In 2019, Congress amended Section 547(b) by requiring a plaintiff to undertake “reasonable due diligence” before filing a complaint to recover a preference.
What does it mean? On pain of dismissal, must a preference complaint rebut defenses available to the defendant?
In an opinion on June 13, Delaware Bankruptcy Judge Mary F. Walrath laid out allegations by a preference plaintiff that satisfy the new pleading requirement, if that’s what the amendment is. Her requirements won’t burden a responsible plaintiff while laying the foundation for sanctions if the plaintiff ignored a plainly winning defense.
The Complaint
Before filing avoidance actions, the chapter 11 debtor hired a professional to conduct an analysis of transfers made before bankruptcy. If a preference was identified, the debtor wrote a demand letter inviting the potential defendant to discuss settlement or raise defenses.
Receiving no response to a demand letter, the debtor filed a complaint to recover about $850,000 in preferences and constructive fraudulent transfers. The complaint alleged that the plaintiff had conducted an analysis and determined that the transfers were avoidable and not protected by any applicable defense.
The defendants filed a motion to dismiss. Among other things, the defendants relied on the amendment to Section 547(b), which became effective in early 2020. The section now provides that:
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 [that
contains the elements of a preference required by subsections (b)(1)-(5) of Section 547].
The defendants argued that the amendment added a new element to a preference that the plaintiff must plead in a complaint. Specifically, the defendant contended that the complaint must allege in detail the due diligence undertaken by the plaintiff, including an analysis of the defenses available to the defendant.
Judge Walrath denied the motion to dismiss the preference claim.
What the Amendment Means
Judge Walrath read the complaint and ruled that it alleged the “traditional elements” of a preference. She then turned to the question of whether the amendment requires a new element of pleading and what sufficient allegations would be.
Judge Walrath found “no explanation, in the Code or in the legislative history to the amendment, of what is required to meet the new requirement.” She cited one bankruptcy court for holding that the amendment lays out a condition precedent that the plaintiff must allege and prove. Other courts have disagreed, she said.
Taking sides was “unnecessary to resolve in this case,” Judge Walrath said. Even if reasonable due diligence is a new element for a preference claim, she said that the debtor had “adequately pled factual allegations to satisfy that element.”
The complaint said that the debtor had conducted an analysis of the transfers “and whether they were protected from avoidance by any applicable defense.” The complaint also alleged that the debtor received no response to a demand letter “inviting an exchange of information regarding any potential defenses with respect to the Transfers.”
Judge Walrath denied the motion to dismiss the preference claim, holding that “the Debtors allege sufficient facts to state a plausible claim that they met the added requirement of section 547.”
Of perhaps greater significance, Judge Walrath went on to hold “that there is no requirement that the Debtors plead how the affirmative defenses are not available; the Debtors must simply plead that they considered them.”
The defendant did not walk away empty-handed. Judge Walrath dismissed the claim for constructive fraudulent transfers because the plaintiff did not plead facts to show that the debtor was insolvent. She said there “is no presumption of insolvency under section 548 as there is in section 547.”
In 2019, Congress amended Section 547(b) by requiring a plaintiff to undertake “reasonable due diligence” before filing a complaint to recover a preference.
What does it mean? On pain of dismissal, must a preference complaint rebut defenses available to the defendant?
In an opinion on June 13, Delaware Bankruptcy Judge Mary F. Walrath laid out allegations by a preference plaintiff that satisfy the new pleading requirement, if that’s what the amendment is. Her requirements won’t burden a responsible plaintiff while laying the foundation for sanctions if the plaintiff ignored a plainly winning defense.