Given the same simple facts and the same controlling precedent, a majority on a Tenth Circuit panel disagreed with the circuit’s Bankruptcy Appellate Panel about a recurring preference question: Does the recipient of an earmarked loan receive a preference?
Reversing the BAP, the Tenth Circuit saw no preference in a 2/1 opinion, even though a broad reading of the circuit’s own authority suggested there was a preference.
One thing is clear, the Tenth Circuit is unlikely to adopt the earmarking defense to a preference, except when a triangular transaction involves codebtors or guarantors.
The Loan from Mother
In bankruptcy court, the facts were undisputed on cross motions for summary judgment.
A son (who later became the debtor) owed $21,700 to a law firm. The son gave his mother a note for $21,700. Three days later, the mother wrote a $21,700 check to the firm drawn on her personal bank account.
The son filed a chapter 13 petition two weeks later. After the case converted to chapter 7, the trustee sued the law firm for a preference.
The mother submitted an affidavit in opposition to the trustee’s motion for summary judgment. She said that her son had no interest in the account she used to pay the law firm. She went on to say that the loan was conditioned on paying the law firm and no one else. She said that her son never had any possession, dominion or control over the proceeds, nor could he direct how the proceeds would be applied.
The bankruptcy court denied the law firm’s summary judgment motion and granted judgment in favor of the trustee, finding a preference under Section 547. The BAP affirmed. Stevens Littman Biddison Tharp & Weinberg LLC v. Walters (In re Wagenknecht), 18-093, 2019 BL 204831, 2019 Bankr. Lexis 1739 (B.A.P. 10th Cir. June 4, 2019). To read ABI’s report on the BAP decision, click here.
The BAP (Incorrectly) Interprets Marshall
Although unsuccessfully, the BAP attempted to divine the result from the Tenth Circuit’s binding authority, Parks v. FIA Card Services N.A. (In re Marshall), 550 F.3d 1251 (10th Cir. 2008). The BAP found Marshall “factually similar.”
The debtor in Marshall had paid off one credit card balance with a loan from another credit card issued by a different bank. The bank making the loan directly paid off the balance on the other credit card.
Given the expansive definition of “property” in Section 541, the Tenth Circuit in Marshall employed two tests to determine whether the loan proceeds were property of the debtor, making the payment a preference. The circuit court in Marshall found that both tests were satisfied.
The first test, dominion or control, was satisfied in Marshall because the Tenth Circuit said that the transaction was “essentially the same” as if the debtor had drawn down the line of credit on the new card and used the proceeds to pay off the old card balance. Id. at 1256.
The second test, diminution of the estate, was satisfied, the Tenth Circuit said, because the loan proceeds “were an asset of the estate for at least an instant before they were preferentially transferred” to pay off the old card. Id. at 1258.
Applying Marshall, the BAP said that the debtor in the case on appeal exercised “his ability to control the loan proceeds” by signing the note. The BAP found “no material distinction between Marshall . . . and this case,” because “borrowed funds were used to pay the Debtor’s creditor.”
On the second test, the law firm argued there was no diminution of the estate, but the BAP said that Marshall adopted “a rule of law based upon the purpose served by recovery of preferential transfers.” The BAP went on to say that the “dominion/control test and the diminution of the estate test are strained, but they are required by Marshall.”
The BAP upheld the bankruptcy court’s finding of a preference, noting, however, that Marshall was “based upon a legal fiction, not reality.”
The Circuit Reads Marshall Differently
For the court of appeals, the majority opinion on August 24 was authored by Circuit Judge David M. Ebel. Supreme Court Justice Neil M. Gorsuch replaced Judge Ebel on the Tenth Circuit when Judge Ebel took senior status in 2006.
In the circuit, the appeal turned on whether the transfer was property of the estate. Other elements to a preference were met under Section 547.
Judge Ebel explicated Marshall like the BAP but reached the polar opposite result. Unlike the BAP, he said that the case on appeal presented “a different set of facts.”
The mother said she would make the loan only to pay the debt to the law firm. Judge Ebel said that the debtor therefore had no dominion and control on the first test because he had no ability to direct the distribution of loan proceeds.
On the second test, Judge Ebel said there was no diminution of the estate because the loan proceeds never became estate property.
The majority reversed the two lower courts and remanded the case, having found no preference.
The Dissent
Circuit Judge Mary Beck Briscoe “respectfully” dissented. She would have found as preference applying Marshall. She said that the majority “ignores the realities of the transaction.”
In Judge Briscoe’s interpretation of the facts, the debtor’s assets “effectively increased” by the mother’s loan, but his debts increased by the same amount. She saw the son as having dominion and control “constructively” though his mother.
Judge Briscoe also disagreed with the majority’s finding that the loan proceeds never became part of the bankruptcy estate. Again citing Marshall, she said the test was not whether the net value of the estate changed. Rather, the proceeds would have been estate property had they not been transferred before bankruptcy. Id. at 1258.
