Basic Bankruptcy Preference Terminology

Bankruptcy preference law uses confusing and often counter-intuitive terminology. This article focuses on a few of the bankruptcy preference terms that seem to be most confusing.

Antecedent Debt

The phrase “antecedent debt” is not defined in the Bankruptcy Code.   To understand the phrase requires that each of its words be considered separately.

Patching together the Definitions of Debt and Antecedent

Under the Code, a “debt” is a “liability on a claim.” See  Section 101(12)   A “claim,” in turn, is a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” See  Section 101(5)   Simply, a debt is any obligation of the debtor giving rise to a creditor’s right of payment.

The term “antecedent” means “comes before”.  So “antecedent debt” means an obligation that comes before a transfer.  The plainest example is when you receive a payment against what you already are owed at the time of the payment.

Its all about Timing

Understanding an applying the definition of “antecedent debt” is all about timing.  No “antecedent debt” existed if you were paid in advance of the time the debtor’s obligation to pay arose  or you are paid “at the same time as” the obligation to make payment arose.  (See discussion below on the difficulties presented by cash on delivery (COD).   Determining if an antecedent debt existed requires two inquiries – when did the debtor’s obligation arise and when was the payment made.  Only by comparing the time of each of these instances can a determination be made whether an antecedent debt existed.

Dangerous Assumptions

With respect to suppliers of goods and services, the frequent assumption is that the obligation arose upon the delivery of goods or the receipt of services.  While this is most often the case, it is not always the case.  For this reason, it is important to look at the documents that represent the contract – e.g. supply agreement, purchase order, quotation.  The contract may delay the time that the obligation arose.  For example, some contracts may require inspection, written acceptance, performance testing or  receipt of invoice before the obligation to make payment arises.


The Confusion Between Antecedent Debt and Contemporaneous Exchange

“Antecedent debt” and the “contemporaneous exchange defense” should not be confused.  The trustee has the burden to prove that a transfer was made on account of an “antecedent debt”.  See Section 547(b).  Once the trustee has met this burden of proof (along with the four other elements of an avoidable transfer), the creditor has the burden of proving a defense.

So what is the relationship between an antecedent debt and a contemporaneous exchange?   A contemporaneous exchange exists when an antecedent debt came into existence, however briefly, but then is satisfied by a transfer in such a short period as to be considered “contemporaneous”.  

Professionals often get confused by mixing into an already difficult inquiry the question whether a supplier intended to extend “credit”.  An antecedent debt can, and often does, exist even where a supplier never intended to extend credit.  The existence of an “antecedent debt” is “on” “off”.  Intent has nothing to do with an antecedent debt inquiry.  

For example, COD often involves the creation of an antecedent debt – the goods are delivered, and after delivery a check is handed over.  The trustee, in proving an avoidable transfer, can stop there.   But if you ask the supplier whether it intended to extend “credit” in requiring cash on delivery (COD), the answer is always a resounding “NO”.  The contemporaneous exchange defense, in essence,  is the absence of intent, by both the supplier and the debtor, for there to be an extension of credit.   Click the following link to go to a discussion of the elements of the “Contemporaneous Exchange Defense

Bankruptcy Preference

Bankruptcy preference lawyers refer to payments by a customer during the 90 day period prior to filing date of bankruptcy by an array of terms:

voidable preferences, voidable transfers, bankruptcy preferences, bankruptcy preference payments, bankruptcy preference transfers, preferences in bankruptcy, preferential payments, avoidable transfers or avoidable payments, and just plain preferences.

All these terms mean the same thing. For a more detailed explanation of how to identify a bankruptcy preference, see the article “Bankruptcy Preferences – Basics – Part 1- Identifying a Preference Payment” on this website.

Payments and Transfers

In the above list of terms, you can see that the words “transfer” and “payment” are used interchangeably.This can get confusing in the days of wire transfers, ACH debits, set-offs, return of goods and other exchanges.Simply, a debtor can transfer any type of property or interest.  It make no difference if the property or interest is tangible, intangible, contingent, fixed, liquidated, unliquidated.   A “transfer” can be made for any reason or no reason.   A transfer does not have to benefit the recipient or reduce the value of the debtor.

A “payment” is a type of transfer that is made to benefit the recipient.A payment usually is in the form of money but it can take the form of any kind of property.  For example, if you received a return of inventory during the preference period, the value of that inventory is a “payment” for purposes of bankruptcy preferences.

Void and Avoidable

Also, the terms “preference” or “preferences”, voidable, and avoidable are used interchangeably.The heading of Section 547 of the Bankruptcy Code is “Preferences”.However, that term is not used in the body of Section 547.Instead, the phrase “avoidable transfer” is used.If an “avoidable transfer” was made, the remedy of the customer’s bankruptcy representative is “avoid the transfer”.

“Voidable” has largely replaced “avoidable” in most legal discussions.It makes more sense to say “voidable” when you are talking about reversing something that has already occurred.How do you “avoid” something that has already occurred?