The Earmarking Defense to Voidable Preference Liability: A Reconceptualization

Abstract

In this article, the authors consider the earmarking defense to voidable preference liability. The earmarking defense states that if a debtor borrows from B to pay off A, A has not received a voidable preference. The usual justification is that A has received B's property, not the debtor's property. Such a rationale does not work. The debtor always owns the proceeds of the loans it obtains. As proof, when the debtor borrows from B in exchange for collateral, courts affirm that loan proceeds are indeed debtor property, and A is indeed guilty of voidable preference.

The authors show that earmarking is simply the "contemporaneous exchange" defense in an unusual form. Prior to the Bankruptcy Code, this defense was judge-made. Congress elected to embody the defense in 547(c)(1). Therefore, it follows that earmarking should be governed statutorily by 547(c)(1).

If this suggestion is followed, the parameters of the earmarking defense would change in ways that are more consistent with the logic of voidable preference law, especially as that law has been applied to check kiting cases.