Category: Preference Litigation


Part I of this preference action mini-series discussed preference basics, defining what constitutes a preference and outlining claims and defenses.  This post sets forth tips for mediating preference actions from the standpoints of the mediator and practitioner.

For The Mediator

  • Calculate whether the preference claim was brought within the relevant statute of limitations.  In general, the statute of limitations for preference claims is 2 years from the date the bankruptcy was filed.
  • Submit proposed mediation procedures to the bankruptcy court for approval, if necessary in your jurisdiction.
  • Notice the mediation between 35 and 40 days before the hearing date:

“[T]he mere noticing of a case for hearing can cause parties to settle in advance in order to avoid the time and expense of attending the hearing.” –Interview with Lester J. Levy, Esq., ABI Journal, Vol. XXII, No. 3 (April 2003), http://www.jamsadr.com/faq-on-bankruptcy-mediation-04-01-2003/.

  • Hold a pre-mediation conference and encourage the parties to exchange key pieces of discovery.
  • Familiarize yourself with the claims and potential defenses available to the plaintiff and defendant, respectfully.  Understand options for the settlement of preference claims (See example settlement options in Practitioner section below).
  • Understand what transactions constitute a preference.  If a transfer constitutes a preference, it is always a preference subject only to the establishment of certain defenses.
  • Request that the parties submit claims analyses (if completed), including any ordinary course or new value analyses.  This will help you assist the parties in whittling down preference exposure to establish an agreed upon preference amount and move toward settlement.
  • Request copies of any stipulations to which the parties have agreed.  For example, if the parties have agreed that 5 of 10 transactions are subject to the new value defense, that is significant to the mediation process.  You can then help them focus on resolving the dispute surrounding the remaining 5 transactions instead of starting from all 10.
  • During the mediation, use caucusing to address the strengths and weaknesses of plaintiff’s preference claims and defendant’s potential defenses.
  • During the mediation, address and work through the relationship of the parties from inception through the date of the preference claim, including:
    • Payment terms (i.e. was payment expected 30 days or 90 days from each invoice);
    • The actual payment history (i.e. the payment terms may have been 30 days from invoicing, but debtor always actually paid 45 days from invoicing); and
    • Any changed payment terms (i.e. the creditor implemented prepayment or cash-on-delivery terms, which are additional defenses to preference claims).
    • If not already addressed and stipulated by the parties, assist them with establishing a timeline regarding key dates surrounding the subject transfers.  Two pertinent standards relevant to timing issues follow:
        1. Generally, the date of the transfer is the standard for determination of whether the subject payment constitutes a preference.
        2. When the transfer is made by check, the date the check clears, rather than the date that the check is delivered to the creditor, is considered to be the transfer date.  Barnhill v. Johnson, 503 U.S. 393, 112 S.Ct. 1386, 118 L.Ed.2d 39 (1992).

For The Practitioner

  • Seek agreement on the use of a neutral or mediator early in the litigation process:

Use of a neutral in the early phases (when the claim is first asserted by a trustee or debtor-in-possession) has many advantages. A respected neutral can be an agent of reality. Necessary discovery can be accomplished in an effective, less costly manner. Preparing for the session can cause the parties to focus on the likelihood of prevailing as weighed against the cost of trial sooner than court adjudication would promote. Costs and delay are factored into any mediated settlement. Mediation may bring a quick end to the dispute. Even when used at a later date, mediation may help to avoid the delay and expense of a trial or to minimize the disputed issues to be tried.

MWI, Bankruptcy & Finance FAQs, http://www.mwi.org/bankruptcy-faqs.html#1 (citing to ABI Guide to Bankruptcy Mediation, Second Edition (ABI, 2009), written by Jack Esher, Lisa Fenning and Erwin Katz).

  • Understand what transactions constitute a preference.  If a transfer constitutes a preference, it is always a preference subject only to the establishment of certain defenses.
  • Complete and know your client’s and the opposing party’s defenses and positions.  For example, it is important to know whether additional discovery will be necessary.  If the exchange of an additional canceled check or wire transfer would help to narrow the disputed amounts or your client’s preference exposure, this could likely positively impact the mediation process.
  • Understand your client’s ordinary course and new value analyses, and then analyze the opposing party’s responses.   You do not want to be caught off guard with new information presented by the other side during the mediation that your client had not factored into its analysis.
  • Request that a default provision be included in any order establishing mediation procedures, which will detail how the parties and bankruptcy court will proceed if a party does not appear for the mediation.
  • Attempt to negotiate stipulations with the opposing party, regarding timing issues (i.e. relevant transfer dates), ordinary course of business issues (including standards for industry and relationship between the parties), key transfer dates, amount of new value provided (i.e. contemporaneous exchanges and subsequent new value), and any remaining preference exposure.
  • Know whether the parties agreed to any new terms at any point in the payment relationship.  For example, if the alleged preferential transfers were made on a prepayment or cash-on-delivery basis that is an additional defense to a preference claim.
  • Know your settlement options and authority.  The following are options:
  • Dismissal with prejudice based on establishment of reduced or no remaining preference exposure;
  • Payment of portion of alleged preference at outset (i.e. 30-50% of claim);
  • Negotiation for payment of portion of remaining preference exposure after performing ordinary course or new value analysis;
  • Offering waiver of prior filed proof of claim or claim for settlement amount for dismissal of preference claim; and
  • Including proof of claim for any settlement amount as required settlement term in exchange for higher payment on alleged claim.

