It is no surprise that in 2010, Lang, Richert & Patch was once again named “The Firm of Distinction.” With five attorneys earning the title of Super Lawyer and four more earning the title of Rising Star, nearly all of this firm’s practice areas are staffed by attorneys who have been rated by their peers as some of the best in the state.

Lang, Richert & Patch congratulates the following Super Lawyers: personal injury and wrongful death specialist Robert L. Patch II; construction and complex litigation attorney Val W. Saldana; bankruptcy and insolvency advocate Rene Lastreto II; employment and labor law attorney Charles T. Taylor; and construction law specialist Mark L. Creede.

Among Lang, Richert & Patch’s up-and-coming attorneys are Rising Stars: Matthew W. Quall, construction litigation attorney; Craig B. Fry, corporate and business transactions and bankruptcy specialist; Scott J. Ivy, business litigation, attorney; and Ana de Alba, business litigation attorney.

These 9 Super Lawyer and Rising Star honorees come from diverse practice areas and represent nearly half of all attorneys practicing with Lang, Richert, & Patch. Lang, Richert & Patch is proud to have among the largest contingent of Super Lawyer and Rising Star honorees in the Central Valley.

Mr. Lastreto was also a faculty member along with two other practitioners and two prominent Bankruptcy Judges at the California Bankruptcy Forum in Monterey from May 21 through May 23. Mr. Lastreto spoke on evidence issues confronting bankruptcy practitioners in Adversary Proceedings and Contested Matters for the panel discussion entitled “What Do You Mean I Can’t Get That in Evidence!”

On June 25, 2010 Mr. Lastreto will be a faculty member for the Central California Bankruptcy Association Fundamentals of Bankruptcy Law Seminar. Mr. Lastreto will be presenting the attendees with analysis of the Bankruptcy Discharge and Dischargeability of Debts.

On September 24, 2010 at the Radisson Hotel in Fresno Mr. Lastreto along with the Chief Judge of the Central District of California (effective January 1, 2011), Peter Carroll, will be presenting a panel discussion on Exemption Issues in Bankruptcy at the Central California Bankruptcy Association Annual Conference.

Lang, Richert & Patch has a long history of its attorneys participating in peer education further establishing its respected reputation for expertise in the legal community.

The Super Lawyers process is complex and recognized as a bona fide system of identifying the top lawyers in respective practice areas. The publication ensures quality selection by employing 12 indicators of peer recognition and professional achievement, including verdicts, settlements, transactions, representative clients, experience, honors, awards, etcetera..Once the final selections are made, only 5 percent of lawyers in each state make the published list of Super Lawyers, and no more than 2.5 percent are named as Rising Stars.

Lang, Richert & Patch continues to maintain its reputation as “The Firm of Distinction”, with five attorneys earning the title of Super Lawyer and two others being named as Rising Stars. The Super Lawyers hailing from Lang, Richert & Patch include; personal injury and wrongful death specialist Robert L. Patch II, construction and complex litigation attorney Val W. Saldana, bankruptcy and insolvency advocate Rene Lastreto II, employment and labor law attorney Charles T. Taylor, and construction law specialist Mark L. Creede. LR&P further recognizes Rising Stars, Matthew W. Quall, construction litigation attorney, and Craig B. Fry, corporate and business transactions and bankruptcy specialist.

The selection of Super Lawyers and Rising Stars from Lang, Richert & Patch represents the broad and diverse set of skills and backgrounds the firm brings to litigation matters. The seven Super Lawyer and Rising Star honorees represent two thirds of the lawyers currently practicing with Lang, Richert, & Patch and is by far the largest contingent in the Central Valley. Attorney Val Saldana commented that the title is, “as much an honor for the entire firm, as it is for the individuals involved”. Saldana further noted, “we have always taken a collaborative team approach to our complex litigation matters.” The multiple Super Lawyer and Rising Star distinctions demonstrate Lang, Richert & Patch’s ability to provide aggressive and effective results to a wide range of client demands.

