From the perspective of the defendant, preference law sometimes seems to operate on the “gotcha” principle.
But from the perspective of the bankruptcy trustee, “there is a strong fairness argument to be made” in recovering preferences when some creditors are paid and others aren’t, Bankruptcy Judge Jeffrey P. Norman of Houston said in an opinion on August 18.
The chapter 7 debtor was the owner of the working interest in an offshore well that “blew out.” To ameliorate and repair the damage, the debtor chartered a vessel. The debtor’s payments for the vessel were a preference, but the owner of the vessel is appealing.
Payments After the Blowout
The debtor had insurance covering some of the loss. Less than one week after the insurer paid the debtor about $4.8 million, the debtor paid almost $270,000 to the vessel owner. The payment fell within the 90-day preference period. The payments to the vessel owner were on account of three invoices that were paid 107 days, 87 days and 43 days after the invoices were issued by the vessel owner.
The vessel owner had a claim for more than $300,000 that the debtor did not pay for the charter. Judge Norman said that the vessel owner had been paid about 47% of its expenses in connection with the blowout, while other creditors were paid nothing.
The trustee sued the vessel owner for $270,000 in preferences. After trial, Judge Norman rejected all of the defenses proffered by the vessel owner and awarded judgment in favor of the trustee for the $270,000, plus prejudgment interest at 5.34%.
‘An Interest of the Debtor in Property’
The vessel owner principally argued there was no preference because the insurance proceeds were not an “interest of the debtor in property,” a requisite for the recovery of a preference under Section 547(b).
Judge Norman said that the phrase is not defined in the Bankruptcy Code, but the Supreme Court has interpreted the term to mean “property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings.’” He also cited the Supreme Court for saying that the phrase “is synonymous with the term ‘property of the estate’ under § 541.”
Applying the law to the facts, Judge Norman noted that the debtor controlled the insurance proceeds and that they were comingled after receipt from the insurer. Even if the proceeds were to be used exclusively for expenses incurred in the blowout, he said that “the decision of who[m] to pay, when to pay, and how much to pay was still under the exclusive control of the Debtor.”
Judge Norman held that the payments were from an interest of the debtor in property because the funds would have been property of the estate had the payments not been made. “Additionally,” he said, “the funds . . . held in a commingled account that could have been used to pay other creditors presumptively constitutes property of the estate.”
No Earmarking
Judge Norman also rejected the earmarking defense, which, he said, “should only be applied sparingly.” He cited the Fifth Circuit for saying there is no earmarking defense when the debtor “exercised control” over the funds.
Although physical control is not the only determinative factor, Judge Norman noted how there was no agreement with the insurance company for using the proceeds only for costs resulting from the blowout.
“Additionally,” Judge Norman cited the Fourth Circuit for saying that “‘the earmarking doctrine applies only when the debtor borrows money from one creditor and the terms of that agreement require the debtor to use the loan proceeds to extinguish specific, designated, existing debt.’” In that regard, the record did not show a direction from the insurance company to use the proceeds only for blowout expenses.
No ‘Ordinary Course’ Defense
The vessel owner contended that the payments were in the “ordinary course,” giving rise to a defense under Section 547(c)(2)(A).
“Unfortunately,” Judge Norman said, there were no historical transactions between the debtor and the owner. Moreover, the invoices called for payment within 30 days, and the payments were all beyond 30 days.
‘Fairness’
Payments from insurance proceeds were not made pro rata, while some “lucky” vendors were paid in full and others received nothing, Judge Norman said.
Judge Norman saw the trustee as having “a strong fairness defense” because bankruptcy “should stand for the proposition that all creditors are treated fairly and equally.” He gave judgment to the trustee for the $270,000 because the vessel owner “should not be able to retain [47%] of its invoices under these facts while other creditors were paid zero or amounts much less than [47%].”
The owner is appealing.
From the perspective of the defendant, preference law sometimes seems to operate on the “gotcha” principle.
But from the perspective of the bankruptcy trustee, “there is a strong fairness argument to be made” in recovering preferences when some creditors are paid and others aren’t, Bankruptcy Judge Jeffrey P. Norman of Houston said in an opinion on August 18.
The chapter 7 debtor was the owner of the working interest in an offshore well that “blew out.” To ameliorate and repair the damage, the debtor chartered a vessel. The debtor’s payments for the vessel were a preference, but the owner of the vessel is appealing.