Although not exhaustive, I hope these tips are helpful to the mediation of your next preference action.  Please share your thoughts or favorite tips for settling preference actions.

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Picture this . . .Widget Factory has been providing widgets to Small Business for 5 years.  In those 5 years, Small Business paid each invoice within 30 days of receipt.  The past 6 months of payments, however, have been a bit more suspect.  Small Business began making payments over 30 days past the date of invoicing and missed a few payments here and there.  But, Small Business doubled up on a couple of invoices in the last 90 days to catch up.  After struggling financially to keep up with creditors and the demand of its customers, Small Business filed for bankruptcy protection.  Upon review of Small Business’s schedules and questioning during the meeting of creditors, the trustee filed an adversary proceeding to recover the payments made to Widget Factory in the 90 days before the bankruptcy filing.  This is what the bankruptcy world affectionately refers to as a preference action.

The focus of this post, which is Part I of II in a mini-series on mediating preference actions, is to generally (very generally!) define and outline the elements of a preference action.

Preference claims customarily arrive as a demand to repay amounts the creditor received from its customer in the 90 days before the customer’s bankruptcy case . . . . To many creditors, preference claims come as surprises.  After all, there is no dispute that the customer owed the debt and the creditor earned the payment.”  Often, creditors view preference claims as unfair, asking why they should be required to repay monies that were legitimately due and owing to them. Under ordinary business circumstances, this position in well-taken.  But,”[t]he primary underlying principle supporting the return of preferential payments is the fair and equal treatment of all unsecured creditors.  Disgorging payments made is intended to redistribute the bankruptcy estate’s assets equitably among all of the unsecured creditors. . . . [C]reditors who repay preferences will hopefully recover at least a part of what they returned by participating pro rata in distributions with other unsecured creditors. . . . Section 547 does not require ‘intent‘ to receive a preference, notice of insolvency, fraud or any other subjective element.  Because the policy behind the preference statutes is equal distribution, intent or notice is irrelevant.”

So, how do we know if a payment is a preference?  Preferences are defined under Section 547 of the Bankruptcy Code by the following five elements:

  1. A transfer of an interest of the debtor in property to or for the benefit of a creditor;
  2. A transfer for or on account of antecedent debt owed by the debtor before such transfer was made;
  3. A transfer made while the debtor was insolvent;
  4. A transfer made during the preference period (the Bankruptcy Code presumes that a debtor was insolvent in the 90 days before the petition date and the reach-back period is extended to one year for insiders—family members, business partners, etc.); and
  5. The transfer enables the creditor to receive more than if the case preceded under chapter 7.

No, no you say, that isn’t right.  Shouldn’t the creditors have some defense?  Well, of course.  There are 10 of them:

  1. The transfer was made in a contemporaneous exchange of new value to the debtor;
  2. The transfer was made in the ordinary course of business;
  3. The transfer was a security interest in property securing a new value to the debtor;
  4. The transfer was made after the creditor provided new value;
  5. The transfer was a security interest in inventory or a receivable;
  6. The transfer was the fixing of a statutory lien;
  7. The transfer was of an alimony or child support payment;
  8. The transfer was of property with an aggregate value less than $600 in a case involving primarily consumer debt;
  9. The transfer was of property with an aggregate value of less that $5,475 in a case not involving consumer debt; or
  10. The transfer was pursuant to an alternative repayment schedule.

There are also several other defenses that are specific to particular industries, such as grain producers, fishermen and warehousemen.

As you would imagine, the assertion of preference claims and affirmative defenses, lead to a flurry of negotiations, charts, documents, calculations and other supporting evidence to whittle down what amount of the questioned payments are actual preferences, if anything.  This is why preference actions are often the subject of mediation.

Stay tuned for Part II on how mediation can be used in preference actions.

Sources:

Quotations and excerpts from Wheeler, David B., ABI Preference Handbook, American Bankruptcy Institute (2d ed. 2008), at 1, 3, 8–21, 29, 36–38.

