The Preference That Wasn't and the Trustee's Avoidance Powers
Cedar Peak Manufacturing Inc. has been insolvent for eight months. On January 10, it pays its longtime supplier, Ironwood Parts Ltd., $95,000 for invoices that were 90 days past due. On February 1, Cedar Peak grants its bank a security interest in its equipment to secure a new $200,000 loan, and the bank registers the same day. On March 15, Cedar Peak transfers a company truck worth $40,000 to its former president in satisfaction of an unpaid consulting fee. Cedar Peak files for bankruptcy on April 1. The trustee challenges all three transactions. Ironwood says it was simply paid a debt it was owed; the bank says it gave new value; the former president says the truck was earned compensation.
1. Can the trustee avoid the $95,000 payment to Ironwood as a preference?
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Probably yes, unless Ironwood can establish a defense. A preference requires a transfer of the debtor's interest in property, to or for the benefit of a creditor, on account of antecedent debt, made while insolvent, within the preference period (generally 90 days before filing, or one year for insiders), and enabling the creditor to receive more than it would in a Chapter 7 liquidation. All elements appear present: Ironwood was paid on a 90-day-old debt, Cedar Peak was insolvent, and the payment was within 90 days of an April 1 filing (January 10 is 81 days before). Paying an unsecured supplier in full gives it more than the pro rata distribution it would otherwise receive.
Defenses to check: (1) contemporaneous exchange for new value-not available, the debt was old; (2) subsequent new value-Ironwood would need to show it delivered new goods on credit after the payment, which the facts do not support; (3) ordinary-course-of-business defense-available only for security interests, not for cash payments on antecedent debt; (4) the payment was not made while insolvent-the eight-month insolvency defeats this. The trustee can therefore recover the $95,000, and Ironwood's claim is restored as a general unsecured claim, which will recover only a fraction.
2. Is the bank's February 1 security interest vulnerable, and does the answer change because the bank registered the same day?
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The security interest is likely safe because it was given for new value, not on account of antecedent debt. The preference analysis turns on whether the transfer was 'on account of an antecedent debt.' The bank advanced $200,000 simultaneously with or after taking the security interest, so the grant of the lien was a contemporaneous exchange for new value. That defeats the preference element even if the debtor was insolvent and the transfer occurred within 90 days.
Same-day registration strengthens the position. Perfection on the same day as the advance means the bank was not unperfected for a period during which other creditors could have levied; an unperfected interest that is perfected later can be avoided as a preference if it was unperfected more than 30 days after attachment and the debtor was insolvent. Here there is no gap. The bank should also confirm it gave 'reasonably equivalent value' in the form of the loan and that the loan proceeds were actually advanced, not merely committed.
One caveat: if the $200,000 merely refinanced or extended an existing unsecured loan rather than adding new money, the new-value defense weakens, and the analysis shifts to whether the bank improved its position during the preference period. The exam answer should distinguish new money from rollover.
3. Can the trustee recover the $40,000 truck from the former president?
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The trustee has a strong claim under both preference and fraudulent-transfer theories, and the former president's 'earned compensation' argument is unlikely to prevail. As a preference, the transfer to a former president may be treated as an insider transaction, which extends the look-back period to one year, and April 1 minus March 15 is only 17 days, well within either period. The transfer was on account of an antecedent debt (unpaid consulting fees), while insolvent, and let an insider receive full value where an unsecured creditor would receive a fraction.
The fraudulent-transfer analysis is even stronger. If the consulting services were not reasonably equivalent in value to a $40,000 truck, or if the debtor received no new value at the time of transfer, the trustee can avoid the transfer as constructively fraudulent. The former president's insider status invites scrutiny of the valuation. The trustee can recover the truck or its value from the transferee.
Defenses the president might raise: he provided services and the fee was contractual; the transfer was in the ordinary course. But ordinary-course protection is narrow and generally unavailable for insider transfers to a debtor's own officer. The trustee should also check whether the truck was encumbered, since the trustee takes the interest the debtor had, subject to valid liens.