Although most preferential payments arise in federal cases and are governed by the Federal Bankruptcy Code, many creditors of Wisconsin corporations are unaware of another type of preference litigation available under chapter 128 of the Wisconsin statutes. Specifically, under Chapter 128, litigants are afforded the ability to liquidate company assets in state court receiverships. Although this process bears a resemblance to ordinary Chapter 7 liquidation, Wis. Stat. § 128.07 departs from the Federal Bankruptcy Code in its treatment of preferences in several important respects.
Much like federal law, Wisconsin law also seeks to prevent preference payments with the primary objective of placing all similarly situated creditors on equal footing with respect to payment of debts. However, preferences under Wisconsin law contain fundamentally different elements that require distinct analysis.
Under Wis. Stat. § 128.07, the elements of a preference are;
- A payment or transfer of property;
- Payment was made to a creditor;
- Payment was made within four months prior to the bankruptcy petition under Wis. Stat. ch. 128;
- The debtor was insolvent at the time of payment; and
- The payment enabled the recipient to obtain a greater percentage of its debt than it would have received in a bankruptcy receivership.
Although there are numerous differences between Wisconsin law and the Federal Bankruptcy Code, the scope of this article includes only the most common distinctions that arise in Wisconsin preference law.
Timing of a Preference
Typically, the first two requirements of a preference are less contentious as the issues of whether a transfer of property was made and whether that transfer was made to a creditor are comparatively straightforward. However, the timing of preference claims under Wisconsin law differs from the Federal Bankruptcy Code provisions and can be a source of confusion or mistake for creditors and lawyers unfamiliar with Wisconsin law. Under federal law, a preferential transfer requires that the payment occur within 90-days of the bankruptcy filing. See U.S.C. Section 547(b)(4)(A). This 90-day period is extended to one year for certain “insiders” such as a relative of the debtor, a co-owner, an officer of the debtor, or any other person with a sufficiently special relationship to the debtor. Unlike the Federal Code, Wisconsin law provides a four-month preference period for all transfers regardless of whether insiders are involved. Thus, the applicable law governing a preference claim can have a dramatic impact on whether a particular transfer is considered a preferential payment.
Use of Preferences Under Wisconsin Law
Whether a given payment is recoverable as a preference is determined by reference to Wis. Stat. § 128.07(2). Under this section, a payment is typically treated as a preference if the creditor had “reasonable cause to believe the transfer would affect a preference.” Id. Namely, courts look to whether the creditor has reason to believe that the transferor was insolvent.
Specifically, Wisconsin courts focus their analysis on the effect of the payment. Goetz v. Zeif, 181 Wis. 628, 195 N.W. 874 (1923). Thus, a litigant can establish that reasonable cause exists by submitting evidence that would lead an ordinarily prudent businessperson to believe that the transfer would affect a preference. Id. Further, if a creditor has knowledge of facts sufficient to cause an ordinarily prudent businessperson to desire additional information, then some courts have also charged the creditor with knowledge of any facts that a reasonable inquiry would have disclosed. Clower v. First State Bank of San Diego, 343 F.2d 808, 810 (5th Cir. 1965). However, mere knowledge of late payments or poor financial conditions is not, by itself, always sufficient to establish reasonable cause. See In re Salmon, 249 F. 300, 303 (2d Cir. 1917).
Although preference disputes commonly arise, there are a number of defenses to these claims. However, the availability of defenses under Wisconsin law is materially different from those available under the Federal Bankruptcy Code. In fact, some Wisconsin courts have held that defenses to preferential transfers must be created by statute. See Goetz v. Zeif, 181 Wis. 628, 629, 195 N.W. 874 (1923). Thus, the defenses available under Wisconsin law are limited. Conversely, the Federal Bankruptcy Code provides a lengthy list of defenses to preference claims. See 11 U.S.C. 547(c)(2) & (4). Although a range of defenses are available under federal law, for purposes of this article, only the following common defenses will be discussed;
Contemporaneous exchange for new value;
Subsequent new value provided; and
Payments made in the ordinary course of business.
Ordinary Course of Business
Unlike the expansive list of defenses provided under the Federal Bankruptcy Code, Wisconsin Chapter 128 does not contain any express statutory defense for payments made in the “ordinary course of business.” However, Section 547(c)(2) of the Federal Code provides;
(c) The Trustee may not avoid under this section a transfer —
(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was –
(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or
(B) made according to ordinary business terms.
The creditor bears the burden of proving that the payment was made “in the ordinary course of business.” With respect to the first element, a creditor can typically demonstrate that a debt was incurred in the ordinary course of business by looking the history of dealings between the parties. For example, if the parties routinely did business and the creditor historically shipped goods with 30-day invoices, then payment of those invoices within the 30 days may be considered in the ordinary course of business. However, this showing alone does not establish a preference payment defense. Rather, the creditor must also show that the transfer was made according to ordinary business terms. This showing typically requires some degree of subjective analysis and also requires examination of objective factors. Ultimately, whether a creditor has a defense under this section is dependent upon the facts of the case.
Although Wisconsin law does not expressly recognize this defense, a creditor could argue that payments made in the ordinary course of business should be considered when determining whether a given payment is preference under Wis. Stat. § 128.07. Specifically, if payments are made in the reasonable course of business, it is arguable that a creditor accepting such payment would not have cause to believe that the payment might effectuate a preference.
Contemporaneous Exchange for New Value & Subsequent New Value Provided
Much like the preceding defense, Wisconsin Chapter 128 also contains no express statutory defense for “new value.” However, defenses relating to “new value” exist under the Federal Bankruptcy Code. Section 547(c)(1) provides the following exception for the contemporaneous exchange of new value;
(c)The trustee may not avoid under this section a transfer—
(1) to the extent that such transfer was—
(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and
(B) in fact a substantially contemporaneous exchange;
Further, under Section 547(a)(2) of the Federal Bankruptcy Code, “new value” is defined as;
money or money’s worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation[.]
Thus, under specific circumstances a creditor may be permitted to obtain preferential payment in exchange for providing new value to the debtor’s estate. Courts permit this defense because preferential payment in such cases would not materially diminish the debtor’ estate and thus would not substantially reduce the amount available to other creditors in bankruptcy. Although “new value” defenses are not statutorily established in Wisconsin, parties can use Bankruptcy Code defenses to develop effective arguments against the application of state preference law. Specifically, parties may effectively allege that a particular payment made for “new value” would not enable the recipient to obtain a greater percentage of its debt than it would have received in a bankruptcy receivership, and thus, the payment should not be treated as a preference under Wisconsin law.
Due to the complexity of preference law, creditors receiving a preference demand should be aware of potentially applicable defenses and understand the jurisdictional impacts of the controlling law. Whether a given preference claim is meritorious may largely depend on whether Wisconsin or Federal law applies to the claim. The Bankruptcy Team at The Rose Group is available to assist creditors in developing effective strategies and responding to preference demands, please contact us with any questions.