11 U.S.C. § 547(b) (Elements of Preference Claim).

11 U.S.C. § 547(c) (Affirmative Defenses).

Even in light of the litigious and adversarial nature of some matters nowadays, many parties are willing to engage in mediation to attempt to resolve matters or various sub-issues.  I have heard from several practitioners, however, that while the mediation process allowed their clients to tell their stories through caucusing and/or facilitative discussions with the other side, the mediation did not yield any significant movement in their interests.  As a result, they left the mediation table still touting their positions and had not moved closer to settlement.  In fact, a few practitioners have stated that they wished the mediator was more helpful in getting their client to understand the weaknesses in their position.  Well, the parties and the mediators in those situations were likely approaching the mediation from different perspectives; perhaps they were respectively viewing the process through evaluative and facilitative lenses (or some other lens).

There are several forms of mediation.  For an effective mediation process, it is important for practitioners to understand each method, agree on an approach for the mediation and communicate the same to the mediator.  So, what types of mediation exist?  There are four widely recognized approaches, although the methods and approaches are not just limited to the following.

First, Evaluative Mediation “is generally understood to be a process which may include an assessment by the mediator of the strengths and weaknesses of the parties’ cases and a prediction of the likely outcome of the case. . . .  Some parties wish to retain an evaluative mediator to help them get an objective view of their case and to prod the parties to reach a reasonable settlement based upon the merits of their case.”  Although every circumstance should be evaluated differently, it is likely that parties mediating bankruptcy-related issues may be seeking more of an evaluative mediation process, because of the need to resolve such matters on a “faster track.”  Further, evaluative mediators are more likely to be chosen for their subject matter expertise, which may be beneficial in the bankruptcy context.  After all, under this approach it would be important for the mediator to know the difference between valuation issues, contested confirmation hearings and preference actions.  Evaluative mediation, however, should not be confused with neutral evaluation, or a neutral evaluator’s approach.  “Neutral evaluation is a disciplined and principled process.  The neutral is chosen for knowledge and experience and listens to the arguments of both sides, researches the matter and comes up with an opinion.”  An evaluative mediator, on the other hand, may or may not give an opinion and/or a proposal for settlement.

Second, Facilitative Mediation is probably the most common approach people think of when they hear the word mediation.  Facilitative mediation is the process by which the mediator “helps parties think about how to work through difficulties and toward a resolution of their own making [if so desired] without outside pressure.”  Under this approach, “[t]he mediator asks questions; validates and normalizes parties’ points of view; searches for interests underneath the positions taken by parties; and assists the parties in finding and analyzing options for resolution.  The facilitative mediator does not make recommendations to the parties, give his or her own advice or opinion as to the outcome of the case, or predict what a court would do in the case.  The mediator is in charge of the process, while the parties are in charge of the outcome.”

Third, Transformative Mediation,  in some respects, appears to be a hybrid of the common approaches.  The distinguishing factor is that the ultimate goal is for the parties to leave the mediation with an improved relationship.  “The parties . . . work with the mediator to determine the appropriate resolution process for their situation. . . . Recognition is generally considered to be an important part of transformative mediation, so that each party can understand how the other one defines the problem.”  This approach is often used to resolve workplace conflicts, because the conflicting parties typically continue to work together.  Transformative mediation, however, could easily be extended to bankruptcy cases where parties such as lenders and debtors, debtors and creditor-suppliers and debtors and landlords need to maintain a continuing relationship during and after the bankruptcy case is closed.

Fourth, “Narrative Mediation builds on the storytelling metaphor.  It is both an approach and a methodology, providing mediators with a way of incorporating stories into the very fabric of mediation.”  This allows parties to move from positions of “victimized and protagonist” and “victimizer and antagonist,” to a shared story without pinning the responsibility for the conflict on any one side.  “This leaves conflict parties with a previously ‘closed’ interpretation (their story) open to new possibilities and interpretations.”  The ultimate goal is that through storytelling, the parties move toward a “new climate of openness [leading] to the genesis of  a new account [story] and mutually satisfying interpretations and outcomes.”

While there are several approaches to mediation, the takeaway here is that the parties should work together to agree on a method, communicate that approach to the mediator and re-evaluate where necessary to change methods given the particulars of their individualized situations and any changed dynamics over time.  Mediators should also be clear to communicate their methods to the parties (whether it be one method or a combination of methods and approaches), encourage the parties to agree on the approach and understand what methods work best for specialized issues, matters and areas.

What method, if any, do you think best suits bankruptcy-related disputes?

Sources:

Zena Zumeta, Styles of Mediation: Facilitative, Evaluative and Transformative Mediation, http://learn2mediate.com/resources/nafcm.php.

Diane Cohen, Evaluative Mediation, http://www.mediate.com/articles/CohenDbl20110321.cfm (Mar. 2011).

What Facilitative Mediation Has to Offer, http://dianecohenmediation.com/site/what-facilitative-mediation-has-to-offer/ (Jan. 2010) (originally published at mediate.com).

Alison Faria, What is Transformative Mediation?, http://www.wisegeek.com/what-is-transformative-mediation.htm.

Toran Hansen, The Narrative Approach to Mediation, http://www.mediate.com/articles/hansenT.cfm (Sept. 2003).

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