In Official Committee of Unsecured Creditors v. Whalen (In re Enron Corp.), the Bankruptcy Court for the Southern District of New York considered whether the debtor’s pre-bankruptcy payment of an employment bonus one day before it became due was “for or on account of an antecedent debt owed by the debtor before such transfer was made” for purposes of determining whether section 547(b) of the Bankruptcy Code made the payment avoidable as a preferential transfer. Reasoning that the debtor made the early payment on account of a liability that arose against it upon formation of the employment contract and rejecting the defendant’s argument that a debt is not incurred until it becomes due for section 547(b) purposes, the court denied the defendant’s motion for summary judgment respecting the issue.

Factual Background

The controversial transfer was in payment of a employment bonus to John C. Baxter (“Baxter”), then Vice Chairman and Chief Strategic Officer of debtor Enron Corporation (“Enron” or the “Debtor”), and occurred one day before payment was due under the employment contract. Less than a year later, Enron commenced a voluntary bankruptcy case under Chapter 11. Baxter died shortly thereafter.

The Official Committee of Unsecured Creditors in the case (the “Committee,” or the “Plaintiff”) commenced an action against the executrix of Baxter’s estate, Carol Whalen (“Whalen,” or the “Defendant”), to avoid the transfer as preferential under section 547(b) and as a fraudulent transfer under sections 548(a)(1)(B) and 544(b) of the Bankruptcy Code and N.Y. Deb. & Cred. Law §§ 270-81. The Whalen decision primarily addresses Whalen’s motion for summary judgment on the issue of whether the transfer met the requirements of section 547(b) for avoidance, which the court identified as:

A “transfer of an interest of the debtor in property” ...where the transfer (1) was made to or for the benefit of a creditor, (2) was on account of an antecedent debt, (3) was made while the debtor was insolvent, (4) was made on or within ninety days before the petition date2 and (5) was for an amount greater than the creditor would have received in a Chapter 7 liquidation, if the transfer had not been made, and otherwise under the provisions of the Bankruptcy Code.3

The Parties’ Arguments

In her motion for summary judgment, Whalen argued that, because the transfer occurred a day before it was due, the debt had not been “incurred,” and Enron was not (yet) obliged to pay it; therefore, she asserted the payment was not made “for or on account of an antecedent debt owed by the debtor before such transfer was made,” and thus could not be avoided as preferential. The Committee’s counter-argument seems to have mostly focused In Official Committee of Unsecured Creditors v. Whalen (In re Enron Corp.),1 the Bankruptcy Court for the Southern District of New York considered whether the debtor’s pre-bankruptcy payment of an employment bonus one day before it became due was “for or on account of an antecedent debt owed by the debtor before such transfer was made” for purposes of determining whether section 547(b) of the Bankruptcy Code made the payment avoidable as a preferential transfer. Reasoning that the debtor made the early payment on account of a liability that arose against it upon formation of the employment contract and rejecting the defendant’s argument that a debt is not incurred until it becomes due for section 547(b) purposes, the court denied the defendant’s motion for summary judgment respecting the issue.

Factual Background

The controversial transfer was in payment of a employment bonus to John C. Baxter (“Baxter”), then Vice Chairman and Chief Strategic Officer of debtor Enron Corporation (“Enron” or the “Debtor”), and occurred one day before payment was due under the employment contract. Less than a year later, Enron commenced a voluntary bankruptcy case under Chapter 11. Baxter died shortly thereafter.

The Official Committee of Unsecured Creditors in the case (the “Committee,” or the “Plaintiff”) commenced an action against the executrix of Baxter’s estate, Carol Whalen (“Whalen,” or the “Defendant”), to avoid the transfer as preferential under section 547(b) and as a fraudulent transfer under sections 548(a)(1)(B) and 544(b) of the Bankruptcy Code and N.Y. Deb. & Cred. Law §§ 270-81. The Whalen decision primarily addresses Whalen’s motion for summary judgment on the issue of whether the transfer met the requirements of section 547(b) for avoidance, which the court identified as:

A “transfer of an interest of the debtor in property” ...where the transfer (1) was made to or for the benefit of a creditor, (2) was on account of an antecedent debt, (3) was made while the debtor was insolvent, (4) was made on or within ninety days before the petition date2 and (5) was for an amount greater than the creditor would have received in a Chapter 7 liquidation, if the transfer had not been made, and otherwise under the provisions of the Bankruptcy Code.3

The Parties’ Arguments

In her motion for summary judgment, Whalen argued that, because the transfer occurred a day before it was due, the debt had not been “incurred,” and Enron was not (yet) obliged to pay it; therefore, she asserted the payment was not made “for or on account of an antecedent debt owed by the debtor before such transfer was made,” and thus could not be avoided as preferential. The Committee’s counter-argument seems to have mostly focused on whether the debt had been “incurred” on the day of payment even though it was “due” the next day. It also noted, however, that Baxter had a claim, whether or not it had matured, on the payment date.

