Lessons Learned on Preference Pleading Requirements to Satisfy Twombly and Iqbal

The Preference Complaint
The Chapter 7 trustee filed an action in the Bankruptcy Court against defendant Mitsubishi Digital Electronics America, Inc. to avoid and recover the alleged preferential transfers pursuant to Bankruptcy Code sections 547 and 550.

Pursuant to Bankruptcy Code section 547, subject to certain defenses, the trustee may avoid any transfer of an interest of the debtor in property:

• to or for the benefit of a creditor,
• for or on account of an antecedent debt owed by the debtor before such transfer was made,
• made while the debtor was insolvent,
• made on or within 90 days before the bankruptcy petition date, and
• that enables such creditor to receive more than such creditor would have received if the case were a case under Chapter 7, the transfer had not been made, and such creditor received payment of such debt to the extent provided by the provisions of the Bankruptcy Code.  

Bankruptcy Code section 550 provides that, to the extent a transfer is avoided under section 547, the trustee may recover, for the benefit of the estate, the property transferred or the value of such property.

By the complaint, the trustee alleges that prior to the petition date, “one or more of the Debtors transacted business with the Defendant, on account of which one or more of the Debtors was indebted to the Defendant.” The complaint defines the debtors as, collectively, four identified affiliates.

In addition, the complaint alleges that Mitsubishi “received payment from one or more of the Debtors” within the 90-day period before bankruptcy in the total amount of $933,962.41. The trustee attached a schedule to the complaint that purports to identify the check payments totaling $933,962.41. The schedule listed the name of the creditor, the check numbers, check-clear dates, and the check amounts.

The complaint also alleges, on information and belief, that the transfers “were made on account of an antecedent debt or debts owed by one or more of the Debtors to the Defendant.”

Pleading Standards
Rule 8 of the Federal Rules of Civil Procedure, incorporated in the preference action by Rule 7008 of the Federal Rules of Bankruptcy Procedure, requires only that a complaint contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” The statement must provide “the defendant fair notice of what the plaintiff’s claim is and the grounds upon which it rests.” Conley v. Gibson, 355 U.S. 41 (1957).

For a party to survive a motion to dismiss for failure to state a claim in compliance with Rule 8, the complaint “must contain sufficient factual information, accepted as true, to ‘state a claim to relief that is plausible on its face.’” Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009)(citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). A claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 129 S. Ct. at 1949. “[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged but not shown—that the pleader is entitled to relief.” Iqbal, 129 S. Ct. at 1950.

The Motion to Dismiss and Court Decision
Mitsubishi filed a motion to dismiss, arguing that the complaint fails to establish a plausible claim for avoidance of the alleged preferential transfers, because the complaint asserts only legal conclusions and the statutory language of Bankruptcy Code section 547, instead of sufficient factual allegations.

More specifically, Mitsubishi asserted three deficiencies in the complaint: the failure to identify the nature of the alleged antecedent debt, the failure to allege which debtor made the transfers, and the failure to describe the relationship between the transferor debtor and defendant.

The court agreed, finding that the complaint “does not meet the pleading standards of Twombly and Iqbal.” Miller, 452 B.R. at 154. The court also noted that “[t]he standards for pleading a cause of action have increased, and cases decided before Iqbal and Twombly may no longer be good law.” Miller, 452 B.R. at 154.

The court initially found that the trustee had not sufficiently identified the transferor of the alleged preferential payments to Mitsubishi, stating: “Because there is more than one debtor in this case, the Court concludes that the Trustee must identify the transferor precisely by name.” Miller, 452 B.R. at 155.

The court then rejected the trustee’s argument that the complaint provided Mitsubishi with sufficient detail regarding the nature of the transfer in the action:

The Court finds that the present proceeding and Complaint are distinguishable from Oakwood Homes [a case cited by the Trustee, 340 B.R. 510 (Bankr. D. Del. 2006)]. In Oakwood Homes, the complaint extensively detailed transfers the Debtor made to its securities underwriter involving a Loan Assumption Program and detailed the relationship between the parties including how the transfer arose, which adequately provided the defendant with the nature of the transfer and sufficient notice of what the transfers sought to be avoided. [Citation omitted.] No such detail regarding the antecedent debt which the transfer satisfied is present in the Trustee’s Complaint in this case. [Citation omitted.]

Miller, 152 B.R. at 155.

The court acknowledged that the complaint provides the check numbers, dates, and the amount of each check but found the complaint deficient in providing no other information “to explain the nature of the antecedent debt which the checks satisfied.” Miller, 152 B.R. at 155. [Citation omitted.] The court stated further:

The Complaint provides no detail of any relationship between the Debtors and Mitsubishi such as the identity of contracts between the parties or any description of goods or services exchanged. Without such information, the Court determines that the Trustee has failed to describe sufficiently the nature of the antecedent debt.

Miller, 152 B.R. at 155.

The court granted the trustee leave to amend the complaint, finding that the failure of the trustee to amend the complaint as a matter of course within 21 days of service of the complaint did not preclude the trustee from amending the complaint with leave of court, and based on its belief that “there is enough basis for the Trustee to allege a claim if granted leave to amend.”

Practical Tips
The Miller decision suggests some practical consideration for parties involved in preference litigation.

For plaintiffs and their counsel, some tips include:

• Start the process of investigating potential preference claims well in advance of the two-year statutory deadline for bringing such claims in an effort to avoid last-minute filings based on limited information and document review.
• Analyze payments made during the preference period, including information and documents evidencing who made the payments, when, how, and to whom, as well as information and documents concerning the nature of the relationship between the parties and the alleged antecedent debt.
• The preference complaint should not simply consist of legal conclusions and the statutory elements of a preference claim under Bankruptcy Code section 547.
• The complaint should contain sufficient factual allegations to support the claim, including factual allegations concerning the nature of the relationship of the parties and the antecedent debt. The complaint should name the transferee and the transferor, particularly when multiple debtors are involved, and provide other factual information on the transfers at issue.
• Consider filing an amended complaint as a matter of course within 21-days after service of the original complaint under Federal Rule of Civil Procedure 7015(a)(1)(B) to address any perceived deficiencies that might otherwise invite a potential motion to dismiss based on Twombly and Iqbal. 

For defendants and their counsel, some tips include:

• Analyze whether the complaint is simply based on legal conclusions and the statutory elements of a preference claim and therefore subject to a motion to dismiss under Twombly and Iqbal.
• If the complaint is not simply based on legal conclusions and the statutory elements of a preference claim, analyze the factual allegations in the complaint and consider whether the complaint still fails to allege sufficient allegations to make out a plausible claim as required under Twombly and Iqbal.
• Even if the complaint could be the subject of a motion to dismiss under Twombly and Iqbal, consider whether you want to file the motion to dismiss. The amount of the lawsuit may not warrant the time and expense associated with the motion to dismiss as opposed to early settlement negotiations or the filing of an answer to the complaint. On the other hand, you may want to file the motion to dismiss to send a message that you intend to defend the lawsuit vigorously, which may in turn drive the parties to settlement then or sometime later.
• When preparing the motion to dismiss, consider whether the complaint alleges facts sufficient for each element of the preference claim, and if not, be sure to address each deficient element.
• If you lose on the motion to dismiss, be sure to file a timely answer. If you prevail on your motion to dismiss, when the amended complaint is filed, be sure to consider whether the deficiencies in the initial complaint have been corrected. If the deficiencies have not been corrected, consider filing a motion to dismiss the amended complaint.

The Miller case highlights the importance of providing sufficient factual allegations in a preference complaint or risk receiving a motion to dismiss and potential dismissal of the complaint.

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