Lang, Richert & Patch has strived for more than 40 years to provide its clients with premier legal services through establishing an open and collaborative environment while maintaining a result driven mentality. The experience and expertise of the firm has earned the respect of both the local and legal communities. The firm also received the prestigious, Martindale-Hubbell AV-rating, which is the highest peer rating for ethics and ability. Looking ahead, Val Saldana notes that, “we have worked hard to achieve preeminent status in the business litigation and bankruptcy departments. And we intend to keep on building.”

Understanding the Intentions
At first read, the legislation seems straightforward and reasonably defined. However, when applying real-world scenarios, the ambiguities begin to appear. The aim of SB 1137 is to avoid residential, non-judicial foreclosures whenever possible, by requiring additional communications between the borrower and lender.

What Loans are Affected by the New Foreclosure Law?
The answer is not as clear as one might hope, but the text of the legislation identifies loans made between January 1, 2003, and December 31, 2007 that are “secured by residential real property and are for owner-occupied residences.” Loan agreements signed and dated during these periods meet this initial requirement. Whether these loans are “secured by residential property and…are for owner-occupied residences” is the more difficult determination. Many legal professionals agree that this section is not limited to “1-4 residential properties.” More likely this covers any loan secured by property on which the borrower principally resides.

What are the New Notification Requirements for Affected Loans in Default?
The new notice provisions affect both Notice of Default (“NOD”) and Notice of Sale (“NOS”) requirements. The new laws require lenders to contact borrowers at least 30 days prior to filing a NOD. If contact cannot be made, lenders must file a declaration with their NOS stating that “due diligence,” as defined by the statute, has been followed. Some very limited exceptions exist.
The new NOS provisions require increased compliance for any loan secured by residential property, where the mailing address of the borrower is different from the mailing address of the property. Presumably, the legislature included these provisions for the protection of tenants who might not otherwise get notice. Lenders are required to provide statutory language to tenants including posting and mailing notices in English, Spanish, Chinese, Tagalog, Vietnamese, and Korean. There are statutory fines for anyone tearing down the notices.

Conclusion
In addition to notice requirements, the new laws also have post-foreclosure implications for lenders. Any REO’s (properties retained by the lender after an unsuccessful foreclosure sale) that are not properly maintained may expose lenders to fines of up to $1000 per day by local government entities. While this is just a brief introduction to the new compliance regulations, it is easy to see that lenders need to make immediate changes to their current foreclosure practices. Policies and procedures need to be implemented to ensure that lenders are following the proper time line and notice requirements. Although the laws may be more complex and ambiguous than they first appears, compliance is mandatory, but manageable.

If you have questions or concerns related to this or any other legal issue, please contact Lang, Richert and Patch at (559) 228-6700.

In Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co. (2007), the United States Supreme Court recently ruled that attorneys’ fees can be recovered in connection with an unsecured or undersecured claim pursuant to a contractual or statutory right in the context of a bankruptcy case. The Supreme Court’s decision overruled the Ninth Circuit Court of Appeals and changed the law with respect to all bankruptcy cases in California.

The decision arose out of the Chapter 11 bankruptcy case of Pacific Gas & Electric Co. (“PG&E”). During the course of the bankruptcy case, PG&E and Travelers Casualty & Surety Co. (“Travelers”) entered into a stipulation which provided for an unsecured claim for attorneys’ fees. Upon successfully litigating their claim in bankruptcy court, Travelers filed an amended proof of claim and asserted a contractual right to recover the attorneys’ fees it incurred in litigating its underlying claim. Travelers’ claim was disallowed by the Bankruptcy Court, the District Court, and the Ninth Circuit Court of Appeals. The primary rationale for not allowing the fees was previous Ninth Circuit authority to the effect that creditors are not entitled to attorneys’ fees where “the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law.” In re Fobian, 951 F.2d 1149, 1153 (9th Cir. 1991). The dispute over Travelers’ right to recover attorneys’ fees went all the way up the Supreme Court.

