortunately, there seems to be no real consequence if a plaintiff fails to undertake reasonable due diligence into known or knowable affirmative defenses. At best, courts have dismissed actions, without prejudice, or allowed plaintiffs to amend their complaints. If a trustee can simply refile its action or amend its complaint, is there any value to opposing a preference case based on this issue alone? Would consideration of Rule 9011 sanctions be an appropriate consideration where the affirmative defenses were clearly known or knowable?
We have seen some who take this new requirement seriously and it is noticed and appreciated. We have been pleasantly surprised to receive the occasional demand letter that recites actual account history, gives credit for obvious subsequent new value and payments made in the ordinary course of business, and makes a reasonable demand after taking such defenses into consideration. These, however, tend to be the exception rather than the norm.
For now, as the bankruptcy bar adjusts to the new due diligence requirements under 547(b), creditors’ counsel should remain vigilant when defending against preference demands.
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