Opinion ID: 1189483
Heading Depth: 4
Heading Rank: 1

Heading: Development and Elements of the Earmarking Defense

Text: When the other elements of a preferential transfer are established, § 547(b)'s prefatory language sweeps into the bankruptcy estate any transfer of an interest of the debtor in property. Although this provision has a potentially expansive reach, it is not without limits. In addition to the exceptions to preference liability set forth in § 547(c)none of which are at issue herethis Court adopted another limitation on § 547(b), the judicially-crafted earmarking doctrine: [T]here is an important exception to the general rule that the use of borrowed funds to discharge the debt constitutes a transfer of property of the debtor: where the borrowed funds have been specifically earmarked by the lender for payment to a designated creditor, there is held to be no transfer of property of the debtor even if the funds pass through the debtor's hands in getting to the selected creditor. See In re Hartley, 825 F.2d at 1070; In re Smith, 966 F.2d [1527, 1533 (7th Cir.1992)]; In re Bohlen Enters., Ltd., 859 F.2d 561, 564-66 (8th Cir.1988). The courts have said that even when the lender's new earmarked funds are placed in the debtor's possession before payment to the old creditor, they are not within the debtor's `control.' Bohlen, 859 F.2d at 565 (citing cases). McLemore v. Third Nat'l Bank in Nashville (In re Montgomery), 983 F.2d 1389, 1395 (6th Cir.1993). The earmarking doctrine applies whenever a third party transfers property to a designated creditor of the debtor for the agreed-upon purpose of paying that creditor. See In re Hartley, 825 F.2d at 1070. Under such circumstances, the property is said to be earmarked for the designated creditor. As a result, there is deemed to have been no transfer of an interest of the debtor in property, even if the property passes through the hands of the debtor on its way to the creditor. In re Montgomery, 983 F.2d at 1395. The earmarking doctrine, then, is a judicially-created defense that may be invoked by a defendant to a preference action in an attempt to negate § 547(b)'s threshold requirementa transfer of an interest of the debtor in property. In order for the doctrine to apply, however, it must be that: (a) the agreement is between a new creditor and the debtor for the payment of a specific antecedent debt; (b) the agreement is performed according to its terms; and (c) the transaction according to the agreement does not result in a diminution of the debtor's estate. In re Bohlen Enters., 859 F.2d at 566.