Petition Rather Than Transfer Date Valuation of Collateral Appropriate in Determining Secured Creditor’s Preference Liability

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, post-petition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the "best interests" test or whether a "cram-down" plan can be confirmed despite the objections of dissenting creditors. Depending on the context, bankruptcy courts rely on a wide variety of standards to value estate assets, including retail, wholesale, liquidation, forced sale, going-concern, or reorganization value.

When assets are valued may be just as important as the method employed to assign value. In the context of preference litigation, for example, whether collateral is valued as of the bankruptcy petition date or at the time pre-bankruptcy that a debtor made allegedly preferential payments to a secured creditor can be the determinative factor in establishing or warding off avoidance liability. This controversial valuation issue was the subject of a ruling recently handed down by an Eighth Circuit bankruptcy appellate panel in Falcon Creditor Trust v. First Insurance Funding (In re Falcon Products, Inc.). Taking sides on an issue that has produced a rift among bankruptcy and appellate courts, the bankruptcy appellate panel ruled that, in assessing whether a defendant in preference litigation received more as a consequence of pre-bankruptcy payments than it would have been paid in a chapter 7 liquidation, the creditor’s collateral must be valued as of the bankruptcy petition date rather than the date of the payments.

Avoidance of Preferential Transfers

One of the fundamental goals underlying U.S. bankruptcy law is the equitable distribution of assets. To that end, the automatic stay generally prevents an individual creditor from pursuing its claim against a debtor after the initiation of a bankruptcy case, in part to prevent one creditor from recovering a greater proportion of its claim relative to other similarly situated creditors. In addition, the Bankruptcy Code recognizes that the goal of providing equal treatment to similarly situated creditors would be thwarted if debtors, voluntarily or otherwise, had an unfettered ability to pay certain favored creditors on the eve of a bankruptcy filing more than they would otherwise receive in a bankruptcy case. Accordingly, Bankruptcy Code section 547(b) provides that a chapter 11 debtor-in-possession (“DIP”) or bankruptcy trustee may "avoid" any transfer of the debtor’s interest in property -

1. To or for the benefit of a creditor;
2. For or on account of an antecedent debt owed by the debtor before such transfer was made;
3. Made while the debtor was insolvent;
4. Made on or within 90 days before the date of the filing of the petition (or up to one year if the transferee is an "insider"); and
5. That enables such creditor to receive more than it would have received if the transfer had not been made and the debtor’s assets had been liquidated under chapter 7 of the Bankruptcy Code.

Although a debtor is presumed to be insolvent within 90 days of filing for bankruptcy, the DIP or trustee bears the burden of proving each of these five elements.

The fifth element is important. It requires a comparison between what the transferee actually received and what it would have received in a hypothetical chapter 7 liquidation. The requirement is based upon the common-sense principle that a creditor need not return a payment received from the debtor prior to bankruptcy if the creditor is no better off vis-à-vis other creditors than it would have been had the creditor waited for the estate to be liquidated and its assets distributed in accordance with the Bankruptcy Code’s distribution scheme.

Section 547(b)(5) codifies the U.S. Supreme Court’s ruling in Palmer Clay Products Co. v. Brown. In Palmer, the Court held that, in construing a section of the former Bankruptcy Act of 1898 providing for avoidance of preferential transfers, whether a transfer is preferential must be determined “not by what the situation would have been if the debtor’s assets had been liquidated and distributed among his creditors at the time the alleged preferential payment was made, but by the actual effect of the payment as determined when bankruptcy results.” The other four elements of a preferential transfer in section 547(b) are determined at the time the transfer is made.

Payments to a fully secured creditor will generally not be preferential because the creditor would not receive more as a consequence of the payment than it would receive in a chapter 7 liquidation. Payments to a partially secured creditor, however, may be preferential, at least in part. Whether a creditor is fully or only partially secured can hinge on when its collateral is valued, particularly in commercial relationships involving an ongoing series of secured transactions and payments. This was the situation addressed by an Eighth Circuit bankruptcy appellate panel in Falcon Products.

