The Unsecured Creditors Comm. v. Community Bank(In re Stinson Petroleum Co., Inc.), Case No. 12-60234 (5th Cir., Jan. 7, 2013)
Pre-petition, the debtor engaged in a check-kiting scheme using accounts held at two banks. As a result of the scheme, one of the banks incurred substantial losses, and prior to filing its petition, the debtor made wire transfers to this bank to cover those losses. Following the petition filing, the Unsecured Creditors Committee moved to avoid the transfer as an avoidable preference under section 547(b) of the Bankruptcy Code. The Court of Appeals for the Fifth Circuit affirmed the lower courts’ decisions, and held that the chapter 7 trustee failed to carry his burden to show that the bank received a greater distribution from the pre-petition transfers than it would have under a chapter 7 liquidation.
The debtor, Stinson Petroleum Company, Inc., engaged in a check-kiting scheme involving accounts held at Community Bank and Evergreen Bank. Evergreen discovered the scheme first and froze Stinson’s account prior to losing any money. Community, however, did not discover the scheme until it had incurred losses approaching $7 million. Community agreed to accept two wire transfers totaling $3.5 million from Stinson. Stinson subsequently filed for bankruptcy under chapter 11. The Unsecured Creditors Committee commenced an adversary proceeding against Community in an attempt to avoid the two wire transfers as preferential transfers under section 547(b) of the Bankruptcy Code. The case was converted to chapter 7 liquidation, and the bankruptcy trustee was substituted as the plaintiff in the adversary proceeding. The bankruptcy court determined that, under state law, Community held a perfected, first priority security interest in the amount of the dishonored checks that were part of the check-kiting scheme, and that the trustee failed to prove that Community received a greater return than it would have received in a liquidation. The district court affirmed, and the trustee appealed to the Fifth Circuit.
Under section 547(b) of the Bankruptcy Code, a trustee may avoid certain transfers that meet the requirements of section 547(b)(1)-(5). Section 547(b)(5) provides that the trustee must prove that the transfer at issue enabled a creditor "to receive more than such creditor would receive if – (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title." The trustee had the burden of proving each element of section 547(b).
Community argued that the trustee failed to meet its burden under section 547(b)(5). Under Mississippi state law, a bank extending provisional credit on a deposited check prior to actually collecting funds on that check automatically obtains a perfected security interest in the check and proceeds. Accordingly, as a matter of law, a fully secured creditor who receives a pre-petition payment does not receive a greater percentage than he would receive in a liquidation proceeding. Undeterred, the trustee argued that Community could not guarantee when and whether it would have received any payment from the debtor under liquidation.
The Court of Appeals rejected the trustee’s argument and held that the relevant inquiry was whether Community improved its position because of the pre-petition wire transfers relative to a distribution under a hypothetical chapter 7 liquidation. The court affirmed the judgment of the district court because the district court did not clearly err in concluding that the trustee failed to prove that Community would not have received at least $3.5 million in a chapter 7 liquidation.
This case gives some comfort for financial institutions that are the victims of a debtor’s check-kiting scheme. If applicable state law provides that a bank providing provisional credit is a secured creditor, the bank should take comfort in the fact that (i) the bank should have strong defenses to an avoidance action brought to recover any pre-petition repayments made on account of the fraudulent checks, and (ii) the bank will be a secured creditor in the debtor’s bankruptcy case (up to the amount of the fraudulent checks).