The unanimous opinion of the Supreme Court was written by the newest member of the Court: Associate Justice Samuel A. Alito, Jr. In a carefully reasoned opinion, the Court held:

1. Under § 502(a) of the Bankruptcy Code, a properly filed creditor claim is allowed against the debtor unless a party in interest objects.
2. Even where a party in interest objects, the court “shall allow” the claim “except to the extent that” the claim implicates an exception enumerated in § 502(b).
3. The applicable exception to a claim for reasonable attorneys’ fees is § 502(b)(1), which disallows claims which are “unenforceable against the debtor . . . under any agreement or applicable law.” For instance, if a claim is based on a contract and the contract is unenforceable, then the claim is disallowed.
4. Section 502(b)(1) is consistent with the well-established legal principle that, unless curtailed by provisions in the Bankruptcy Code, claims in bankruptcy are based on the underlying substantive law that creates the claim, which is often times state law. Therefore, if the claim is valid under state law, it is valid in bankruptcy unless there is something in the Bankruptcy Code to the contrary.
5. The Supreme Court rejected the Fobian rule on the ground that the Fobian rule is not supported by the text of the Bankruptcy Code.

The Travelers decision simply means that a creditor’s right to reasonable attorneys’ fees is not affected by the filing of a bankruptcy case. A creditor’s right to attorneys’ fees is created and defined by statute or contract. That right is no longer abridged by attorneys’ fees incurred in connection with litigation that is “peculiar to federal bankruptcy law.” Significantly, in California, if one party to a contract has an attorneys’ fees provision, it is automatically deemed mutual. Cal. Civ. Code § 1717. Therefore, if a secured lender had a one-sided attorneys’ fee provision in a promissory note, then, by operation of law, the debtor has the same fee provision upon which to claim attorneys’ fees in post-bankruptcy litigation.

There are some stabilizing mechanisms to this increased availability of attorneys’ fees in the context of bankruptcy, both legal and practical. As a legal matter, under § 502(b)(4), any claim for attorneys’ fees must be “reasonable.” Therefore, the court will not award fees for unnecessary, excessive or overpriced legal work. As a practical matter, because bankruptcy, by definition, involves situations in which resources are limited, a creditor claim for attorneys’ fees under § 502(b) will probably not be paid 100 cents on the dollar, and could possibly not be paid at all.

Another potential ramification of the Travelers decision is that, in situations where a right to attorneys’ fees exists, there is a built-in incentive for both creditors and debtors to avoid contentious litigation. The stakes are increased because of the newfound ability to seek attorneys’ fees in bankruptcy if there is a contractual or statutory basis for doing so. Accordingly, both creditors and debtors will likely be more cautious in how they proceed in bankruptcy disputes. For example, creditors will be more likely to investigate and verify the amount and validity of their claim before filing a proof of claim or an adversary proceeding. Conversely, debtors will need to be especially discerning with respect to objecting to claims or filing adversary proceedings in connection with claims.

by Alane Becket

With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), fundamental changes in how distribution of a debtor’s income will be made during a bankruptcy case went into effect. Unfortunately, touted as a “creditor’s bill,” an analysis of BAPCPA has uncovered several examples of the law of unintended consequences. Indeed, credit card companies and other unsecured creditors, and those who purchase this type of account, should proceed with caution when making projections based on media hype and rumor.

When analyzing and anticipating the net result of BAPCPA for a creditor or debt buyer’s bottom line, it is one thing to make general predictions about recoveries, but another to understand why the changes will occur and what can be done by unsecured creditors to make a positive difference for recoveries. This article will focus on some of the major changes made by BAPCPA and their effects on unsecured recoveries.

First, the Means Test, which is designed to require debtors who have the ability to make at least partial repayment to their creditors to enter into a Chapter 13 Plan or face dismissal from bankruptcy, is probably the single most publicized aspect of the consumer amendments to the Bankruptcy Code. However, under scrutiny, it does not appear that this provision will result in a significant shift of debtors into Chapter 13 as intended. One of the primary reasons for this is that the Means Test is only applied to debtors with income above the median income for their state. As a majority of consumer debtors have incomes below their state median, the Means Test will be inapplicable to a large percentage of debtors. Thus, a majority of Chapter 7 filers will be permitted to remain in Chapter 7, unaffected by the Means Test.

