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Debtor Entitled to Avoid as Preferences Two of Three Prepetition Transfers

Monday, April 1, 2013
By Diane Davis

The U.S. Bankruptcy Court for the Central District of California March 12 held that a Chapter 11 debtor is entitled to summary judgment on one of its prepetition transfers to the defendant as an avoidable preference under Bankruptcy Code Section 547(b) (Imagine Fulfillment Services LLC v. DC Media Capital LLC (In re Imagine Fulfillment Services LLC), Bankr. C.D. Cal., No. 2:12-ap-01514-WB, 3/12/13).

Judge Julia W. Brand concluded that the defendant's filing of a Notice of Judgment Lien was a transfer of an interest in the debtor in property on account of an antecedent judgment, for the benefit of creditors while the debtor was insolvent. The court, however, determined that the debtor was not entitled to summary judgment on the issue of whether the transfer allowed the defendant to receive more than it would in a hypothetical liquidation under Chapter 7 had the transfer not occurred because of the existence of the Order for Appearance of Judgment Debtor (ORAP) Lien.

The court found that the recording of the abstract of judgment with the Los Angeles County Recorder was not an avoidable preference because the act was not a transfer since the debtor did not own any real property.

With respect to the third transfer involving the sheriff levying on the debtor's bank account, the court held that the transfer was avoidable as a matter of law, and the debtor was entitled to summary judgment.

The court also concluded that the defendant was not entitled to summary judgment on its affirmative defenses under Sections 547(c)(2) and (c)(9) because the filing of the Notice of Judgment Lien did not occur in the ordinary course of business. 

State Court Judgment

Plaintiff/debtor Imagine Fulfillment Services LLC (IFS) filed for Chapter 11 protection March 25, 2012. Prior to the petition date, a dispute arose between IFS and DC Media Capital LLC. DC Media sued IFS in a California state court, alleging breach of contract. The state court entered judgment in favor of DC Media and against IFS for breach of contract and damages for $2.3 million, plus prejudgment interest of $967,776, attorneys' fees of $541,946, and costs of $29,556, for a total of $3.9 million.

On Dec. 27, 2011, DC Media filed a Notice of Judgment Lien with the California Secretary of State. Subsequently, IFS filed a notice of appeal of the judgment, which remains pending.

On March 5, 2012, DC Media caused the Los Angeles County Sheriff's Office to levy on IFS's Wells Fargo bank account. The Sheriff seized approximately $81,196, to which the sheriff continues to hold and has not turned over to DC Media. As of the petition date, IFS had not satisfied the judgment. During the period when DC Media was a creditor of IFS, IFS did not own real property. 

Arguments of Parties

IFS sought summary judgment that the filing of the Notice of Judgment Lien (transfer one), the recording of the abstract of judgment with the Los Angeles County Recorder (transfer two), and the sheriff's levy on IFS's bank account (transfer three) are avoidable preferences under Bankruptcy Code Section 547(b).

DC Media argued that summary judgment must be denied because there are genuine issues of material fact that remain as to (1) whether transfer one was made during the 90-day window, (2) whether IFS was insolvent on the transfer dates, and (3) whether DC Media will receive more from the transfers than it would receive in a hypothetical Chapter 7 liquidation.

DC Media also sought summary judgment that (1) transfer one was not avoidable under Section 547(c)(2) because the filing of the Notice of Judgment Lien was made in the ordinary course of business and according to ordinary business terms, and (2) transfer two was not avoidable under Section 547(c)(9) because IFS owns no real property and therefore the abstract of judgment is less than the $5,850 minimum amount that IFS may recover as a preferential transfer.

A trustee or debtor-in-possession may avoid certain transfers made 90 days before the bankruptcy filing that would otherwise prefer one or more creditors at the expense of other creditors, the court explained, citing Section 547(b). To avoid a transfer as preferential, the court explained, IFS must show all of the following elements:
  1.  a transfer; 
  2. of the debtor's property or of an interest in the debtor's property;  
  3. to or for a creditor's benefit;  
  4. on account of an antecedent debt;  
  5. made within 90 days prior to filing of the petition (or within one year if the transferee was an insider);  
  6. made while the debtor was insolvent;  
  7. that allows the creditor to receive more than it would receive in a case under chapter 7 if the transfer had not been made and the creditor received payment as provided in the Code.   
Transfer One

The court found that transfer one was made within the 90-day preference period. DC Media argued that transfer one cannot be avoided under Section 547(e)(3), contending that transfer one was not made as to these postpetition transfers until IFS acquired rights in the accounts receivable. The court rejected this argument, noting that the issue is when transfer one--the attachment and perfection of DC Media's judgment lien--was made, not whether assets acquired after the petition date are transfers. While DC Media's judgment lien attaches to IFS's after-acquired property, when such property is acquired does not affect then the judgment lien itself was created under California law, the court said. Because the judgment lien was created on Dec. 27, 2011, IFS has carried its burden of proof that transfer one was made within the 90-day window, the court concluded.

