When the Sum of the Parts are More than the Whole: How Fully Secured Creditors Can Be Preferred in Bankruptcy

The bankruptcy system seeks to provide debtors with relief from overwhelming debt, while ensuring a fair and equitable distribution to creditors. Though the filing of a bankruptcy petition stays most debt collection efforts and repayment outside of the bankruptcy system, payments made prior to the bankruptcy filing may diminish funds available to distribute to creditors during the bankruptcy case. In order to prevent pre-petition transfers from impacting post-petition distribution within the bankruptcy system, the Bankruptcy Code provides the bankruptcy trustee with the power to avoid various pre-petition transfers and to recover those transfers from the recipient. With regard to one of those potential transfers—preferential transfers—courts regularly find that transfers to fully secured creditors cannot be avoided. However, this conventional wisdom fails to consider how other sections of the Code that allow such creditors to recover additional payments in bankruptcy causes a benefit to those creditors at the expense of others. This article seeks to resolve the lack of congruity between these sections to protect the purposes behind recovery of preferential pre-petition transfers.