Follow by Email

Thursday, May 15, 2014


     If you or your company have had any exposure to adversarial proceedings you are likely familiar with the terms ordinary course, new value and contemporaneous exchange for new value. Apart from these “better known” defenses to preference claims, the Bankruptcy Code provides for additional defenses which you may not be as familiar.

     These “lesser known” defenses are: the Earmarking, Conduit and Agency defenses. Because they utilize the similar terminology and application, they are easily confused. In fact, often times they are improperly combined into a single defense! Just like the “standard” preference defenses listed above, if any of these defenses apply, they are a complete defense to an otherwise avoidable transfer.

      The Earmarking Defense: In large construction projects developers/owners (in this case the “debtor”) will often seek funding from a third party lender (bank) in order to finance the project. These third party lenders (bank) agree, via lending agreements, to apply funds of the debtor to pay the costs of construction (i.e. contractors and suppliers). Payments made to contractors, subcontractors and suppliers are then exchanged for lien releases. Payment of “funds from the estate” made in exchange for lien release may not fall into the preference trap. These payments simply exchange one secured creditor (bank) for another (supplier/contractor) whose security comes from having lien or bond rights. The effectiveness depends on the lien or bond rights being perfected.

      The Conduit Defense: This defense applies when the debtor transfers money through your company to a third party. The recent case of In Re. Custom Contractors, decided by the 11th Circuit, serves to illustrate the application of this defense. In Custom Contractors the debtor, in order to meet its tax obligations, made certain payments to the IRS. The IRS argued it was a mere conduit and could not be held liable for the payments because the payments made were refunded to the debtor. The funds merely passed through the IRS and were not made in payment of a preexisting debt. The Bankruptcy Court agreed with the IRS. The Court further explained that in “[Order] to meet the mere conduit or control test and avoid liability . . . [it must also be found] that they acted in good faith as an innocent participant in the fraudulent transfer” In Re Custom Contractors, LLC., 2014 U.S. App. Lexis 5501 (11th Cir. 2014).

      The Agency Defense: The Agency Defense is triggered when the debtor transfers money to the Defendant, who in turn transfers those same funds to a third party under an express agreement. The key here is the existence of a prior agreement specifying that the debtor does not transfer any interest in the property. The Defendant is a legal agent of the debtor.

      Defending Adversarial claims by a Trustee or Debtor in Possession requires a complete appreciation of the specific facts, legal principles and jurisdictional nuisances at play. If you are ever faced with defending a preference claim you are urged to contact your legal counsel to discuss what legal theories can be utilized in your defense. If you have any questions please feel free to contact us. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you free written information about our qualifications and experience. Additionally, the information above is not intended to be legal advice. Please consult with an experienced lawyer if you have a specific issue or dispute.


The Soto Law Group, P.A.
2400 East Commercial Boulevard
Suite 400
Fort Lauderdale, FL  33308
TEL:  954-567-1776
FAX:  954-567-1778