19 Apr Balance Transfers Can Be Avoidable Preferences
Bankruptcy law allows a trustee to recover payments made to creditors on the eve of bankruptcy, even if the payment was made with borrowed money the debtor never touched, according to the Sixth Circuit Court of Appeals.
The situation is very typical. A consumer carrying too much debt gets an offer to transfer balances from one credit card to another, often with a low teaser interest rate. Feeling like they’ve just been offered a lifeline, they grasp it only to discover soon that the situation is just too far gone. And they file bankruptcy soon thereafter.
In this case, the court was confronted with these common facts. Since the balance transfer occurred within 90-days, the trustee argued that the bank which received the payoff should give it back as a preference. The bank argued n part that the debtor didn’t really give up anything of value — her estate was not diminished — by the payment. The court shot this argument down.
The court reasoned that since the debtor exercised control over the loan proceeds (by writing the transfer check), this was enough. Relying on precedent, the court reasoned that the “determinative factor in the diminution-of-estate analysis is the degree of control exercised by the debtor over distribution of the funds.” In other words, because the debtor could have taken the cash and held it as an asset, or used it to repay all creditors equally, the ability to direct the funds to only one creditor was the decisive fact.
At one level, of course the decision is obviously right. The law should keep up with evolving technology and commerce. Simply because you can direct one bank to pay another bank on your debts without actually taking the money in your own hands should not mean the substance of the deal is ignored.
And clearly one of the critical features of preferences is at work here. One creditor is getting treated better than the others on the eve of a bankruptcy filing. One of the reasons a preferential payment is “avoided” in bankruptcy is to discourage creditors from pushing their debtors so hard that they either become insolvent or to drive them into bankruptcy. In theory, it ought to encourage creditors to work with debtors in ways that help them avoid bankruptcy.
In reality though, these balance-transfer-as-preference decisions don’t quite fit the model well. After all, in the case of consumer debts, the balance transfer does nothing to make the consumer less solvent. It moves the “hot potato” of debt from one place to another. And it may actually improve the consumer’s solvency in that a lower interest rate and payment may make it more likely they could avoid bankruptcy — as is almost always the idea behind such transfers.
In theory, these decisions would not do anything to discourage such credit offers from banks, they might even slightly encourage them because the new lender may recover something from the bankruptcy when it would not have otherwise.
On the other hand, as most credit card loans are made by only a few institutions, it is almost as likely that such decisions will reduce the overall offer of balance transfer loans in the long run. These days, the large credit card banks act very similarly, when one raises a fee, the others seem to follow suit shortly. Any given large bank is likely to have to give up more preference recoveries — much of which may be absorbed in trustee fees and costs in the average small consumer case — than it ever recovers from trustee distributions. In an era of tightening credit, it might make sense for such lenders collectively to reduce the balance transfer options for its weakest customers.
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