Test_Insider_Preference Tests Mainuvta05btestpreference
INSIDER PREFERENCE TEST
INSIDER PREFERENCE TEST § 5(b)
(b) A transfer made by a debtor is voidable as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.
Prefatory Note (UFTA 1984).
As under the Uniform Fraudulent Conveyance Act, a transfer or obligation that is constructively fraudulent because insolvency concurs with or follows failure to receive adequate consideration (clause (3) above) is voidable only by a creditor in existence at the time the transfer occurs or the obligation is incurred.
Either an existing or subsequent creditor may avoid a transfer or obligation for inadequate consideration when accompanied by a condition referred to in clause (1) or (2) above.
Prefatory Note (UFTA 1984).
The new Act adds a new category of fraudulent transfer, namely, a preferential transfer by an insolvent debtor to a creditor that is an insider of the debtor and that has reasonable cause to believe the debtor to be insolvent.
An insider is defined in much the same way as in the Bankruptcy Code and includes a relative, also defined as in the Bankruptcy Code, a director or officer of a corporate debtor, a general partner, or a person in control of a debtor.
This provision is available only to an existing creditor.
Its premise is that an insolvent debtor is obliged to pay debts to creditors not related to the debtor before paying insiders that have reason to know of the debtor’s financial distress.
Reporter's Comment to § 5(b).
Subsection (b) renders a preferential transfer—i.e., a transfer by an insolvent debtor for or on account of an antecedent debt—to an insider voidable when the insider had reasonable cause to believe that the debtor was insolvent.
This subsection adopts for general application the rule of such cases as Jackson Sound Studios, Inc. v. Travis, 473 F.2d 503 (5th Cir. 1973) (security transfer of corporation’s equipment to corporate principal’s mother perfected on eve of bankruptcy of corporation held to be voidable); In re Lamie Chemical Co., 296 F. 24 (4th Cir. 1924) (corporate preference to corporate officers and directors held voidable by receiver when corporation was insolvent or nearly so and directors had already voted for liquidation); Stuart v. Larson, 298 F. 223 (8th Cir. 1924), noted 38 Harv.L.Rev. 521 (1925) (corporate preference to director held voidable). See generally 2 G. Glenn, Fraudulent Conveyances and Preferences 386 (Rev. ed. 1940).
Subsection (b) overrules such cases as Epstein v. Goldstein, 107 F.2d 755, 757 (2d Cir. 1939) (transfer by insolvent husband to wife to secure his debt to her sustained against attack by husband’s trustee); Hartford Accident & Indemnity Co. v. Jirasek, 254 Mich. 131, 139, 235 N.W. 836, 839 (1931) (mortgage given by debtor to his brother to secure an antecedent debt owed the brother sustained as not voidable).
Reporter's Comment to § 5(b) cmt. 3.
Subsection (b) does not extend as far as § 8(a) of the Uniform Fraudulent Conveyance Act and Bankruptcy Code § 548(b) (1984) in rendering voidable a transfer made by an insolvent partnership to a partner.
A general partner is an insider of the partnership, but a transfer by the partnership to the partner nevertheless is not vulnerable to avoidance under § 5(b) unless the transfer is for an antecedent debt and the partner has reasonable cause to believe that the partnership is insolvent.
By contrast, the cited provisions of the Uniform Fraudulent Conveyance Act and the Bankruptcy Code make any transfer by an insolvent partnership to a general partner voidable.
Avoidance of the partnership transfer without reference to the partner’s state of mind and the nature of the consideration exchanged would be unduly harsh treatment of the creditors of the partner and unduly favorable to the creditors of the partnership.
This is the Insider Preference Test. As the name suggests, this is not really a fraudulent transfer test at all, but a preferential transfer test roughly analogous to that found in the U.S. Bankruptcy Code. The test has four elements:
1. The debtor was insolvent;
2. The transfer was to an insider;
3. The transfer was in payment of an old debt; and
4. The insider should have known that the debtor was insolvent.
A transfer that occurs before the claim is also not actionable, i.e., it cannot be used by future creditors.