Falcon Products

Business furniture manufacturer Falcon Products, Inc. ("Falcon"), entered into a commercial premium finance agreement in 2004 with First Insurance Funding ("First Insurance" to finance several insurance policies. Under the agreement, Falcon made a $470,000 down payment on the policies and agreed to repay the $1.4 million balance, plus interest, in 10 monthly installments. Falcon granted First Insurance a security interest in the unearned premiums under the policies to secure the premiums financed. The value of the unearned premiums diminished each day by an amount equal to the value of the daily insurance coverage provided under the policies. In the event that Falcon failed to make a payment, First Insurance had the right to cancel the policies and apply any unearned premiums to the unpaid balance owed to it.

On December 6, 2004, Falcon paid the first monthly installment of approximately $145,000. Immediately prior to the payment, Falcon owed First Insurance $1.45 million, and the unearned premiums (the collateral) had a value of $1.7 million, such that First Insurance was oversecured by approximately $240,000. Falcon paid the second $145,000 premium installment (plus a $7,000 late fee) on January 10, 2005. Immediately prior to this payment, Falcon owed First Insurance $1.3 million, and the unearned premiums had a value of approximately $1.5 million, so First Insurance was oversecured by approximately $215,000.

Falcon and its affiliates filed for chapter 11 protection on January 31, 2005, in Missouri. On the petition date, Falcon owed First Insurance $1.16 million, and the unearned premiums had a value of $1.4 million. The bankruptcy court confirmed Falcon’s chapter 11 plan in October 2005. The plan vested authority to prosecute estate avoidance actions in a creditor trust (the “Trust”). The Trust later sued First Insurance to recover as preferential the December 2004 and January 2005 payments (approximately $297,000) made by Falcon under the premium finance agreement.

The only disputed issue in connection with the preference litigation was whether, in applying section 547(b)(5), First Insurance’s collateral should be valued as of the petition date or the dates on which the challenged transfers took place. The bankruptcy court ruled that the hypothetical liquidation test should be applied as of the transfer dates. Because the evidence established that the value of the collateral exceeded the amount of Falcon’s debt on both transfer dates, the bankruptcy court concluded that neither transfer allowed First Insurance to recover more than it would have received in a hypothetical chapter 7 liquidation. It accordingly granted summary judgment in favor of First Insurance. The Trust appealed.

The Appellate Panel’s Ruling

An Eighth Circuit appellate panel reversed, ruling that the hypothetical liquidation test set forth in section 547(b)(5) must be conducted as of the petition date rather than the transfer date(s). Acknowledging that the statute does not specifically indicate when the hypothetical test should be applied, the panel concluded that the Supreme Court’s ruling in Palmer mandates that the test be conducted as of the petition date. Addressing the unworkable nature of a contrary approach, the Palmer court stated:

We may not assume that Congress intended to disregard the actual result, and to introduce the impractical rule of requiring the determination, as of the date of each payment, of the hypothetical question: What would have been the financial result if the assets had then been liquidated and the proceeds distributed among the then creditors?

Faulting the bankruptcy court for failing even to address Palmer, the panel rejected First Insurance’s contention that Palmer was not controlling because it dealt only with payments to unsecured creditors. Nothing in Palmer, the panel explained, expresses any such limitation, and the statute the Court was construing (section 60a of the former Bankruptcy Act) is substantially similar to section 547(b). Moreover, it emphasized, the concern articulated in Palmer over the “impracticality” of applying the hypothetical test on the date of each transfer “is no less (and is probably greater) when payments on secured claims are involved.”

Many courts, the appellate panel noted, improperly conflate a preference analysis with a preference defense analysis by concluding that a secured creditor did not receive a preference because it was fully secured on the date of the transfer even though it would have been undersecured as of the petition date. By reasoning that there is not a preference because the payment to the secured creditor results in a release of an equivalent value of collateral, the appellate panel emphasized, these courts confuse the analysis required by section 547(b)(5) with the “contemporaneous exchange for new value” defense set forth in section 547(c). According to the appellate panel, this approach is flawed. A bankruptcy court must conclude that all of the elements of a preference under section 547(b) have been satisfied before considering whether the transferee can rely on any of the defenses set forth in section 547(c). The appellate panel reversed the bankruptcy court’s grant of summary judgment and remanded the case below.


