United States: Preferences: Surprise – Being Fully Secured May Not Be A Complete Defense

Last Updated: December 12 2013
Article by Vicki R. Harding

Gladstone v. Bank of America, N.A. (In re Vassau), 499 B.R. 864 (Bankr. S.D. Cal. 2013) –

A chapter 7 trustee sought to avoid payments made to a fully secured senior mortgagee within 90 days prior to bankruptcy as preferential to an undersecured junior mortgagee.

Property valued at ~$1.1 million was subject to a lien securing senior debt of ~$988,000 and a junior lien of ~$265,000.  The debtors made 10 payments totaling ~$42,000 to the senior mortgagee within 90 days before filing bankruptcy.

Everyone agreed that the senior lender was fully secured, so that the payments were not preferential as to the senior lender (since it did not receive more than it would have in a chapter 7 bankruptcy).  Everyone also agreed that the junior mortgagee was undersecured.  So, the trustee argued that the payments made to the senior lender were preferential as to the junior mortgagee since reducing the fully secured senior claim by $42,000 meant that an additional $42,000 worth of collateral was available for the junior mortgagee in the bankruptcy.

The elements of a preference claim under Section 547(b) of the Bankruptcy Code are that there is a 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, (3) made while the debtor was insolvent, (4) made within 90 days before bankruptcy (or between 90 days and one year before bankruptcy in the case of an insider), (5) that allows the creditor to receive more than it would receive in a chapter 7 bankruptcy.  The two elements at issue in this case were whether the debtor's payments to the senior lender were "to or for the benefit of" the junior creditor, and whether those payments allowed the junior creditor to receive more than it would in a chapter 7.

The junior mortgagee argued that non-insiders who indirectly benefit from a payment are not liable for a preference based on Section 547(i).  However, the court found that this section applies only to (1) transfers between 90 days and one year before bankruptcy, and (2) transfers relating to insiders.  So, it did not provide any protection for an indirect benefit to a non-insider for transfers made within 90 days of bankruptcy.

The junior mortgagee also argued that the payments were not made for its benefit since that was not the intent of the debtors.  However, the court held that the intent of the parties was not relevant.  Rather it is the effect of the transaction that is controlling.  Here the transfer benefited the junior mortgagee since reduction of the senior secured claim meant that the junior creditor's secured claim in the bankruptcy was correspondingly increased.

The court had a more difficult time with the requirement that the junior mortgagee received more than it would have in a chapter 7.  If this requirement was interpreted to mean assessment of a hypothetical liquidation where the trustee sells all assets and distributes the proceeds according to the priorities of the Bankruptcy Code, then the junior mortgagee received more than it would have in a chapter 7.

However, as a practical matter, if assets are over-encumbered in most cases a chapter 7 trustee will simply abandon the property to the debtor.  An abandonment is not a transfer but rather a reversion of property to the debtor subject to all liens, so the junior mortgagee would not really "receive" any payment of its debt in the chapter 7.

In evaluating which approach to adopt, the court noted that the primary purpose of a preference action is to discourage a race to the courthouse by creditors and to insure equal treatment for similarly situated creditors.  In other words, the harm that is being addressed is a payment made to one creditor at the expense of others.  That a harm occurred in this case:  regardless of whether the property was sold and proceeds distributed or the property was abandoned, there was $42,000 that otherwise would have been available to pay unsecured creditors that was removed from their reach (by the payments to the senior creditor and the corresponding increase in the junior creditor's secured claim).  Consequently, the court concluded that the prepetition payments to the senior secured creditor were a preference as to the junior secured creditor.

The court acknowledged that it could be seen as "somewhat unfair to require a creditor such as Junior Lienholder to 'return' money it never physically 'received.'"  However, in addition to noting that the junior creditor might have instigated the payments, the court pointed out that under Section 550 of the Bankruptcy Code a preference can be recovered from either (1) the entity for whose benefit the transfer was made, and (2) the "initial transferee."  In this case the senior and junior claims were held by the same entity.  "However, in cases in which they are separate, it seems that a trustee might find it simpler to recover the transfers from the direct transferee" – in other words, from the senior creditor.

As a general principle, creditors tend to accept money and worry about the consequences later on the theory that it is better to have cash in hand than not.  Normally, a creditor that is fully secured is not concerned about potential preference claims (since it would have been entitled to full payment in a chapter 7 proceeding, and thus one of the elements of a preference claim is not met).

However, this case illustrates that the analysis may be more complicated if there are junior secured creditors.  In that case, it may be worth structuring payments so that other defenses will also be available.  For example, in this case the court later determined that payments of ~$17,000 were made in the ordinary course of business, and thus not avoidable as a preference (although the rest of the payments were subject to avoidance).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Vicki R. Harding
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.