Ninth Circuit Holds Courts May Entertain Hypothetical Preference Actions Within Section 547(b)(5)'s Hypothetical Liquidation Analysis

In Schoenmann v. Bank of the West (In re Tenderloin Health), No. 14-17090, D.C. No. 4:13-cv-03992-JSW, the Ninth Circuit Court of Appeals reversed the district court's order affirming the bankruptcy court's summary judgment in favor of Bank of the West ("BOTW") in an adversary proceeding for avoidance of a preferential transfer brought by a Chapter 7 trustee ("Trustee"). Specifically, the Ninth Circuit held "that courts may entertain hypothetical preference actions within section 547(b)(5)'s hypothetical liquidation when such an inquiry is factually warranted, supported by appropriate evidence, and so long as the hypothetical preference action would not result in a direct conflict with another section of the Bankruptcy Code."

In 2009 and 2011, Tenderloin Health ("Debtor") obtained a $300,000 loan from BOTW, secured in part by the Debtor's deposit accounts with BOTW. In late 2011 or early 2012, the Debtor wound up its affairs and sold its only real property. From the sale proceeds, the Debtor paid BOTW $190,595.50 ("Transfer") to fully satisfy its outstanding loan obligation and the Debtor deposited the remaining sale proceeds of $526,402.05 in its BOTW deposit account. On July 20, 2012, the Debtor filed for Chapter 7 bankruptcy ("Petition Date"). As of the Petition Date, the Debtor's BOTW deposit account contained $564,115.92.

In the preference action, the Trustee sought to recover the Transfer, which was made to BOTW within ninety days of the Petition Date. At issue before the Ninth Circuit was whether the "greater amount test" under 11 U.S.C. ยง 547(b)(5) had been met. Under Section 547(b)(5) of the Bankruptcy Code, the Trustee had to demonstrate that by virtue of the Transfer, BOTW received more than it would have in a hypothetical Chapter 7 liquidation had the Transfer not occurred. The bankruptcy court granted BOTW's motion for summary judgment, finding BOTW did not receive more than it would have in a hypothetical liquidation because it maintained a right to setoff that entitled it to full payment, and the Debtor's deposit account held sufficient funds on the Petition Date. However, the Trustee asserted that she could avoid the $526,402.05 deposit in a hypothetical liquidation, resulting in only $37,713.87 in the BOTW deposit account on the Petition Date, which was significantly less than the $190,595.50 BOTW received, even allowing for setoff. The Ninth Circuit found that because the Trustee could demonstrate that BOTW received more due to the Transfer than it would have in hypothetical liquidation, summary judgment was improper.

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