On the other hand, the ability to pass the Means Test and file under Chapter 7 does not mean that a debtor eligible for Chapter 7 will necessarily file under that chapter. Debtors will continue to use Chapter 13, regardless of whether or not they have passed the Means Test, for traditional reasons, such as to prevent foreclosure on real property, to modify secured claims, to discharge certain taxes, to pay attorney fees and the like. Thus, it appears that, while the Means Test will require a percentage of debtors to proceed under Chapter 13, this provision alone will not translate into significantly larger recoveries for unsecured creditors. This is especially true when considered along with some of the sleeper provisions in BAPCPA.

Second, BAPCPA’s definition of income raises several issues when put into practice. Under BAPCPA, all of the debtors’ income is calculated under its new definition of Current Monthly Income (CMI). CMI is calculated as the average of the last six months’ income received by the debtor from all sources, with some exclusions, most notably, Social Security Income. Thus, unlike under the old law where a debtor’s future income determined plan payments, under BAPCPA, a debtor’s CMI is used as a starting point, and thus, by definition, is backward looking – a formula that may not accurately reflect a debtor’s current or future available income. For example, a debtor who was unemployed for part of the last six months but who is now employed will have CMI – the average of the previous 6 months’ income – that is less than his actual monthly income. When calculating the plan payment, then, the debtor begins the process by using an income amount that is less than the debtor’s actual monthly available income. As a result, creditors share in a smaller payment amount.

As with the Means Test in Chapter 7, in Chapter 13, a debtor’s CMI is again determinative and dictates important aspects of the repayment plan. Once a debtor’s CMI is determined, the debtor is permitted to deduct monthly expenses to reach the debtor’s “disposable income”, which is then used to pay unsecured creditors. For debtors whose income is below the median, monthly expenses must be “reasonable and necessary” and will be viewed under traditional standards established by previous judicial decisions on what constitutes reasonable and necessary expenses for a Chapter 13 debtor. For debtors with income above the state median, monthly expenses will be those set forth in section 707 that are used for the Means Test. Close scrutiny of these standard expenses uncovers numerous ways in which these expenses, and the official forms developed for use by debtors in determining disposable income, produce artificial results, potentially shielding significant income from creditors.

Another issue is whether a debtor is required to include all or any part of a non-filing spouse’s income as part of the debtor’s CMI. According to the precise terms of BAPCPA, CMI includes income that the debtor receives from all sources and includes “any amount paid by any entity other than the debtor … on a regular basis for the household expenses of the debtor…” There are sure to be heated debates over whether and how much of a debtor’s spouse’s income should or must be included in a debtor’s CMI, especially if a debtor claims deductions for dependents, one of whom is the spouse.

Third, all debtors are now permitted to both contribute to and repay loans from retirement plans as part of their monthly expenses. In the past, these practices were judged under the reasonable and necessary standard, with the result that in many cases, debtors were prohibited from continuing contributions or making repayments to retirement plans before paying unsecured creditors. Now that these payments are sanctioned under BAPCPA, debtors have incentive to both contribute to retirement plans and to take loans from those assets, knowing that they will be repaid while the debtor is in bankruptcy.

BAPCPA also calls for repayment, in full, of certain secured loans, which in the past had been subject to strip down, a process which required a debtor to repay only the value of the collateral, while remainder of the debt was an unsecured claim. Under BAPCPA, automobiles purchased within two and a half years of the bankruptcy and other secured personal property purchased within a year of bankruptcy must be paid for in full or surrendered. Payment in full now means that money which, under the old law, had gone to unsecured creditors will now go to secured creditors.

As these provisions demonstrate, BAPCPA is not necessarily living up to its reputation as a “creditor’s bill.” And, while secured creditors reap the most benefit from the new law, there are still ways unsecured creditors can participate in bankruptcies and take full advantage of the opportunities available to them. The details of the bankruptcy bill and a discussion of how unsecured creditors can realize the most from their accounts was discussed at the Debt Buyers Association Conference, “Racing for Debt”, held February 7-9, 2006 in Las Vegas, Nevada. For more information log onto www.debtbuyers.com.

