Section 547 of the Bankruptcy Code authorizes a trustee (or another appropriate party) to avoid, or clawback, so-called “preferential” transfers. A transfer qualifies as a preference if it was made to or for the benefit of a creditor within 90 days prior to the petition date[1] on account of an antecedent debt while the debtor was insolvent and allows the creditor to receive more than it would have in liquidation. The policy rationale for preference claims is to ensure that no creditor is treated better (or preferentially) to any other creditor because it received payment for its claim just before a bankruptcy filing.
For years, trustees commenced lawsuits against any and all individuals and entities that received payment within the 90-day time period. But there are important defenses to preference litigation.
For example, one of the most common defenses is the new value defenses, which allows the debtor to reduce its preference exposure by providing new goods, services, or credit after the alleged preferential transfer. Although this is an affirmative defense that the defendant bears the burden of proving, its application is generally a mechanical and mathematical exercise with little reasonable room for dispute. The defense can also be calculated by trustees prior to commencing a lawsuit by using the debtor’s books and records.
But because trustees filed lawsuits without considering even the most straightforward defenses such as the new value defense, defendants were regularly forced to pay nuisance settlements (in addition to incurring legal expenses) in order to resolve claims that otherwise had little or no merit.
As part of the Small Business Reorganization Act of 2019, Congress amended Section 547(b) in an attempt to curb those abusive litigation practices. Now, section 547(b) states that the trustee can only avoid transfers “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses.”[2] The scope of this “due diligence” requirement is not well defined in the Bankruptcy Code, and it is unclear what a trustee actually has to do before it can assert a preference claim.
A bankruptcy court in Kansas recently ruled on this issue in two adversary proceedings stemming from the chapter 7 bankruptcy of Sandy Road Farms, LLC.[3] In both proceedings, the trustee asserted in his complaints that he (i) reviewed the debtor’s records, (ii) analyzed transfers to the applicable defendant, (iii) conducted an examination of the defenses, and (iv) sent a letter to the defendant requesting further information on additional defenses. In both cases, the defendants responded to the trustee’s letter with a detailed explanation of potential defenses. Nevertheless, the trustee’s complaints both asserted that the relevant defendant “failed to supply any viable and provable basis for defenses.”
The defendants both argued that the trustee ignored their affirmative defenses, and did not perform sufficient due diligence as required by the statute.
In both cases, the court rejected the defendants’ arguments. First, the court found that the due diligence requirement is a condition precedent to the trustee’s affirmative preference claim. Second, the court found that a general allegation that the trustee has performed due diligence will suffice because the trustee need not plead around potential affirmative defenses.
The court’s rulings appear to be consistent with case law in other districts. But the rulings may also undermine the purpose of the due diligence requirement.
Although it may be inappropriate to expect a trustee to plead around affirmative defenses, Congress wanted to limit the ability of trustees to use section 547 in order to extract payments from individuals or entities that have viable defenses, such as the new value defense. But while the trustee must plead some level of diligence that includes consideration of affirmative defenses, the pleading requirement can be so easily met that a trustee can have knowledge of meritorious defenses and still assert a well-pleaded complaint that fails to take those defenses into account.
[1] A longer time period applies for insiders.
[2] 11 U.S.C. § 547(b).
[3] Rebein v. NutriQuest, LLC (In re Sandy Road Farms, LLC), No. 24-40446, 2025 WL 2990836 (Bankr. D. Kan. Oct. 22, 2025); Rebein v. Tempel Grain Elevators, LLP (In re Sandy Road Farms, LLC), No. 24-40446, 2025 WL 2992178 (Bankr. D. Kan. Oct. 22, 2025).
