Freight brokers are well-accustomed to bankruptcy preference actions. Those actions, which are permitted under the Bankruptcy Code, allow a debtor, trustee or other bankruptcy estate representative to claw back payments made on account of antecedent debt in the 90 days prior to a bankruptcy filing. Trade creditors, especially those in the transportation industry, are often faced with significant preference claims because they provide service to debtors up until (and sometimes after) the debtor’s bankruptcy filing. While many trade creditors are well-versed in the more standard defenses to a bankruptcy preference action, such as new value and ordinary course of business defenses, there also are unique defenses available to freight brokers that are rarely exercised, but may be effective in certain circumstances.

In most cases, a freight broker contracts with a carrier to haul freight on behalf of a shipper. While a shipper often tenders payment directly to a freight broker, the freight broker then generally turns over that payment to the carrier, less any brokerage charges or commission. In situations where the debtor is the shipper, the effect of this scenario is that the alleged preferential payment from the debtor merely passes through the freight broker and ultimately ends up in the hands of the carrier. Since the shipper’s relationship is with the freight broker, however, the freight broker is often the target of the preference claim, not the carrier.

An often overlooked preference defense is the “mere conduit” defense. To be a “mere conduit,” a defendant must “establish that it lacked dominion and control over the transfer because the payment simply passed through its hands and it had no power to redirect the funds to its own use.” [Golden v. The Guardian Life Ins. Co. of Am. (In re Lenox Healthcare, Inc.), 343 B.R. 96, 103 (Bankr. D. Del. 2006)] With the exception of any brokerage charges or commission of the freight broker, it is generally the case that a shipper’s payment only passes through the hands of the freight broker to the carrier. The mere conduit defense should be invoked in this scenario. 

The seminal case involving the tripartite relationship among a shipper, broker and carrier in the context of a bankruptcy preference action is Lyon v. Contech Constr. Prods., Inc. (In re Computrex, Inc.), 403 F.3d 807 (6th Cir. 2005). In Computrex, the debtor was a freight broker and the recipient of the alleged preferential transfers was the shipper. Id. at 809. The shipper argued that the proceeding must be dismissed because the funds that the shipper paid to the debtor on account of the carriers’ invoices were not part of the debtor’s estate. Id. at 810. Rather, the shipper argued that the debtor “was merely a disbursing agent … and thus did not exercise sufficient control and dominion over the funds for them to constitute part of its estate.” Id. In its decision affirming the Bankruptcy Court’s dismissal of the preference action, the Sixth Circuit explained that “the broker’s brief possession of the shipper’s funds was to be similar to that of a transfer station along the road to payment of the shipper’s carriers.” Id. at 811. 

Federal regulations assist a freight broker’s mere conduit defense. Specifically, 49 C.F.R. § 371.3 requires freight brokers to maintain detailed and separate accounting to track and segregate payments due to carriers. As one Court has noted, “the federal regulations … clearly contemplate that brokers … may act as a conduit by collecting freight charges owed to the motor carrier, and making appropriate payment to the carrier, less any brokerage charges.” [Trans. Revenue Mgmt. v. Freight Peddlers, Inc., 2000 U.S. Dist. LEXIS 22909, at *15 (D.S.C. Sept. 7, 2000)]

It is critical that a freight broker remember to assert a mere conduit defense if faced with a preference suit (along with the more common defenses of new value and ordinary course). Because the freight broker often lacks dominion or control over, and has no possessory interest in, the alleged preferential transfers, it may have a persuasive argument for dismissal of the preference suit.