Common sense dictates that transfers to a secured creditor should not ordinarily be preferential because the creditor, which has recourse to its collateral up to the value of its claim in the event of a default or a bankruptcy filing, is not unfairly preferred as a consequence of the payments. Designation as a secured creditor, however, does not end the inquiry. As illustrated by Falcon Products, a creditor’s status as fully or only partially secured may change over time, particularly in situations involving a series of ongoing transfers and changes in valuation of collateral. In this context, whether a transfer is preferential may hinge on when the creditor’s collateral is valued.

Notwithstanding what would appear to be formidable authority to support the approach championed by the bankruptcy appellate panel in Falcon Products, courts continue to disagree on whether the transfer date or the petition date should control in applying section 547(b)(5)’s hypothetical liquidation test. The Falcon Products court’s criticism of selecting the transfer date to apply the test in cases involving secured creditors was not limited to its conclusion that such an approach defies Supreme Court precedent and conflates one of the basic elements of a preference with a preference defense stated in section 547(c).

The court also faulted other courts for concluding that the “add-back” method for analyzing alleged preferences does not apply to transfers to fully secured creditors. Section 547(b)(5) provides that, in determining whether a creditor would have received more as a consequence of a transfer than that to which it would have been entitled in a chapter 7 liquidation, the calculation is to be performed assuming that “the transfer had not been made”—an approach sometimes referred to as the “add-back” method. Some courts have determined that the add-back method does not apply to transfers to fully secured creditors because, in rather circular logic, payments to a fully secured creditor cannot be preferential.

Emphasizing that the language of section 547(b)(5) does not support this position, the Falcon Products court observed that refusal to apply the add-back method in these cases is more of a veiled rejection of a petition-date hypothetical liquidation test than a true objection to the add-back method since the status of the secured creditors in these cases was determined using the add-back method, i.e., by considering the creditor’s secured status immediately prior to the transfer.

The upshot of Falcon Products for the litigants involved is as yet unclear. The evidence indicated that, assuming First Insurance had not received the $297,000 in alleged preferential payments, it would have been owed $1.456 million, while its collateral would have had a value of no more than $1.418 million as of the bankruptcy petition date. This would mean that part of the payments would qualify as a preference, unless First Insurance could establish that it is entitled to rely on one of the preference defenses stated in section 547(c) (e.g., contemporaneous exchange for new value, ordinary-course business payment or subsequent new value).


Falcon Creditor Trust v. First Insurance Funding (In re Falcon Products, Inc.), 381 B.R. 543 (Bankr. 8th Cir. 2008).

Palmer Clay Products Co. v. Brown, 297 U.S. 227 (1936).

In re Rocor Intern., Inc., 380 B.R. 567 (B.A.P. 10th Cir. 2007).

Savage & Assoc. P.C. v. A.I. Credit Corp. (In re Teligent), 337 B.R. 39 (Bankr. S.D.N.Y. 2005).

Telesphere Liquidating Trust v. Galesi (In re Telesphere), 229 B.R. 173 (Bankr. N.D. Ill. 1999).

Schwinn Plan Committee v. Transamerica Insurance Finance Corp. (In re Schwinn Bicycle Co.), 200 B.R. 980 (Bankr. N.D. Ill. 1996).

Sloan v. Zions First National Bank (In re Castletons, Inc.), 900 F.2d 551 (10th Cir. 1993).

Gray v. A.I. Credit Corp. (In re Paris Industries Corp.), 130 B.R. 1 (Bankr. D. Me. 1991).

Kroh Brothers Development Co. v. Commerce Bank of Kansas City, N.A. (In re Kroh Brothers Development Co.), 86 B.R. 186 (Bankr. W.D. Mo. 1983).