Due Diligence and Preference Claims

In 2019, Congress passed the Small Business Reorganization Act that dramatically changed the landscape for preference cases. It added the language that

"the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property."

This "due diligence" standard has been a point of contention in preference litigation ever since. Even years later, courts still have differing standards about due diligence. Antecedent can help parties bringing preference claims to understand the potential defenses in a preference case before facing a motion to dismiss. For parties that receive preference demands Antecedent will let you demonstrate that the other side may not have performed adequate due diligence. But first, let's explore how courts have interpreted this requirement:

Due Diligence is an Element of the Plaintiff's Case

Most courts have held that the due diligence requirement is an element of the plaintiff's case and must be pleaded in the complaint. See, e.g., Husted v. Taggart (In re ECS Refin., Inc.), 625 B.R. 425, 454 (Bankr. E.D. Cal. 2020) (“[D]ue diligence and consideration of affirmative defenses, is an element of the trustee’s prima facie case.” (citation omitted)); In re Pinktoe Tarantula Ltd., No. 18-10344 (LSS), 2023 WL 2960894, at *5 (Bankr. D. Del. Apr. 14, 2023) (collecting cases and determining “the due diligence requirement is an element of a preference claim, not an affirmative defense”). In other words, a plaintiff needs to affirmative plead they conducted due diligence in the complaint. If a plaintiff fails to do so, the complaint may be dismissed, although most courts have granted leave to replead and file an amended complaint.

What This Means: If you are bringing a preference claim, you must analyze potential defenses and you must plead that you did so in your complaint. If you are defending against a preference complaint where the plaintiff does not assert that they performed due diligence you may have grounds for a motion to dismiss.

How Far Must a Plaintiff Go?

In general, courts have allowed preference plaintiffs to give minimal details on their due diligence. Thus far, courts have been quite wary of demanding that plaintiffs "show their homework" by giving detailed descriptions of what they did. For example, defendants have argued that a plaintiff must conduct interviews, review books and records, send detailed demand letters, etc. For the most part, courts have permitted plaintiffs to proceed with minimal allegations. See, e.g, In re Center City Healthcare, Adv. No. 21-50796 (Bankr. D. Del. June 13, 2022). . However, the language about "reasonable" due diligence "in the circumstances of the case" is still important. Courts will consider all factors in determining whether a plaintiff took reasonable steps to investigate defenses. Doing nothing is simply not an option for plaintiffs.

What This Means: Plaintiffs cannot guarantee that all courts will be forgiving if they are not providing details on what due diligence they performed. Things like examining books and records are necessary to assess defenses. Sending demand letters is still a good idea. For defendants, being able to respond to a preference demand letter with a detailed analysis may be key to showing whether due diligence passes muster.

How Antecedent Can Help

Antecedent is a powerful tool for both sides of a preference case. Antecedent lets plaintiffs demonstrate that they examined all facets of a case, including the most common defenses such as new value and ordinary course of business. Antecedent's powerful statistical tools gives the kind of insights used by the biggest players in the preference space, but in a way that is neutral, accurate, and reproducible.

What Antecedent does not do is examine other relevant factors. For example, in a case that seems statistically ordinary there may be factors like collection pressure or debtor favoritism that impacts whether payments would be ordinary. Antecedent also does not examine potential liens or other defenses. Even in cases where the statistical analysis is done, both plaintiffs and defendants should be aware that while statistical analysis can often be the biggest issue in a preference case, it is certainly not the only one. Antecedent gives bankruptcy professionals the tools to perform the statistical side of a preference case and allows them to move their focus to any other issues that may impact its resolution.