Opinion ID: 774955
Heading Depth: 2
Heading Rank: 1

Heading: Greater Amount Test

Text: 14 This case requires us to interpret two sections of the Bankruptcy Code, 11 U.S.C. §§§§ 547(b)(5) and 547(g). 11 U.S.C. §§ 547(b) permits a trustee to avoid any transfer of an interest of the debtor in property when certain conditions are met. One of the conditions is that the transfer enable the creditor to receive more than such creditor would receive if: 15 (A) the case were a case under chapter 7 of this title; 16 (B) the transfer had not been made; and 17 (C) such creditor received payment of such debt to the extent provided by the provisions of this title. 18 11 U.S.C. § 547(b)(5). TCFC and the trustee dispute whether the 36 payments made during the preference period enabled TCFC, as a result of the 36 payments, to receive more than if the payments had not been made and TCFC had received payments only pursuant to a Chapter 7 liquidation. Section 547(g) places the burden of proof on the trustee to show all of the conditions of §§ 547(b). Thus, the trustee must show that the creditor received a greater amount than it would have if the transfer had not been made and there had been a hypothetical chapter 7 liquidation as of the petition date. If the trustee shows that TCFC received a greater amount by virtue of the 36 payments, then the payments are avoidable as preferential transfers. See In re Lewis W. Shurtleff, Inc. , 778 F.2d 1416, 1421 (9th Cir. 1985). The trustee contends that he satisfied his burden because: 1) the 36 payments plus the amount that TCFC received from the post-petition sale of its collateral is greater than the amount received from the post-petition sale of the collateral standing alone; and 2) TCFC has not traced the source of the allegedly preferential payments to sales of its collateral. We disagree with both of the trustee's arguments. 19 A. The add-back method does not satisfy the trustee's burden when the payments come from collateral secured by a floating lien 20 The trustee tried to satisfy his burden under §§ 547(b)(5) by adding the amount of the 36 payments to the amount TCFC received as a result of the post-petition sale of its remaining collateral. The trustee then compared this amount to the obviously smaller amount of the post-petition sale by itself and concluded that TCFC must have received a greater amount because of the payments. Some bankruptcy courts have used the same add-back method employed by the trustee to determine the status of a creditor on the petition date. See In re Al-Ben, Inc., 156 B.R. 72, 75 (Bankr. N.D. Ala. 1991) (adding alleged preferences to the amount of unpaid balance at the petition date to find the creditor's secured status); In re Estate of Ascot Mortgage, Inc., 153 B.R. 1002, 1018 (Bankr. N.D. Ga. 1993) (adding pre-petition amounts received to what would have been received under a chapter 7 liquidation). 21 We agree with the bankruptcy court and the district court, however, and conclude that the add-back  calculation does not satisfy the trustee's burden in this case. Pre-petition transfers to a creditor that is fully secured on the petition date are generally not preferential because the secured creditor is entitled to 100 percent of its claims. See In re LCO Enterprises, 12 F.3d 938, 941 (9th Cir. 1993). This is not a hard and fast rule. As the bankruptcy court in this case noted, payments that change the status of a creditor from partially unsecured to fully secured at the time of petition may be preferential. See Porter v. Yukon Nat'l Bank, 866 F.2d 355, 359 (10th Cir. 1989). Moreover, a transfer may be avoided when the creditor is fully secured at the time of payment, but is undersecured on the petition date. See In re Estate of Suffola, Inc., 2 F.3d 977, 985-86 (9th Cir. 1993). The trustee failed to show, however, that TCFC was undersecured at any time during the preference period. Instead, the evidence submitted showed that as of the petition date, the value of the collateral held by Smith's exceeded its indebtedness to TCFC. 3 If TCFC was never undercollateralized, then TCFC could not have received more by virtue of the 36 payments than it would have received in a hypothetical liquidation without the payments. 22 It is important to understand that TCFC did not loan one fixed amount to the debtor; instead, TCFC held afloating lien. A floating lien is a financing device where the creditor claims an interest in property acquired after the original extension of the loan and extends its security interest to cover further advances. The floating lien is a lien against a constantly changing mass of collateral for a loan value that will change as payments are received and further advances are made. See 3 Norton Bankr. L. & Prac. 2d §§ 57.23. The cases the trustee cites applying the add-back method do not deal with floating liens. It is not correct to assume that the 36 payments gave TCFC more than it would have received if the payments had not been made. Instead, under a floating lien arrangement, those payments are used to liquidate part of the debtor's debt. Then, new credit under the