Opinion ID: 3048909
Heading Depth: 3
Heading Rank: 2

Heading: The Burden of Proof for an Earmarking Defense

Text: [7] As the district court noted, there is “substantial confusion” over who bears the burden of proof on an earmarking defense. The Ninth Circuit Bankruptcy Appellate Panel addressed this question in Sierra Steel, where it denied an earmarking defense because the defendant “ha[d] not traced the funds to money received by the debtor from [the lender].” 96 B.R. at 275. While the Sierra Steel court started from the general principal that the trustee has the burden of establishing that property is part of the bankruptcy estate, it also noted that the funds in question were disbursed from the defendant’s general account. Id. at 274 n.5. The source of the funds raised the presumption that the funds were property of the bankruptcy estate and the burden of proof accordingly shifted from the trustee—to establish that the funds were part of the estate 2 Rule 8 lists the following as “affirmative defenses” that are waived if not pled in the answer: accord and satisfaction, arbitration and award, assumption of risk, contributory negligence, discharge in bankruptcy, duress, estoppel, failure of consideration, fraud, illegality, injury by fellow servant, laches, license, payment, release, res judicata, statute of frauds, statute of limitations, [and] waiver. Fed. R. Civ. P. 8(c). IN RE ADBOX, INC. 6685 —to the defendant—to show that they were not. Id. (citing In re Bullion Reserve of N. Am., 836 F.2d 1214, 1217 n.3 (9th Cir. 1988)).3 [8] We follow well-established law in holding that the trustee bears the initial burden of establishing that a transfer is an avoidable preference under § 547. See Sierra Steel, 96 B.R. at 274. If, however, the trustee establishes that the transfer of the disputed funds was from one of the debtor’s accounts over which the debtor ordinarily exercised total control, we follow the approach of Sierra Steel and find that the trustee makes a preliminary showing of an avoidable transfer “of an interest of the debtor” under § 547(b). The burden then shifts to the defendant in the preference action to show that the funds were earmarked. [9] In the present case, the Metcalfs assert an earmarking defense regarding funds first deposited in Adbox’s general account and then disbursed to the Metcalfs. Accordingly, while Adbox bore the initial burden of proving that the funds were part of the bankruptcy estate, that burden shifted to the Metcalfs when the funds were deposited into Adbox’s general account. 3 After Sierra Steel, the Ninth Circuit Bankruptcy Appellate Panel made passing reference to this issue again in In re Lee, where it noted that “[i]f [the defendant] were asserting an earmarking defense, it failed to meet its burden to present evidence on such a theory.” 179 B.R. 149, 156 n.3 (B.A.P. 9th Cir. 1995) (citing Sierra Steel, 96 B.R. at 274-75). While we acknowledge that In re Lee may be read to suggest that the defendant always bears the initial burden of proof in an earmarking defense, we do not believe such a reading is proper. In re Lee addressed earmarking only as a hypothetical, and moreover, its statement only suggests that the defendant in that case would have had the burden of proof on an earmarking defense, not that all defendants always have it. We read In re Lee to be entirely consistent with Sierra Steel and the law of this circuit, as described above. 6686 IN RE ADBOX, INC.