When the Drafting Committee for what became the UVTA (2014) met, there was considerable discussion that this preference test had no place in the UVTA, that its inclusion in the UFTA (1984) had been a mistake, and that it should be axed from the UVTA. But noting that many states do not have their own preferential transfer regimes, and nobody having any particularly strong feelings about the subject either way, § 5(b) barely survived. Some states that do indeed have their own preferential transfer regimes, such as California, have chosen not to enact § 5(b).
INSIDER PREFERENCE TEST BURDEN § 5(c)
§ 5(c) Subject to Section 2(b), a creditor making a claim for relief under subsection (a) or (b) has the burden of proving the elements of the claim for relief by a preponderance of the evidence.
Prefatory Note (UVTA 2014): Evidentiary Matters.
New §§ 4(c), 5(c), 8(g), and 8(h) add uniform rules allocating the burden of proof and defining the standard of proof with respect to claims for relief and defenses under the Act.
Language in the former comments to § 2 relating to the presumption of insolvency created by § 2(b) has been moved to the text of that provision, the better to assure its uniform application.
Reporter's Comment to §5(c) cmt. 4.
Subsection (c) was added in 2014. Sections 2(b), 4(c), 5(c), 8(g), and 8(h) together provide uniform rules on burdens and standards of proof relating to the operation of this Act.
The principles stated in Comment 11 to § 4 apply to subsection (c).
The creditor has the burden of proof. Since this test is largely mathematical, the courts routinely grant summary judgment for the creditor under this test.
DEFENSES PECULIAR TO §§ 4(a)(2) AND 5
§ 8(e) A transfer is not voidable under Section 4(a)(2) or Section 5 if the transfer results from:
A creditor cannot void all but an intent-based fraudulent transfer if it involves: (1) Termination of a lease; or (2) Enforcement of a UCC Article 9 security interest.
(1) termination of a lease upon default by the debtor when the termination is pursuant to the lease and applicable law; or
Reporter's Comment to § 8(e) cmt. 5.
Subsection (e)(1) rejects the rule adopted in Darby v. Atkinson (In re Farris), 415 F.Supp. 33, 39-41 (W.D.Okla. 1976), that termination of a lease on default in accordance with its terms and applicable law may constitute a voidable transfer.
(2) enforcement of a security interest in compliance with Article 9 of the Uniform Commercial Code, other than acceptance of collateral in full or partial satisfaction of the obligation it secures.
Prefatory Note (UVTA 2014). Defenses.
The amendments refine in relatively minor respects several provisions relating to defenses available to a transferee or obligee, as follows: (3) Section 8(e)(2) as originally written created a defense to an action under § 4(a)(2) or § 5 to avoid a transfer if the transfer results from enforcement of a security interest in compliance with Article 9 of the Uniform Commercial Code.
The amendments exclude from that defense acceptance of collateral in full or partial satisfaction of the obligation it secures (a remedy sometimes referred to as “strict foreclosure”).
Reporter's Comment to § 8(e)(2).
Subsection (e)(2) protects a transferee that acquires a debtor’s interest in an asset as a result of the enforcement by a secured party (which may but need not be the transferee) of rights pursuant to and in compliance with the provisions of Part 6 of Article 9 of the Uniform Commercial Code. Cf. Calaiaro v. Pittsburgh Nat’l Bank (In re Ewing), 33 B.R. 288, 9 C.B.C.2d 526, CCH B.L.R. ¶ 69,460 (Bankr. W.D.Pa. 1983) (sale of pledged stock held subject to avoidance under § 548 of the Bankruptcy Code), rev’d, 36 B.R. 476 (W.D.Pa. 1984) (transfer held not voidable because deemed to have occurred more than one year before bankruptcy petition filed).
The global requirement of Article 9 that the secured party enforce its rights in good faith, and the further requirement of Article 9 that certain remedies be conducted in a commercially reasonable manner, provide substantial protection to the other creditors of the debtor. See U.C.C. §§ 1-304, 9-607(b), 9 610(b) (2014).
The exemption afforded by subsection (e)(2) does not extend to acceptance of collateral in full or partial satisfaction of the obligations it secures.
That remedy, contemplated by U.C.C. §§ 9-620–9-622 (2014), is sometimes referred to as “strict foreclosure.”
