By: Scott B. Riddle, Esq.

Flatau v. The Walman Optical Co. (In re Werner), Adv. No. 06-5101, 2007 Bankr. LEXIS 975 (Bankr. M.D. Ga. March 22, 2007)(Walker). 

Within 90 days of the filing of his Chapter 7 petition, the debtor used his credit card to pay $4,000 to the defendant optical company.  The payment satisfied an obligation of another company, which obligation the debtor had guaranteed.  The Chapter 7 trustee filed suit to recover the payment as a preferential transfer, and a motion for summary judgment.

The key question was whether the payment, via credit card, constituted an interest in the debtor’s property, as defined by §547(b).  The court found only one case on point –

In Loveridge v. The Ark of Little Cottonwood, Inc. (In re Perry), 343 B.R. 685 (Bankr. D. Utah 2005), the debtor paid the defendant $ 9,000 by credit card, and the trustee commenced a preference action to recover the payment. The defendant filed a motion to dismiss for failure to state a claim, which the court granted. The only preference element in issue was whether the transfer was of an interest of the debtor in property. Id. at 686-87.

Because "interest of the debtor in property" is undefined by the Bankruptcy Code, the court in Perry applied the definition supplied by the Supreme Court in Begier v. IRS, 496 U.S. 53, 110 S. Ct. 2258, 110 L. Ed. 2d 46 (1990). In Begier, the court defined the term as "property that would have been part of the estate had it not been transferred before the commencement of the bankruptcy proceedings." Id. at 58, 110 S. Ct. at 2263; see also Perry, 343 B.R. at 687 n.6. The Supreme Court noted this definition furthered the fundamental bankruptcy policy of equality of distribution to similarly situated creditors. 496 U.S. at 58, 110 S. Ct. at 2262-63.

Relying on the Begier definition, the court in Perry found that a debtor’s use of a credit card does not constitute a transfer of an interest of the debtor in property. 343 B.R. at 688. The court reasoned, "[a]t most, a debtor’s credit constitutes merely potential wealth. Creditors of an estate cannot force a debtor to use credit to create liquidity available for distribution." Id.

The Court declined to follow the Perry decision-

The Trustee has cited two preference cases in which the debtors initiated balance transfers from one credit card to another. Reisz v. Napus Fed. Credit Union (In re Anderson), 275 B.R. 264 (Bankr. W.D. Ky. 2002); Growe v. AT&T Univ. Card Servs. (In re Adams), 240 B.R. 807 (Bankr. D. Maine 1999). In Anderson, the balance transfer was made directly from one credit card issuer to the other. 275 B.R. at 265. The defendant argued the transfer was not a preference because it did  not diminish the estate. The court analyzed the argument as an earmarking defense (in which funds from one creditor are designated to pay another creditor). Id. at 265-66. The court rejected that argument and noted that the key fact was the debtor’s control over the money. Id. at 266. "[I]f the debtor decides which creditor is paid, the proceeds were not ‘earmarked’ by the new lender for repayment of the existing loan, and thus, the proceeds still constitute ‘an interest of the debtor in property’ avoidable under § 547(b)." Id. (citing In re Spitler, 213 B.R. 995, 998 (Bankr. N.D. Ohio 1997)).

In Adams, the debtor used convenience checks from one credit card issuer to pay the balance due on a different credit card, and the defendant also raised the earmarking doctrine. 240 B.R. at 808. Rather than focusing on whether the debtor had dominion and control over the funds transferred, the court in Adams set forth a three-part test for earmarking: first, the new lender and the debtor must expressly agree the funds loaned will be used to pay a specific debt to a different creditor; second, the agreement must be  performed according to its terms; and third, the transaction must not diminish the bankruptcy estate. Id. at 810. The court quickly dispensed with the first two elements, noting there was no agreement between the debtor and the new credit card company that the convenience checks would be used to pay a specific debt. Without an agreement, the second element, performance, is impossible. Id. at 811.

However, the court concluded that the transfer did diminish the estate, not by increasing the debtor’s liabilities, but "negatively impact[ng] equal distribution of assets among [the debtor’s] creditors." Id. at 812. The debtor accessed funds available to her. Although she could have distributed the funds among all her creditors, she transferred them to one select creditor. Id. Consequently, the court concluded, the transfer was of an interest of the debtor in property. Id.

The Court finds the reasoning in Anderson and Adams more persuasive than the reasoning in Perry. Walman Optical is essentially advancing a tracing argument: because the source of the funds in this case can be traced to a party other than Debtor,  the funds cannot be said to be an interest of Debtor in property. However, tracing is irrelevant to a preference claim. Allowing it in this case because the trace is an easy one would only open the door to endless possibilities in more difficult cases. The fact is Walman Optical benefitted by receipt of a payment during the preference period on an obligation owed by Debtor. Debtor initiated and directed the transfer of funds from his credit card account to Walman Optical. He could not have done so if he had no interest in the funds. There is no reason to distinguish this scenario from one in which a debtor obtains a cash advance and uses the advance to pay one of many creditors.

As the otther elements of §547(b) were also established, the court granted summary judgment in favor of the Trustee.  This is an interesting interpretation of the term "interest" in the funds.