Payment of Pre-Petition Debt by Debtor’s Mother Is Preferential Transfer

Posted by NCBRC - July 25, 2019

In what the panel called a strained application of a legal fiction, the BAP for the Tenth Circuit found that money paid by the chapter 7 debtor’s mother directly to one of the debtor’s creditors was a preferential transfer where it preceded the bankruptcy by fewer than 90 days, was secured by a promissory note by the debtor, and favored one creditor over the debtor’s other creditors. Stevens, Littman, Biddison, Tharp and Weinberg, LLC. v. Walters (In re Wagenknecht), 2019 WL 2353534 (B.A.P. 10th Cir. June 4, 2019) (case no. 18-93).

The debtor’s mother paid over $21,000 to a law firm to pay off her son’s debt. Although the debtor was never in possession of the funds, the bankruptcy court granted summary judgment in favor of the trustee upon finding that, by paying off one creditor within ninety days of filing for bankruptcy, the transfer was preferential and was therefore avoidable under section 547. The law firm appealed.

The primary issue on appeal was whether the funds were “an interest of the debtor in property” within the meaning of section 547(b). The panel found that the was case was governed by Parks v. FIA Card Servs., N.A. (In re Marshall), 550 F.3d 1251 (10th Cir. 2008). In Marshall, the debtors paid off their credit card debt with funds acquired through, and paid directly by, another credit card account. The Marshall court applied a two-part test to determine the debtor’s interest in the property: 1. Dominion/control, and 2. Diminution of the estate. Although the debtor in Marshall never actually possessed the funds, the Tenth Circuit found that, under an expansive reading of section 541’s definition of estate property, the debtors controlled the use of the funds—albeit fleetingly—and, therefore, they were property of the estate. It followed, therefore, that their use to pay off a single creditor diminished the property of the estate.

Here, the panel found the situation to be essentially the same as that of Marshall. The mother’s payment of the debt to the law firm was contingent upon the debtor’s promise to repay the loan and, although the mother averred that the debtor was not free to use the funds for any purpose other than the repayment of the loan, the panel found that the debtor directed use of the funds. The panel emphasized the reality of the debtor’s role in the transaction, finding that had the mother’s payment to the law firm been a gift over which the debtor had no control, the conclusion might have been different, but since the debtor signed a Note for the loan and its purpose was limited to repayment of his debt to the law firm, the panel found sufficient dominion or control over the funds.

With respect to diminution of the estate, the panel acknowledged that the challenged transaction did not, in reality, change the net value of the estate. However, under the legal fiction that the funds flowed through the estate on their way from the mother’s account to the creditor, the court found the requisite diminution.

On a procedural note, the panel reversed the bankruptcy court’s finding that the mother’s affidavit attesting to the limited purpose of the loan was inadmissible parol evidence, finding instead that the affidavit supplemented the form Note and its averments were not inconsistent with its terms.

The panel affirmed the bankruptcy court’s grant of summary judgment to the trustee. The law firm has appealed to the Tenth Circuit, Case No. 19-1206 (filed June 11, 2019).

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