Alane Becket is a managing partner at Malvern, Pennsylvania based Becket & Lee, LLP, a law firm specializing in the representation of consumer creditors and debt purchasers in bankruptcy matters. Information on the firm can be found at www.becket-lee.com.

A “dragnet clause” is a contract provision stating that a mortgage secures all the debts that the mortgagor may at any time owe to the mortgagee. California courts have upheld the general validity of dragnet provisions. Union Bank v. Wendland, 54 Cal.App.3d 393, 398 (1976). They also recognize the risk that such provisions may be included in a trust deed or mortgage without the debtor’s knowledge or understanding. “Clauses such as this are often termed ‘dragnet’ or ‘anaconda,’ ‘as by their broad and general terms they enwrap the unsuspecting debtor in the folds of indebtedness embraced and secured in the mortgage which he did not contemplate… ‘….” Wong v. Beneficial Savings & Loan Association, 56 Cal.App.3d 286, 292 (1976) emphasis in original.

Most modern forms of deeds of trust contain a dragnet clause. One example follows:

Trustor agrees to (1) pay the principal and interest on the note of even date herewith; (2) perform each agreement in this deed of trust; and (3) pay such further sum as the then recorded owner of the property may hereafter borrow from beneficiary [lender], evidenced by another note (or notes) reciting it is so secured. Bernhard, California Mortgage and Deed of Trust Practice (3rd. Ed.), The Regents of the University of California, 2000; page 699.

While Courts will generally uphold the validity of dragnet clauses, that is not always the case. Often when challenged by the debtor or creditors who also claim a security interest in the real property secured by the deed of trust, Courts construe the clause as not including certain debts that the creditor asserts are secured by the deed of trust. This article will state the current state of the law with regard to the validity of dragnet clauses covering pre-existing or contemporaneous debts (either in existence or entered into at the time the deed of trust was executed) or those debts incurred after the deed of trust was recorded.

Pre-existing or contemporaneous debts.

Courts in California have rejected the view that a broadly worded dragnet clause may never be applied to other existing or contemporaneous debt. However, California Courts have consistently adhered to a construction of such clauses that depends more on “the actual expectations of the parties… than the literal wording of the boilerplate clause.” Fischer v. First International Bank, 109 Cal.App.4th 1433, 1435 (2003) citing Ostayan v. Serrano Recoveyance Co., 77 Cal.App.4th, 1411, 1421 (2000). Generally a proponent of a dragnet clause bears the burden of establishing that the parties intended all existing or contemporaneous loans to be included within its scope. Wong, supra, at 294. This construction makes sense because it is easy to include specific existing obligations when that is the party’s intent. If the parties fail to include those obligations a court can likely confer that no such intent existed or that, if it did, it was a secret intent. Fischer, supra, 109 Cal.App.4th at 1447. When you add to that analysis the view in California that a trust deed containing a dragnet clause that is printed on a standard bank form is considered a contract of adhesion, Lomanto v. Bank of America, 22 Cal.App.3d 663, 668 (1972), enforcement will depend on whether the provision is within the reasonable expectation of the weaker or “adhering” party (the Bank’s customer). See Armendariz v. Foundation Health Phychcare Services, Inc., 24 Cal.4th 83, 113 (2000).

Relevant factors articulated in the case law which help

California Courts determine whether a broadly worded dragnet clause was mutually intended by the parties to cover pre-existing or contemporaneous debts include: (1) the language and specificity of the dragnet clause; (2) whether the parties were aware of the dragnet clause and appreciated its significance; (3) whether the other loans were of the same type or character as the primary loan; and (4) whether the Bank relied upon the dragnet clause as security for the other loans. Fischer, supra, 109 Cal.App.4th at 1446.

In order to make it more likely that if challenged by the debtor or another creditor, a dragnet clause would be construed to include contemporaneous or pre-existing debts, creditors should consider these options.