An exemption for strict foreclosure is inappropriate because compliance with the rules of Article 9 relating to strict foreclosure may not sufficiently protect the interests of the debtor’s other creditors if the debtor does not act to protect equity the debtor may have in the asset.
SPECIAL DEFENSE TO INSIDER PREFERENCE TEST § 8(f)
§ 8(f) A transfer is not voidable under Section 5(b):
Reporter's Comment to § 8(f) cmt. 6.
Subsection (f) provides additional defenses against the avoidance of a preferential transfer to an insider under § 5(b).
With regard to the Insider Preference Test only, the Transferee can get a credit for new value, unless it was: (1) Secured by a lien; (2) Made in the ordinary course; or (3) Secured for the purpose of rehabilitating the debtor.
(1) to the extent the insider gave new value to or for the benefit of the debtor after the transfer was made, except to the extent the new value was secured by a valid lien;
Reporter's Comment to § 8(f)(1).
Paragraph (1) is adapted from Bankruptcy Code § 547(c)(4) (1984), which permits a preferred creditor to set off the amount of new value subsequently advanced against the recovery of a voidable preference by a trustee in bankruptcy to the debtor without security.
The new value may consist not only of money, goods, or services delivered on unsecured credit but also of the release of a valid lien. See, e.g., In re Ira Haupt & Co., 424 F.2d 722, 724 (2d Cir. 1970); Baranow v. Gibraltor Factors Corp. (In re Hygrade Envelope Co.), 393 F.2d 60, 65-67 (2d Cir.), cert. denied, 393 U.S. 837 (1968); In re John Morrow & Co., 134 F. 686, 688 (S.D.Ohio 1901).
It does not include an obligation substituted for a prior obligation. If the insider receiving the preference thereafter extends new credit to the debtor but also takes security from the debtor, the injury to the other creditors resulting from the preference remains undiminished by the new credit.
On the other hand, if a lien taken to secure the new credit is itself voidable by a judicial lien creditor of the debtor, the new value received by the debtor may appropriately be treated as unsecured and applied to reduce the liability of the insider for the preferential transfer.
(2) if made in the ordinary course of business or financial affairs of the debtor and the insider; or
Reporter's Comment to § 8(f)(2).
Paragraph (2) is derived from Bankruptcy Code § 547(c)(2) (1984), which excepts certain payments made in the ordinary course of business or financial affairs from avoidance by the trustee in bankruptcy as preferential transfers.
Whether a transfer was in the “ordinary course” requires a consideration of the pattern of payments or secured transactions engaged in by the debtor and the insider prior to the transfer challenged under § 5(b). See Tait & Williams, Bankruptcy Preference Laws: The Scope of Section 547(c)(2), 99 Banking L.J. 55, 63-66 (1982).
The defense provided by paragraph (2) is available, irrespective of whether the debtor or the insider or both are engaged in business, but the prior conduct or practice of both the debtor and the insider-transferee are relevant.
(3) if made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor.
Reporter's Comment to § 8(f)(3).
Paragraph (3) has no analogue in Bankruptcy Code § 547 (1984).
It reflects a policy judgment that an insider who has previously extended credit to a debtor should not be deterred from extending further credit to the debtor in a good-faith effort to save the debtor from a forced liquidation in bankruptcy or otherwise.
A similar rationale has sustained the taking of security from an insolvent debtor for an advance to enable the debtor to stave off bankruptcy and extricate itself from financial stringency. Blackman v. Bechtel, 80 F.2d 505, 508-09 (8th Cir. 1935); Olive v. Tyler (In re Chelan Land Co.), 257 F. 497, 5 A.L.R. 561 (9th Cir. 1919); In re Robin Bros. Bakeries, Inc., 22 F.Supp. 662, 663-64 (N.D.Ill. 1937); see Dean v. Davis, 242 U.S. 438, 444 (1917).
The amount of the present value given, the size of the antecedent debt secured, and the likelihood of success for the rehabilitative effort are relevant considerations in determining whether the transfer was in good faith.
BANKRUPTCY CODE INSIDER TEST § 548(a)(1)(B)(IV)
(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.
INSIDER PREFERENCE TEST TOPICS AND OPINIONS