floating lien is extended and is secured by new collateral. It is not enough for the trustee to show that the 36 payments plus the amount received upon dissolution exceeded the amount of TCFC's secured claim as of the petition date. Since collateral and indebtedness changed throughout the preference period, these values do not prove that TCFC received more by virtue of the payments than it would have received without them. Under §§ 547(b)(5), the trustee must show that the amount of indebtedeness under the floating lien was greater than the amount of collateral at some point during the 90-day period. See In re Schwinn Bicycle Co., 200 B.R. 980, 992-93 (N.D. Ill. 1996) (At no point in time did the collateral value fall below the outstanding debt, and therefore TIFCO was not preferenced in having received payments on its secured debt.). 23 The trustee contends that the existence of the floating lien means that the burden is shifted to TCFC under §§ 547(c)(5). Section 547(c)(5) provides an affirmative defense for creditors when the trustee has successfully demonstrated that the creditor received more from the payments than under a hypothetical liquidation. Section 547(c)(5) insulates the transfer of a security interest in after-acquired property, i.e., a floating lien, provided that the creditor does not improve its position during the preference period. In effect, the trustee contends that the existence of a floating lien means that he does not have to prove that the creditor was undersecured at some point during the 90-day period and therefore received more by virtue of the payments than the creditor would have if the creditor had waited for a chapter 7 liquidation. 24 We reject the trustee's argument. 4 A floating lien does not shift the burden of showing avoidability to the creditor. The trustee still has to satisfy his burden under§§ 547(b)(5). The Tenth Circuit has addressed the question of what needs to be shown by a trustee to avoid a transfer financed by the sale of inventory subject to a floating lien. See In re Castletons, 990 F.2d 551 (10th Cir. 1993). In Castletons, the creditor held a floating lien on the debtor's inventory, accounts receivable, and proceeds. The trustee sought to avoid the payments given by the debtor to the creditor during the preference period. The Tenth Circuit affirmed the district court's holding that the trustee failed to show that the creditor received more from the challenged payments than it would have received in a chapter 7 liquidation. It explained: 25 [A]ll payments to [the creditor] came from assets already subject to its security interest. It is further uncontested that the nature of [the creditor's ] security interest in debtor's assets was never altered during the preference period. 26 Under these circumstances, it cannot be said, as §§ 547(b)(5) requires, the transfers enabled[the creditor] to receive more on its debt than would be available to it in a Chapter 7 distribution. 27 Id. at 555. Essential to the court's holding was its recognition that the creditor held a floating lien: While the identity of individual items of collateral changed because of sales and subsequent acquisitions of new collateral, the overall nature of [the creditor's] security interest remained the same. Id. at 556. 28 It is true that other courts have evaluated floating lien cases by proceeding directly to the §§ 547(c)(5) affirmative defense without a discussion of the requirements of §§ 547(b)(5). See In re Wesley Indus., 30 F.3d 1438, 1443 (11th Cir. 1994); In re Lackow Bros., Inc., 752 F.2d 1529, 1530-31 (11th Cir. 1985). But in those cases, the parties had stipulated or the bankruptcy court had found that the creditor was undersecured as of the petition date. In other words, the §§ 547(b)(5) burden had already been satisfied so it did not need to be discussed. The trustee in this case never showed that TCFC was undersecured at any point during the 90-day period and the bankruptcy court determined that TCFC was fully secured as of the petition date. The trustee did not satisfy his burden. See Richard F. Duncan, Preferential Transfers, the Floating Lien, and Section 547(c)(5) of the Bankruptcy Reform Act of 1978, 36 Ark. L. Rev. 1, 20 (1987) ([I]t is not necessary to reach the question of application of section 547(c)(5) until after the trustee has met his burden of proving all of the necessary elements of a preference under section 547(b).); James J. White & Daniel Israel, Preference Conundrums, 98 Com. L.J. 1, 4 (1993) (It is important to remember, however, that 547(c)(5) applies only to a creditor who is undersecured ninety days before bankruptcy. The creditor who is fully secured cannot be attacked under 547(b). There is no initial deficiency and later transactions cannot improve the creditor's position.). 