1. Specify in the deed of trust the specific debts that intend to be covered by the deed of trust. Since it is preferable to utilize forms, it may be appropriate to modify the form to include reference to an exhibit so that all the debts can be listed.
2. Include in the instruments that are to be secured by the deed of trust specific reference to the fact that a deed of trust of a certain date is to serve as security.
3. Have the debtor sign a separate document stating the debtor specifically recognizes that more than one debt is to be secured by the deed of trust and that the debtor recognizes the significance of that fact. For example, if the debtor defaults on one of the obligations secured by the deed of trust, the foreclosure process could begin.
4. The creditor’s internal documents should establish very clearly that the deed of trust is to serve as security for multiple obligations.
5. The loans to be secured by the deed of trust should be similar in character.

Future advances.

In contrast to debts which may be in existence when a deed of trust is signed and recorded, other issues arise when a lender lends additional monies after the deed of trust is signed and recorded and wants the obligation secured by the deed of trust expanded to include the later advances. Obviously, if a loan is in existence when a deed of trust is signed and recorded, a strong argument could be made that if the parties intended to include those loans under the umbrella of the deed of trust, they could have done so. Such an argument may not be available with respect to future advances made by a lender.

The California Civil Code contemplates that a lien may be created and take immediate effect as security for performance of obligations which do not yet exist. Civil Code Section 2884. The example of the dragnet clause at the beginning of this article limits the obligations secured by a deed of trust to those that specifically refer to the existing deed of trust.

As with contemporaneous or pre-existing obligations, the courts try to construe dragnet clauses consistent with the expectations of the parties. Strong evidence of the party’s intention to include subsequent loans is if the initial and subsequent loans are related. See Union Bank, supra, 54 Cal.App.3d 393. Where disputes arise generally is not between the debtors and creditors in this area but rather between creditors asserting priorities to the collateral. Obviously, if a deed of trust specifically describes future obligations that it secures, a competing creditor will have difficulty establishing that the advance made under that deed of trust is not entitled to priority. This is especially true if the party subsequently signs notes or other instruments specifying the debt was secured by that deed of trust. See Bernhard, supra, at page 708. However, if the creditor has to rely upon a broadly worded dragnet clause, a debtor can argue that it did not know what the clause meant and bring into question the validity of the security for the advance. Lomanto, supra, 22 Cal.App.3d 663.

Many lenders are aware of issues that arise whether an advance made by a lender secured by a deed of trust is optional or obligatory. If obligatory advances, they are generally believed to be secured by the deed of trust. However, if the advances are optional, they are not. Deeds of trust rarely state whether future advances are optional or obligatory. In many cases, deeds of trust do include covenants of the borrower that if the lender has to make certain expenditures (such as attorneys’ fees) to protect the security, it will be secured by the deed of trust. Those types of clauses, however, while technically “future advance clauses” really are more specific statements of the borrower’s obligations which are secured by the deed of trust. Some helpful guidelines for lenders with senior liens that may contemplate additional advances are:

1. Specifically state in the deed of trust the amount and timing of advances that may be required and for which the deed of trust will act as security.
2. Any subsequent instrument signed that is to be secured by the deed of trust should make specific reference to the deed of trust.
3. Provide notice to any subordinate creditor who has recorded a deed of trust or that the senior lender knows about prior to the advance.

At the same time if a lender wishes to loan funds to a debtor secured by property that is already encumbered, that lender should protect itself in a priority dispute with a senior lienholder. Here are some suggestions to do so:

1. Perform a careful title search to determine the identity of any senior lienholder.
2. Inquire of any senior lienholder of the amount due. Civil Code § 2943 requires the beneficiary of a deed of trust to provide information to certain persons including the trustor or mortgagor under that deed of trust.
3. Give notice to the senior encumbrancer of the existence of the junior lien.
4. Obtain warrantees and representations from the borrower about the balance due secured by the senior trust deed.

Conclusion

Dragnet clauses are enforced by courts to the extent they accurately reflect the parties intentions. They can accurately reflect intentions provided lenders and borrowers carefully document their positions. Both senior lienholders and junior lienholders can take steps to protect themselves in priority fights concerning the collateral by following a few reasonable steps.

