Majority of Courts Still Permit Small-Dollar Avoidance Suits in the Debtor’s Home Court

Congress failed in its attempt at putting the venue of smaller avoidance actions where the defendant resides, rather than in the debtor’s home court.

Interpreting 28 U.S.C. § 1409(b) sua sponte, District Judge Joanna Seybert of Central Islip, N.Y., transferred a chapter 7 trustee’s $7,000 preference suit to the debtor’s home court in Connecticut. Judge Seybert cited and agreed with the majority of courts and an article in the April 2020 edition of the American Bankruptcy Institute Journal written by Michael L. Temin and Martha B. Chovanes, both from Fox Rothschild LLP in Philadelphia. To read the article, click here.

The Small-Dollar Preference Suit

The plaintiff in the small preference suit was the trustee in a chapter 7 case pending in the District of Connecticut. The trustee filed the complaint under Section 547 in a district court in the Eastern District of New York, where the defendant had its headquarters.

The trustee filed a motion asking Judge Seybert to refer the suit to the bankruptcy court in the Eastern District of New York. Instead, Judge Seybert wrote a four-page opinion and sent the case to the trustee’s home court in Connecticut.

The outcome was governed by Section 1409. With exceptions provided in subsections (b) and (d), subsection (a) allows for venue of “a proceeding arising under title 11 or arising in or related to a case under title 11” in the district where the bankruptcy case is pending.

For a proceeding to recover a debt of less than $25,000 owing by a noninsider, subsection (b) places venue in “the district in which the defendant resides” for “a proceeding arising in or related to” a bankruptcy case.

Notably, subsection (b) does not place venue in the debtor’s district for a small-dollar suit “arising under” title 11.

Judge Seybert jumped on the omission of “arising under” in subsection (b). She cited authority for the principle that a preference suit arises under title 11.

Citing the majority of courts and the ABI Journal article by Temin and Chovanes, Judge Seybert held that “the venue provision of Section 1409(b) is inapplicable.”

Under 28 U.S.C. § 1412, Judge Seybert said she had the right to transfer venue sua sponte “in the interest of justice or for the convenience of the parties.” Finding that the interest of justice and judicial economy would be served by transferring the suit to Delaware, she denied the motion to refer the suit to the bankruptcy court on Long Island.

Instead, Judge Seybert transferred the preference suit to the District of Connecticut with a “recommendation” that the suit be referred to the bankruptcy judge.

The ABI Journal Article

The ability of trustees to mount small-dollar preference actions had led to abuse. Sometimes, a trustee would sue everyone who received a payment within 90 days of bankruptcy, even against defendants whose payments were clearly made on time and in the ordinary course of business.

With only a few thousand dollars involved, defendants often would capitulate or settle because hiring a lawyer would cost more than settlement. To stem abuse of Section 547, Congress enacted two reforms as part of the Small Business Reorganization Act that became law in August 2019.

For one, the SBRA amended Section 547(b) by requiring a trustee to perform “reasonable due diligence” by “taking into account a party’s known or reasonably knowable affirmative defenses.”

Second, Congress amended Section 1409(b) by raising the threshold to $25,000 from $13,650.

Still, there was a loophole, as Temin and Chovanes point out in their article.

The ABI Commission to Study the Reform of Chapter 11 noted the absence of “arising under” in Section 1409(b) and recommended that the subsection be amended to “clarify that the section applies to preference actions under section 547.” The Commission also recommended that the threshold be raised to $50,000.

In the SBRA, Congress raised the threshold to $25,000 but did nothing to require that preference suits be filed in the defendant’s district.

Temin and Chovanes cited the majority of courts holding that the absence of “arising under” in subsection (b) permits trustees to file small-dollar avoidance actions in the debtor’s home court. They also cited and criticized the rationale utilized by the minority that require venue in the defendant’s district.

Temin and Chovanes conclude “there is currently no small-dollar venue exception for preference cases.” They recommend that Congress follow the ABI Commission’s suggestion by amending Section 1409(b) “to include the phrase ‘arising under.’”