The Court’s Analysis

Although its analysis ultimately relies on the statutory text, the court notes at the outset that the Bankruptcy Code does not define the term “antecedent debt” and that, despite ostensible consensus, there are disagreements as to the meaning of the phrase in the case law. According to the opinion, the problem is that some courts, in invoking “vague legal maxims,” have merely shifted the inquiry from the meaning of “antecedent debt,” which they agree means a debt the debtor is “legally obligated to pay,” to the meaning of the latter phrase. Thus, the issue is the “sort of legal obligation required to create a debt for purposes of section 547(b),” which is a point on which court opinions differ.4

Early Case Law Focus on Obligation to Pay 

To gain an understanding of how the dispute arose, the court examines the case law the parties cited. It traced the “legally obligated to pay” standard upon which the Plaintiff relied to Barash v. Public Finance Corporation,5 perhaps the first case in which a federal court of appeals decided when a debt is “incurred” by a debtor. It was decided, however, not in the context of Section 547(b), which sets up the basic definition of a preferential transfer, but rather in the context of Section 547(c)(2), a statutory exception to the voidability of otherwise preferential transfers for transfers that occur in the ordinary course of business. Section 547(c)(2) replaced the common law “current expense” doctrine, which held that wages, rent and general operational expenses that amounted to regular, short term credits for current consideration, were not “antecedent debt” for preference purposes. As originally adopted with the enactment of the Bankruptcy Code, the Section 547(c)(2) exception “required that the transfer be made ‘not later than 45 days after such debt was incurred.’”6 The Barash court held that a debt is “incurred” “whenever the debtor obtains a property interest in the consideration exchanged giving rise to the debt,” or, as it alternatively described it, when the debtor becomes “legally bound to pay.”7 According to the Whalen court, when courts were confronted with instalment payments on long term loans and leases, they readily adopted Barash’s “legally obligated to pay” standard for the section 547(c)(2) exception, focusing on the “’legal’ character of the obligation,” i.e., that no legal obligation to pay exists before an instalment falls due. The court also observed that “from the perspective of the nature of the obligation, if the payment is for a term, it is plausible to view the debt as accruing over the course of the term and only being incurred at the expiration of the term.”8

In surveying the case law that the Plaintiff offered examining the “antecedent debt” prerequisite for avoiding preferential transfers under Section 547(b), the court observed that because the “ordinary course” exception of Section 547(c)(2) also requires courts “to determine the date upon which the debt first arose,” the reasoning and conclusions of the Section 547(c)(2) opinions migrated to some Section 547(b) antecedent debt decisions.9 Such decisions focused on legal obligations in the sense of “the point in time at which the creditor gains the right to demand payment.”10 Later decisions, however, “have overwhelmingly rejected the idea that a debt is incurred when payment is due” such that cause of action arises enabling the creditor to sue for payment in a court of law; instead, they focus upon the time at which the contract creating the obligation was formed, even where the later decisions apply the “legally obligated to pay” standard.11

A Debt, Under the Bankruptcy Code, is More Than a Legal Obligation

Moreover, according to the court, an “obvious trend” of broadly interpreting “antecedent debt,” grounded in the statutory text as opposed to the “legally obligated to pay standard,” is discernable.12 The clearest examples are cases in which transfers on account of debts that are disputed or remotely contingent are, despite those facts, held to be antecedent debts owed before the time of transfer. As an example of the former, the Whalen court cites cases in which the controversial transfer was in payment of a settlement on “debt” for which the debtor, as memorialized in the settlement agreement, continued to deny liability.13 For the latter, the court points to cases in which the debtor was a corporate guarantor of certain debts of employees on which it made “anticipatory” payments even though the debts were not yet due and thus the debtor was not obligated, as guarantor, to pay.14

Statutory Definition of Debt

Rather than rely on case law, however, the court preferred to follow what it believed is the correct approach, which is to search for the meaning of “antecedent debt owed by the debtor before such transfer was made” in the statutory text.15 The Bankruptcy Code’s definition of “debt,” is “liability on a claim,” and a “claim” is a “a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.” Therefore, the court observed, “debt” can be restated as “a liability for payment, whether or not such liability is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.”16

Having established the meaning of “debt, the court turns to the problem of defining “antecedent debt,” i.e., “the liability for payment” preceding a transfer. The court viewed the problem as follows:

Under customary rules of statutory construction, “antecedent debt” and “debt” should not be interpreted in such a way as to make them synonymous. However, it is at the same time difficult to imagine a payment made “for or on account of” a debt, but not an antecedent debt. Simply, if the payment was made “for or on account of” a debt, it appears necessarily true that the debt precede the payment.17 The court solves this riddle by recognizing that the Bankruptcy Code does not define “debt” in terms of credit. Thus, a debt that is not antecedent is one that is paid precisely when it arises in a “simultaneous transaction,” or “contemporaneous exchange,” where there is no credit gap filled by an only (contingent or non-contingent) promise to pay.18

A similar problem arises with the statutory language modifying “antecedent debt”: “owed by the debtor before such transfer was made.” The court observed that that phrase “appears superfluous” where “antecedent debt” is defined as a debt that arose prior to payment.19 That problem can be overcome by construing the word “owed” to mean something less than “debt,” a solution the court rejects, or by focusing on who owes, viz, the debtor, the solution the court accepts. In its example, the court presents the case in which the debtor transfers property to pay the debt of an affiliate even though it has no legal obligation (e.g., as guarantor) to do so. While such a payment could be a fraudulent transfer, it would not be preferential, according to the court.

The Court’s Application to the Pre-Paid Debt—Preferential

To summarize, then, under the Whalen court’s analysis, Section 547(b) encompasses “transfers on account of debts which precede and are not contemporaneous with the transfer, and for which the debtor is liable,” whether or not such liability is “reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.”20 When it applied its analysis to the facts of motion before it, the court concluded that the transfer to Baxter was on account of such a debt. Though it had not yet matured, Enron owed the debt pursuant to the employment contract, and the liability on the debt arose at the time that contract was formed.

Comment

The Whalen decision has made it clear that courts will apply the preference laws broadly and that prepayment of an obligation will probably not suffice to avoid the recipient’s preference liability for the payment. Creditors are advised to seek regularity of payment when they can have it, but there is, of course, no sense in turning down a payment only because it is potentially preferential. As a matter of litigation strategy, creditors’ counsel will have to concentrate more on the exceptions of Section 547(c) and less on limiting the meaning of “antecedent debt” in Section 547(b).