13 May Congress Prefers Fewer Preference Lawsuits…?
Henry FloresSenior Counsel
A recent flurry of dozens of preferential transfer lawsuits filed in the Dean Foods bankruptcy cases¹ reminded us of two 2020 statutory changes that might provide leverage to a defendant faced with a preferential transfer demand or lawsuit. One change imposes a pre-lawsuit due diligence requirement upon the plaintiff, and the other creates a venue conundrum for the plaintiff in cases seeking to recover less than $25,000.
Receiving a preferential transfer demand letter (or worse – a lawsuit) can be an infuriating experience for a business. You provide and receive payment for goods or services – that is the way a business is supposed to operate. When a customer later files for bankruptcy, however, the process can turn upside down, and long after your invoice is paid, a trustee or other bankruptcy estate representative might demand that you return all payments that you received during the 90 days before the bankruptcy filing. To add insult to injury, you might be forced to defend the case in a courtroom across the country, which could increase your costs significantly.
Changes to the law in 2020
The Small Business Reorganization Act of 2019 (“SBRA,” effective February 2020) is the subject of much commentary due to the reorganization options that it created for businesses with debt balances below a specified dollar level. Less well-known parts of SBRA include changes to existing law that impact preferential transfer litigation. These changes (1) impose on the trustee-plaintiff a duty to conduct reasonable due diligence and to take into account the defendant’s “known or reasonably knowable” affirmative defenses, and (2) require that litigation “arising in or related to” a bankruptcy case seeking less than $25,000 from a non-insider must be filed in the district in which the defendant resides – not the district in which the bankruptcy case is pending.²
How much diligence is due?
The additional diligence requirement will seemingly add multiple considerations for plaintiffs and defendants in preference lawsuits. What constitutes “reasonable” due diligence? Besides the actual diligence (reasonable or not), how much diligence detail must a plaintiff allege in a preference complaint? Is merely parroting the statute enough, or will courts require plaintiffs to specifically describe their diligence efforts to avoid dismissal or repleading? As due diligence is now part of the plaintiff’s burden of proof under the Bankruptcy Code, how much of the plaintiff’s diligence work is subject to discovery?
It will be interesting to watch the case law develop around the relatively new change to the preference statute. But even in the absence of a body of case law interpreting the diligence requirement, defendants and their lawyers should scrutinize the plaintiff’s work carefully to determine if there is a key failure in the pleadings or the proof.
Who has home court advantage?
The requirement that certain lawsuits must be filed in the defendant’s home district is not new, and the 2020 change under SBRA change merely increased the dollar threshold from $13,650 to $25,000. However, unlike prior law, the SBRA legislative history specifically reflects Congressional intent that a preference lawsuit seeking to recover less than $25,000 from a non-insider must be filed in the district in which the defendant resides.³
If your business receives a preference demand seeking less than $25,000, your counsel should immediately research the plaintiff’s venue options (including case law arising under prior versions of the venue statute, which includes disagreement among bankruptcy courts regarding whether the relevant venue provision applies to preference cases). The prospect of a venue fight or loss of the ability to sue in its “home court” might alter how the plaintiff assesses the value of its lawsuit. If the plaintiff is required to sue in a distant court, it will lose the economies of scale that come with prosecuting all cases in one court that is familiar with the underlying bankruptcy case (and lose the benefit of any global procedural or pre-trial orders entered by the bankruptcy court). A lawsuit seeking less than $25,000 looks a lot less appealing as a stand-alone case in a different jurisdiction.
Preference lawsuits are highly-fact dependent, and the Bankruptcy Code creates some built-in advantages for the plaintiff in these cases. The changes under SBRA, however, seem to level the playing field a bit, and defendants and their counsel should consider those changes when evaluating litigation options and potential preference exposure.
¹ In re Southern Foods Group, LLC, pending under case no. 19-36313 in the United States Bankruptcy Court for the Southern District of Texas (Houston Division).
² The first change is a revision to Bankruptcy Code section that establishes the elements for preferential transfers, while the second change is a revision to the bankruptcy venue provisions of the Judicial Code. See 11 U.S.C. §547(b) and 28 U.S.C. §1409(b).
³ See H.R. Rep. No. 116-171 at p. 4 (“The bill also includes two provisions, not limited to small business chapter 11 cases, pertaining to preferential transfers. … The second provision concerns the venue where such preferential transfer actions may be commenced. Current law requires this type of action to be commenced in the district where the defendant resides if the amount sought to be recovered by the action is less than $13,650.”).
ABOUT THE AUTHOR: Henry Flores is Senior Counsel at Rapp & Krock, PC in the Bankruptcy and Creditors Rights group.
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