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Home New Cases California Bankruptcy Court Rules for Defendant on Trustee’s $8.1 Million Preference Action

California Bankruptcy Court Rules for Defendant on Trustee’s $8.1 Million Preference Action

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February 6, 2022, Northern District of California – Trustee Lois I. Brady for the bankruptcy estate of Debtor, Specialty’s Café & Bakery, Inc. commenced an adversary proceeding against Defendants Customers Bank and the Small Business Administration (SBA), alleging that a transfer of $8.1 million to Customers Bank was an avoidable preference under Bankruptcy Code §547 for which both defendants are liable. 

As pointed out in the opinion, the facts of the case are: Debtor obtained a paycheck protection program loan of $8.1 million from Customers Bank, which the SBA guaranteed. The Bank returned the loan two weeks before filing for bankruptcy. The Trustee contended that she established all the elements of her preference case under Bankruptcy Code §547(b) other than Debtor’s insolvency, and the undisputed facts showed that Defendants cannot establish their affirmative defenses and cannot otherwise defeat her case under Bankruptcy Code §547(b). Defendants disagreed. The Trustee moved for summary adjudication of certain issues. 

(i) Interest of the Debtor in property

According to the Trustee, because the $8.1 million was deposited into Debtor’s bank account, it was presumptively Debtor’s property for the purposes of preference recovery. Defendants countered that Debtor rescinded the loan, in effect terminating it, and the $8.1 million was then impressed with a resulting or constructive trust. The Defendants contended that because property held in trust is not the estate’s property, the $8.1 million was not an interest of the Debtor in the property when it was returned to Customers Bank. 

The Court found the Defendants’ analysis of the issue convincing. Accordingly, the Court concluded that Defendants met their obligation to trace the loan funds. The $8.1 million was held in trust and was not an interest of the Debtor in the property when it was returned to Customers Bank.  

(ii) For or on account of an antecedent debt

The Trustee argued that the loan created a debt, which arose when Debtor signed the note on May 5, 2020; Debtor paid this debt on May 13, 2020 – making it the payment of an antecedent debt to or for a creditor for purposes of satisfying §547(b)(1) and (b)(2).  

The Court did not find this argument convincing in this case’s context. The Court agreed with the SBA that there is, in fact, no debt here. The Court added that by the terms of the paycheck protection program, Debtor had the right to terminate its loan and return the borrowed funds to the lender in the safe harbor period. The Court further adds that as a matter of contract law, Debtor did not pay a debt when it wired $8.1 million to Customers Bank on its terminated loan. The $8.1 million was returned because, at that point, it was the property of Customers Bank. The guidelines permitted Debtor to terminate the transaction. The Court thus ruled that the Trustee failed to prove there was a payment to a creditor for or on account of an antecedent debt as required under Bankruptcy Code §547(b)(1) and (b)(2). 

Next, the Court dismissed the Trustee’s other arguments and found that the Defendants have successfully established their ordinary course of business defense under Bankruptcy Code §547(c)(2). The Court ruled that the transfer was neither a pre-payment nor made in response to threats made by a creditor to cut off a commercial relationship – a pattern in many preference cases. 

The Court denied the Trustee’s motion and granted the Defendants’ motions.

Brady v. United States, SBA (In re Specialty’s Café & Bakery, Inc.), 2022 Bankr. LEXIS 269, United States Bankruptcy Court for the Northern District of California, February 2, 2022

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