As discussed in our earlier post, which you can read here, the Small Business Reorganization Act of 2019 (“SBRA”) created several changes to the law in order to streamline the process by which small businesses may reorganize under a Chapter 11 bankruptcy model.
In addition to streamlining the reorganization process and making Chapter 11 more cost effective for small businesses, the SBRA also adjusted certain rules to protect the rights of creditors that may have received a preferential transfer (“Preference”) from the debtor before bankruptcy.
The 90-day period before the debtor files a bankruptcy case (or one year for insiders), is called the “Preference Period.” Payments that the debtor makes during the Preference Period are “potentially” subject to avoidance, meaning that the creditor might be obligated to return all or a portion of the payment that it received.
Without diving into the nuances of a Preference, it is one of the fundamental policies of the Bankruptcy Code to ensure that all similarly classified creditors should be treated the same. Thus, the Preference doctrine seeks fairness by making creditors that may have received more during the Preference period, i.e., they were preferred over another creditor, to give back the money that they received, and then those funds are shared (pro-rata) with all of the other similarly classified creditors.
With that in mind, the SBRA’s made certain changes that should benefit creditors who may have received a Preference. The changes include:
Normally, the venue for filing a Preference complaint is in the Bankruptcy Court where the Debtor’s case is pending. So, if the bankruptcy case is pending in New York and the creditor/defendant lives in Los Angeles, the lawsuit would normally be filed in New York. This alone can make it very costly for a creditor to defend the Preference complaint. However, under the SBRA, if the potential Preference was less than $25,000 the lawsuit must be filed in the District Court where the defendant resides. So, in the above example where the bankruptcy case is pending in New York, the complaint would need to be filed where the creditor/defendant lives, i.e., in Los Angeles. This should help reduce the financial burden of forcing a “smaller” creditor to litigate an action out of state.
The SBRA requires that before the plaintiff may file a Preference complaint, it must first calculate the creditor/defendant’s potential defenses (such as ordinary course of business, new value, etc.). It is unclear from the SBRA “how much” diligence is required. But in theory, this should help creditors in that it imposes an initial burden on the plaintiff (debtor or trustee) to conduct more reasonable diligence before asserting the complaint and should reduce the number of complaints that are filed for smaller dollar amounts.