The court determined that IFS was insolvent when transfer one was made. Because neither party contended that IFS was on its deathbed, the court viewed IFS as a going concern. The court noted that using the insolvency analysis under Section 547(b)(3), or the “balance sheet test,” the balance sheet book value of a debtor's assets may not always equal the fair market value. Because IFS is presumed to be insolvent during the 90-day preference period, DC Media must introduce at least some evidence to rebut this presumption, the court said.

DC Media introduced evidence of the appraised value of certain of IFS's personal property assets. Based on the information, DC Media argued that a correct value of IFS assets is $788,204, as of Dec. 27, 2011, and also presented evidence that IFS's balance sheet liabilities were overstated by approximately $66,000. Thus, DC Media contended that genuine issues of material fact exist, and the question turns on whether the judgment is a contingent liability. According to the court, to value a liability, a court should engage in a two-step analysis: first, the court must determine whether the liability is contingent, and second, if so, the court should discount the contingent liability to its expected value. 

Contingent Debt

The court looked to the seminal case, In re All Media Props. Inc., 5 B.R. 126 (Bankr. S.D. Tex. 1980), aff'd, 646 F.2d 193 (5th Cir. 1981), overruled on other grounds by In re Trusted Net Media Holdings LLC, 550 F.3d 1035 (11th Cir. 2008), which enunciated the “triggering event test” for determining whether the claims of petitioning creditors were non-contingent, which would enable them to file an involuntary bankruptcy petition. Under All Media, a claim is contingent as to liability if a triggering event is required for the claim to come into existence, the court said. According to the court, judgments are generally considered to be non-contingent liabilities for purposes of determining eligibility to file an involuntary petition or a Chapter 13 petition.

Adopting the “triggering event” test to determine whether the judgment is a contingent liability for purposes of Section 547, the court determined that because the events giving rise to the judgment occurred prepetition and prior to each of the transfers, the judgment is not a contingent debt and was not contingent as of any of the relevant transfers. Including the judgment in the solvency calculation, the court concluded that IFS was insolvent at the time each of the transfers was made, even if the adjustments to IFS's assets and liability values suggested by DC Media are accepted. DC Media failed to rebut the presumption of insolvency, the court said, and, thus, IFS is entitled to summary judgment on this element.

The court also found that transfer one would allow DC Media to receive more than it would in a hypothetical liquidation but for ORAP Lien. The filing of the Notice of Judgment Lien created and perfected DC Media's lien in IFS's personal property, allowing DC Media to receive more than it would in a Chapter 7 liquidation had DC Media's claim remained unsecured, the court said. According to the court, until the status of the ORAP Lien as a preferential transfer is determined, summary judgment cannot be granted as to this element. 

Transfer Three

The court determined that transfer three--the sheriff's seizure of IFS's bank account--was an avoidable transfer. According to the court, this transfer must be avoided because IFS established each element of a preferential transfer under Section 547(b). Transfer three was a transfer of an interest in IFS's property and the sheriff made its levy for the benefit of DC Media. The transfer, the court said, was on account of an antecedent debt, and it was made within the 90-day preference window. Further, IFS was insolvent at the time of the transfer, and DC Media's receipt of the funds held by the sheriff would result in DC Media receiving more than it would receive in a hypothetical Chapter 7 liquidation as in a Chapter 7 case. 

Transfer Two

Under California law, a recorded abstract of judgment creates a lien on real property, the court explained. IFS, however, did not own any real property in Los Angeles County on the date of recordation, the court said. Thus, the court determined that DC Media's recordation of the abstract of judgment did not create or perfect a lien, or otherwise affect IFS's property or an interest in IFS's real property because IFS owned no real property. DC Media's act of recordation was not a transfer under the Code, the court said. Because it was not a transfer, IFS cannot avoid this act under Section 547(b), the court concluded.

Therefore, the court found that IFS was not entitled to summary judgment as to transfer two, and denied as moot summary judgment on DC Media's Section 547(c)(9) defense. 

No Summary Judgment for DC Media

The court concluded that DC Media is not entitled to summary judgment on its second affirmative defense. DC Media argued that the recording of the Notice of Judgment Lien was “payment of a debt incurred” in the ordinary course of business. The court, however, did not agree with that argument. A transfer in the form of a security interest is not the type of payment contemplated by Section 547(c)(2), the court said. Further, the court noted that the unilateral act of recording the Notice of Judgment Lien cannot be characterized as being within the ordinary course of business of both the debtor and the creditor as required by Section 547(c)(2). Transfer one is not a payment of a debt, and thus, the Section 547(c)(2) defense does not apply, the court said.

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