In April 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“Reform Act”). Most of the provisions go into effect on October 17, 2005. While the Reform Act contains many changes to consumer bankruptcy law, it also contains significant provisions applicable to business bankruptcy issues.

In particular, the law has been changed for “preference claims,” litigation filed by bankruptcy trustees or plan agents seeking to have the creditor return hard-earned money received from the bankruptcy debtor within 90 days of the filing of the bankruptcy petition.

The policies underlying preference claims include “equality of distribution” among similarly situated creditors, which includes the theory that creditors paid by a beleaguered debtor as he “slides” into bankruptcy should not benefit at the expense of the other creditors.

To address this “inequality,” bankruptcy law allows estate representatives to sue non-insider creditors to recover payments they received within 90 days of the bankruptcy filing. Insider creditors are subject to a one year “reach back.”

However, not all payments are recoverable as preferences. Only those payments made on antecedent (older) debts are recoverable to the extent the creditor received more than it would have received were the debtor liquidated under Chapter 7 and each creditor received a pro rata distribution.

It should be noted that the law also requires that the debtor was “insolvent” during the 90 day preference period, however, the law presumes insolvency, and it is up to the creditor to prove otherwise.

Creditors, however, do have certain defenses, including that the payment was in “the ordinary course of business” and under ordinary business terms; that the payment was made contemporaneously with the creditor giving “new value” to the debtor; or that after the payment was made the creditor gave the debtor additional “new value.”

Under current law, a creditor defending against a preference claim must prove that an otherwise preferential payment was: (1) made by the debtor in the ordinary course of the debtor and creditor’s business (the “subjective element”); and (2) according to ordinary business terms (the “objective element”). Thus a creditor must prove that the payment was typical both as between the creditor and its customer(the debtor) and according to industry standards.

The objective element is problematic for several reasons. First, while most companies have employees who can testify to industry standards, their knowledge may have been gained from sources that would be inadmissible in court such as trade journals, conversations with peers, etc. This requires a defendant to hire an expert with its attendant costs and other concerns.

The Reform Act makes this defense more tenable since creditors will now need to prove either that the payment was in the ordinary course of business between the creditor and the debtor or was made under ordinary business terms. This should make the defense easier to establish as an expert will not be needed to establish the creditor’s history with the debtor.

In addition, two very irritating aspects of preference practice have also been addressed under the Reform Act: the small case and far away venue.

First, creditors with valid defenses to preference claims have been coerced into unfavorable settlements of small cases due to the economics of litigation. The Reform Act addresses this issue by requiring that a preference claim in a business case must exceed $5,000 to be recoverable.

While still perhaps too low, this threshold should discourage litigation over very small claims. Interestingly, this is a new defense to the preference claim, meaning the creditor must raise and prove the defense. Still, if the facts exist to support the defense, estate representative and their lawyers may face sanctions for pursuing a frivolous case.

Second, because of the bankruptcy law’s venue provisions, creditors would often be required to litigate small cases in far away venues such as Delaware or New York, where the “mega-case” was pending.

Under the Reform Act, any case seeking less than $10,000 from a non-insider must litigate the preference claim in the district where the creditor-defendant resides. Prior law allowed litigation where the main bankruptcy case was pending so long as the claim was over $1,000. This led to virtually all cases being brought in the venue of the main bankruptcy case, forcing creditors to hire counsel in far away places to litigate small cases.

The Reform Act contains many provisions that affect consumers and businesses. While many changes will not affect the daily business of many of the clients of Lang, Richert & Patch, the Reform Act contains some benefits for those who occasionally are involuntarily brought into the bankruptcy process.

Rene Lastreto, II heads the firm’s bankruptcy practice and is certified in Creditor Rights Law. Lastreto has more than 20 years experience dealing with business litigation issues, with a strong focus on complex bankruptcy, collection and insolvency cases. Individuals and businesses facing such problems are encouraged to contact him for a consultation.