Appeal from the Ninth Circuit Bankruptcy Appellate Panel. BAP No. CC-90-1344-OjP. Ollason, Jones, and Perris, Bankruptcy Judges, Presiding.
Before: Jerome Farris, Cecil F. Poole and Alex Kozinski, Circuit Judges. Opinion by Judge Kozinski; Dissent by Judge Farris.
Can an unsecured creditor be better off when the debtor defaults rather than paying off the debt? Yes: Law can be stranger than fiction in the Preference Zone.
Powerine Oil Company (the debtor here) obtained a $250.6 million line of credit from a syndicate consisting of several banks and insurance companies; the loan was secured by most of Powerine's personal property. The security agreement provided that the collateral would serve as security for all letters of credit that "have been, or are in the future, issued on the account of Debtor." ER 101-02.
Koch Oil Company thereafter agreed to sell crude oil to Powerine. To secure Powerine's obligation, it designated Koch as beneficiary of two irrevocable standby letters of credit issued by First National Bank of Chicago, one of the lenders covered by the security agreement. The letters, which were to expire in April 1984, totaled approximately $8.7 million, an amount at all times sufficient to cover the cost of the oil Koch sold to Powerine.
In January and February 1984, Koch billed Powerine $3.2 million for oil it had delivered in December and January. Powerine eventually paid this amount but, unfortunately for Koch, it also filed a chapter 11 bankruptcy petition less than 90 days later. The Committee of Creditors Holding Unsecured Claims (the Committee) eventually brought an action to recover the payment, claiming it was a preference under 11 U.S.C. § 547(b).*fn1
The bankruptcy court held that the transfer was protected by the "contemporaneous exchange for new value" exception of 11 U.S.C. § 547(c)(1) and granted Koch's motion for summary judgment. The Bankruptcy Appellate Panel (BAP) affirmed on a different ground: It held that the payment wasn't a preference because it didn't enable Koch to recover more than it would in a chapter 7 liquidation. Even if Powerine hadn't made the $3.2 million transfer, the BAP reasoned, Koch would have been paid in full because it would have drawn on First National's letters of credit.
Bankruptcy Code section 547(b) sets forth the five elements of a preferential transfer.*fn2 The parties dispute only whether the last element - section 547(b)(5) - was satisfied here. Under this provision, the Committee must prove that Koch "received more than it would [have] if the case were a chapter 7 liquidation case, the transfer had not been made, and [Koch] received payment of the debt to the extent provided by the provisions of the Code." 4 Collier on Bankruptcy Par. 547.08, at 547-45 (Lawrence P. King ed., 15th ed. 1995).
Whether section 547(b)(5)'s requirements have been met turns in part on the status of the creditor to whom the transfer was made. Pre-petition payments to a fully secured creditor generally "will not be considered preferential because the creditor would not receive more than in a chapter 7 liquidation." Id. at 547-47. With respect to unsecured creditors, however, the rule is quite different: "As long as the distribution in bankruptcy is less than one-hundred percent, any payment 'on account' to an unsecured creditor during the preference period will enable that creditor to receive more than he would have received in liquidation had the payment not been made." In re Lewis W. Shurtleff, Inc., 778 F.2d 1416, 1421 (9th Cir. 1985).
Vis-a-vis Powerine, Koch was an unsecured creditor as it didn't hold any security interest in Powerine's property. See 11 U.S.C. § 506(a). Because most of Powerine's assets on the date it filed for bankruptcy were subject to the lien held by the secured creditors, Powerine's unsecured creditors could expect to receive much less than one-hundred cents on the dollar in a chapter 7 liquidation. Consequently, Powerine's $3.2 million pre-petition payment enabled Koch to recover more than it would have in a chapter 7 liquidation, and it was therefore a preference.
The BAP came to the contrary Conclusion by focusing on the fact that Koch could have drawn down the letters of credit, had Powerine not paid it directly. Since Koch would have recovered the full amount owed to it (albeit from First National) had Powerine defaulted, ...