On August 23, 2019, the Small Business Reorganization Act (H.R. 3311; S. 1091) (the “SBRA”) was signed into law. The law is effective 180-days following enactment, that is on February 19, 2020.
Congress incorporated two important changes into the SBRA that may have broader implications beyond small business reorganizations as applicable to the recovery of “preferential transfers” under Section 547 of the Bankruptcy Code.
- First, a debtor or trustee is required to consider a party’s statutory defenses “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses” prior to commencing an action under Section 547.
- Second, the small dollar limit contained in 28 U.S.C. § 1409(b) is increased to $25,000.
“Reasonable due diligence” is not defined in the SBRA and will not doubt be the subject of litigation in the future.
With respect to the venue limitation, presently claims under $13,650 must be brought in the district where the defendant resides, rather than where the bankruptcy case is pending, so as to avoid inconveniencing defendants sued in so-called “small dollar” cases. Given the impracticability of filing small claims in multiple jurisdictions, this change may effectively eliminate claims under an aggregate amount of $25,000.
These amendments were predicated primarily on recommendations made in the report of the American Bankruptcy Institute Commission (the “ABI”) to Study the Reform of Chapter 11.
The ABI identified the following “recommended principles” in its report:
- The trustee’s ability to pursue preference claims under Section 547 of the Bankruptcy Code preserves value for the estate and tempers the “run on the debtor” that may occur immediately prior to a bankruptcy filing. The avoiding power in Section 547 may, however, be subject to abuse in certain cases. The Commission analyzed a variety of potential reforms to section 547, including refining elements of, or shifting the burden of proof for, certain defenses under Section 547(c). After much research and deliberation, the Commission determined that the potential abuses under Section 547 are addressed most effectively through the changes in small preference actions, pleading requirements, and demand requirements described in these principles, and continued judicial oversight in accordance with the Bankruptcy Code.
- The trustee should be precluded from issuing a demand letter to, or filing a complaint against, any party for an alleged claim under Section 547 unless, based on reasonable due diligence, the trustee believes in good faith that a plausible claim for relief exists against such party under Section 547, taking into account the party’s known or reasonably knowable affirmative defenses under Section 547(c).
- The trustee must plead with particularity factual allegations in the complaint that establish a plausible claim for relief under section 547. In accordance with the U.S. Supreme Court’s decisions in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009), legal conclusions or speculative allegations should not be sufficient to support a preference complaint.
- The dollar amount of the defense against preference claims provided in Section 547(c)(9) should be increased to $25,000 in the aggregate. This dollar amount should continue to be increased based on the Consumer Price Index for All Urban Consumers under section 104(a).
- The small claims venue provision in 28 U.S.C. § 1409(b) should be amended to (i) clarify that the section applies to preference actions under Section 547 and (ii) increase the dollar limit for debts (excluding consumer debts) against noninsiders to $50,000 in the aggregate. This dollar amount should continue to be increased based on the Consumer Price Index for All Urban Consumers under section 104(a).
Congress rejected the ABI’s recommendation that a trustee be required to perform “reasonable due diligence” before issuing a demand letter, but adopted the recommendation that such diligence be completed ahead of the filing a complaint.
Congress declined to increase the aggregate amount of the transfers that could not be subject to avoidance as preferential in a non-consumer debtor case from $6,825 to $25,000 under Section 547(c)(9).
However, Congress appears to have seized upon that $25,000 amount for purposes of increasing the “small dollar” venue limitation under 11 U.S.C. § 1409(b).
Congress did not adopt language clarifying that 28 U.S.C. § 1409(b) applies to preference actions commenced under Section 547.
Courts had reached different conclusions over whether 28 U.S.C. § 1409(b) applied to preference claims by comparing the language in 28 U.S.C. § 1409(a) to 28 U.S.C. § 1409(b).
28 U.S.C. § 1409(a) provides:
Except as otherwise provided in subsections (b) and (c), a proceeding arising under title 11 or arising in or related to a case under title 11 may be commenced in the district court in which such case is pending. (emphasis added)
Accordingly, Section 1409(a) identifies three categories of bankruptcy proceedings.
In contrast, 28 U.S.C. § 1409(b) states:
Except as provided in subsection (d) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,375 or a consumer debt of less than $20,450, or a debt (excluding a consumer debt) against a noninsider of less than $13,650, only in the district court for the district in which the defendant resides. (emphasis added)
A Section 547 preference claim arises under title 11. It does not arise in and is not related to a case under title 11.
As Section 1409(b) identifies only those cases “arising in” and “related to” a bankruptcy case, many Courts have concluded that preference claims are not subject to the “small dollar” venue limitation of 28 U.S.C. § 1409(b).
Congress missed the opportunity to correct this oversight in the SBRA.
Reportedly a bill providing for a technical correction to Section 1409(b) is going to be introduced to Congress.
