Preference Actions: Clarifying the Trustee's Pre-Filing Due Diligence Requirements in Section 547(b)

Description

To avoid the abuse of power under Section 547 of the Bankruptcy Code, the Small Business Reorganization Act of 2019 (SBRA) amended Section 547(b) of the Bankruptcy Code to subject a trustee’s exercise of his or her preference avoidance powers to two requirements. Now, the plaintiff may avoid allegedly preferential transfers "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 [547](c)" before commencing suit.

Some case law has developed but controversy still exists regarding what these elements require a trustee to do. The Bankruptcy Code does not define "due diligence under the circumstances of the case" and this will no doubt be the subject of litigation in the future. No one is certain whether reliance on the debtor's filings in the bankruptcy case constitutes "reasonable diligence in the circumstances of the case" or if a trustee must review additional records. Moreover, it is unknown what the consequences will be where a debtor's available books and records are limited or incomplete.

Equally unknown is what it means to adequately "take into account" the defendant's "known or reasonably knowable" Section 547(c) affirmative defenses, such as "contemporaneous exchange," "ordinary course," and "new value" (as well as other potential defenses). The analysis may be more complicated if the transferee was an insider.

Listen as our authoritative panel of bankruptcy practitioners reviews leading cases and guides you through Section 547(b).