Vendors who sell goods to troubled businesses are often shocked when they are later sued by the debtor, a creditors’ committee or a trustee for the avoidance and recovery of preferential transfers. For the benefit of the uninitiated, the Bankruptcy Code permits the filing of lawsuits against creditors to avoid and recover payments on trade debt made during the 90-day period prior to the bankruptcy filing. The policy rationale behind this provision is to dissuade aggressive collection activities that often force the debtor into bankruptcy and to promote the equality of distribution among similarly-situated creditors. Preference actions are, by far, the most common form of litigation brought within a bankruptcy case and the amounts sought to be avoided and recovered can range anywhere from a few thousand to millions of dollars.
The Bankruptcy Code generally gives the debtor, committee or trustee the ability to bring lawsuits where the bankruptcy case is filed. That may mean that a vendor who previously did business with a debtor in California may find itself in the unenviable position of having to defend a preference avoidance action filed in Delaware. Recognizing the unfairness imposed by defending a small matter from afar, the Bankruptcy Code has a venue exception that requires certain small-dollar suits to be brought, not in the debtor’s home court, but in the district where the defendant resides or maintains its principal place of business.
However, due to some quirks in the drafting of the statute, there is judicial conflict whether this small-dollar venue exception applies to preference actions. Rather than capitulating to the demands of a debtor, committee or trustee that has brought a small-dollar preference action, savvy trade vendors will engage experienced counsel who can efficiently and effectively leverage these unsettled venue issues.
Venue for an adversary proceeding is generally proper in the district court in which a bankruptcy case is pending. 28 U.S.C. § 1409(a) provides that except as provided in subsections (b) and (d), a proceeding “arising under,” “arising in” or “related to” a bankruptcy case under title 11 may be commenced in the district court where the bankruptcy case is pending. The exception found in subsection (b) provides, in relevant part, that a trustee may commence a proceeding “arising in” or “related to” such case to recover a debt against a non-insider of less than $12,850 only in the district court for the district where the defendant resides. The omission of proceedings “arising under” from the small-dollar venue exception, and whether such omission was intentional or inadvertent, has created judicial uncertainty about the application of the exception to preference cases.
Bankruptcy courts are courts of limited and specific jurisdiction. There are three defined sources of bankruptcy court jurisdiction. First, a matter “arises under” title 11 if it invokes a substantive right provided by title 11. Second, a proceeding “arises in” a bankruptcy case if it would have no existence outside of the bankruptcy and includes such things as administrative matters, orders to turn over property of the estate and determinations of the validity, extent, or priority of liens. Finally, a proceeding is “related to” a bankruptcy case if the outcome of that proceeding could conceivably have any effect on the estate being administered in bankruptcy.
An action to recover a preference is a substantive right which is provided for and only arises by operation of title 11 and, thus, is recognized as a type of proceeding which “arises under” the Bankruptcy Code.
The omission of the term “arising under” from subsection (b) has created judicial confusion, and courts have arrived at contrasting results as to whether the small-dollar provisions of § 1409(b) apply to preference...