29 B. The burden of tracing the funds used to make the preferential payments is on the trustee 30 The trustee contends that its use of the add-back method is correct because TCFC has not shown that the source of the allegedly preferential payments was sales of TCFC's collateral. In Castletons, it was undisputed that all of the preference period payments came from sales of assets subject to the creditor's floating lien. See In re Castletons, 990 F.2d at 555. In this case, however, the payments came from a commingled account that contained monies from the sales of other goods not subject to TCFC's lien. When Smith's made a sale, the proceeds were deposited into commingled bank accounts. Smith's bank swept the accounts daily, leaving them with zero balances overnight. Thus, the challenged payments were not made directly from the proceeds of the sales of TCFC's collateral. On the other hand, there is no evidence indicating that Smith's did not sell off enough of TCFC's collateral to account for all of the challenged payments. 31 There is some authority for requiring a creditor to establish that funds in a commingled account are traceable to the proceeds of its collateral. See Stoumbos v. Kilimnik, 988 F.2d 949, 957 (9th Cir. 1993) (This court has held that the creditor bears the burden of establishing that a deposit account contains proceeds of collateral covered by a security interest.); In re Gibson Products, 543 F.2d 652, 657 (9th Cir. 1976) (We think that it is fair to place the burden on the creditor to identify his own proceeds and thus to defeat, in whole or in part, the trustee's claim of preference.). But Stoumbos and Gibson Products are not persuasive because they dealt with the intersection of the Bankruptcy Code and section 9-306(4) of the UCC. The UCC provision at issue in those cases allows a creditor to claim all funds in a deposit account where the funds are proceeds from collateral covered by the creditor's security interest. See Stoumbos, 988 F.2d at 957. In this situation, there is a presumption against the creditor and in favor of the trustee. Id. at 957-58. This is the opposite of a §§ 547(b) analysis where the burden of proof is on the trustee and the presumption is in favor of the creditor. See In re Lease-AFleet, Inc., 151 B.R. 341, 347-49 (E.D. Pa. 1993) (acknowledging that under a Code section other than §§ 547, a secured creditor may be obliged to prove the validity of its alleged security interests, but explaining that §§ 547 is a selfcontained Code section which provides its own specific designations of the burdens of proof of the respective parties). 32 Instead, we believe that it is part of the trustee's§§ 547(b)(5) burden to trace the funds used to make the payments to sales of merchandise not subject to TCFC's liens. See In re Robinson Bros. Drilling, Inc., 6 F.3d 701, 703 (10th Cir. 1993) (Under 11 U.S.C. §§ 547(g), a trustee seeking to avoid an allegedly preferential transfer under §§ 547(b)`has the burden of proving by a preponderance of the evidence every essential, controverted element resulting in the preference.' ) (quoting 4 Collier on Bankruptcy ¶¶ 547.21[5] at 547-93 (15th ed. 1993))); cf. In re Prescott, 805 F.2d 719, 726-27 (7th Cir. 1986) (placing burden on trustee to establish value of collateral and to show that value of collateral was less than the amount of indebtedness at time of transfer). One might argue that the creditor will be in a better position than the trustee to prove whether or not the alleged preferential payments came from the proceeds of the sale of its own collateral. On the other hand, in bankruptcy, it is the trustee who accedes to the debtor's books and records and has easier access and a better ability to divine the financial activities of the debtor in its last months of operation. Regardless of which side is better equipped to decipher the debtor's final financial actions, we hold that the language of the statute places the burden of demonstrating the source of such preferential payments squarely on the trustee. 5 See In re Lease-A-Fleet, 151 B.R. at 348 (It is therefore an unfortunate fact of life that a preference plaintiff must effectively prove a negative (that the defendant is not a totally secured creditor), even though the secured creditor is the party with most access to proof of the validity of its own security interests.). 33 Commingled funds or not, §§ 547(b)(5) places the burden on the trustee to show that the payments at issue came from a source other than sales of TCFC's collateral. Here there is no suggestion that any sales of products funded by TCFC were not subject to TCFC's priority lien. Instead, both parties stipulated that TCFC held a valid security interest in Smith's property. It is true that the route the payment took to TCFC was indirect, but we are not prepared to release the trustee from his burden under §§ 547(b)(5) simply because the payments did not, demonstrably, come directly from sale of TCFC's collateral. See In re Compton Corp., 831 F.2d 586, 591 (5th Cir. 1987) (The federal courts have long recognized that `[t]o constitute a preference, it is not necessary that the transfer be made directly to the creditor.' ) (quoting National Bank of Newport v. National Herkimer County Bank, 225 U.S. 178, 184 (1912)). It is up to the trustee to show that the payments did not come from TCFC's collateral before he can use the add-back method to satisfy his § 547(b)(5) burden.