Judge Briscoe saw the majority as “implicitly” adopting the earmarking doctrine, a judge-made, nonstatutory defense to a preference. In her view, earmarking should not be “extended to situations other than those involving codebtors or guarantors.”
In a footnote at the end of the majority opinion, Judge Ebel said that earmarking was not a question on appeal because it was not raised by the appellant. He observed that the Tenth Circuit “has not determined whether the earmarking doctrine applies outside of the codebtor context.”
However, Judge Briscoe quoted Marshall for saying that earmarking undermines the goals of preference law but is not contained in Section 547.
Observations
Between Marshall and the case on appeal, there are subtle differences in the facts that might justify different outcomes.
In Marshall, the debtor was drawing on an existing line of credit. In the case on appeal, the debtor had no line of credit with his mother. She was creating an entirely new loan transaction, for one purpose and one purpose only. In Marshall, the debtor could have drawn the line of credit for any purpose.
Do the slightly different facts justify different outcomes? Was the Marshall panel partial to creditors who would benefit from finding a preference? Was Judge Ebel partial to the defendant because creditors were no worse off?
The defendants were different. In Marshall, the defendant was a bank where the preference judgment was just an ordinary cost of doing business. For the law firm, paying the preference was more consequential.
If any of our readers can explain the different outcomes, please let us know.
Given the same simple facts and the same controlling precedent, a majority on a Tenth Circuit panel disagreed with the circuit’s Bankruptcy Appellate Panel about a recurring preference question: Does the recipient of an earmarked loan receive a preference?
Reversing the BAP, the Tenth Circuit saw no preference in a 2/1 opinion, even though a broad reading of the circuit’s own authority suggested there was a preference.
One thing is clear, the Tenth Circuit is unlikely to adopt the earmarking defense to a preference, except when a triangular transaction involves codebtors or guarantors.
The Loan from Mother
In bankruptcy court, the facts were undisputed on cross motions for summary judgment.
A son (who later became the debtor) owed $21,700 to a law firm. The son gave his mother a note for $21,700. Three days later, the mother wrote a $21,700 check to the firm drawn on her personal bank account.
The son filed a chapter 13 petition two weeks later. After the case converted to chapter 7, the trustee sued the law firm for a preference.
The mother submitted an affidavit in opposition to the trustee’s motion for summary judgment. She said that her son had no interest in the account she used to pay the law firm. She went on to say that the loan was conditioned on paying the law firm and no one else. She said that her son never had any possession, dominion or control over the proceeds, nor could he direct how the proceeds would be applied.
The bankruptcy court denied the law firm’s summary judgment motion and granted judgment in favor of the trustee, finding a preference under Section 547. The BAP affirmed. Stevens Littman Biddison Tharp & Weinberg LLC v. Walters (In re Wagenknecht), 18-093, 2019 BL 204831, 2019 Bankr. Lexis 1739 (B.A.P. 10th Cir. June 4, 2019). To read ABI’s report on the BAP decision, click here.
The BAP (Incorrectly) Interprets Marshall
Although unsuccessfully, the BAP attempted to divine the result from the Tenth Circuit’s binding authority, Parks v. FIA Card Services N.A. (In re Marshall), 550 F.3d 1251 (10th Cir. 2008). The BAP found Marshall “factually similar.”
The debtor in Marshall had paid off one credit card balance with a loan from another credit card issued by a different bank. The bank making the loan directly paid off the balance on the other credit card.
Given the expansive definition of “property” in Section 541, the Tenth Circuit in Marshall employed two tests to determine whether the loan proceeds were property of the debtor, making the payment a preference. The circuit court in Marshall found that both tests were satisfied.
The first test, dominion or control, was satisfied in Marshall because the Tenth Circuit said that the transaction was “essentially the same” as if the debtor had drawn down the line of credit on the new card and used the proceeds to pay off the old card balance. Id. at 1256.
The second test, diminution of the estate, was satisfied, the Tenth Circuit said, because the loan proceeds “were an asset of the estate for at least an instant before they were preferentially transferred” to pay off the old card. Id. at 1258.
Applying Marshall, the BAP said that the debtor in the case on appeal exercised “his ability to control the loan proceeds” by signing the note. The BAP found “no material distinction between Marshall . . . and this case,” because “borrowed funds were used to pay the Debtor’s creditor.”
On the second test, the law firm argued there was no diminution of the estate, but the BAP said that Marshall adopted “a rule of law based upon the purpose served by recovery of preferential transfers.” The BAP went on to say that the “dominion/control test and the diminution of the estate test are strained, but they are required by Marshall.”
The BAP upheld the bankruptcy court’s finding of a preference, noting, however, that Marshall was “based upon a legal fiction, not reality.”