In August, the U. S. Court of Appeals for the 9th Circuit ruled that criminal restitution payments made during the preference period can be avoided and recovered under the Bankruptcy Code’s preference statute, 11 U.S. C. § 547. State Compensation Insurance Fund v. Zamora (In re Silverman), 616 F.3d 1001 (9th Cir. 2010).
Recall that a preference is a payment made by a bankruptcy debtor on or within the 90 days of the bankruptcy filing, to or for the benefit of a creditor, for or on account of an antecedent debt, that enabled the creditor to recover more than it would have recovered at liquidation, made while the debtor is insolvent. Preferential payments are avoidable in bankruptcy. 11 U.S.C. § 547(b). “Avoidable” is bankruptcy-speak for “Pay it back, and get in line with all the other creditors!”
In the Zamora case, a workers’ compensation insurer received payments of $101,531 in criminal restitution payments about 1 month before the debtors filed for bankruptcy. The debtors had pleaded guilty to a scheme that prevented workers from obtaining their workers’ compensation benefits (not nice!).
The insurer argued that there is a judicially created exception to treating the payment of a criminal restitution obligation as an avoidable preference, citing Kelly v. Robinson, 479 U.S. 36 (1986). In Kelly, the Supreme Court held that there is a clear, judicially created exception to discharge, which makes state court criminal restitution obligations nondischargeable. In the Zamora case, however, the 9th Circuit held that there is no clear, judicially created exception to applying the preference statute to criminal restitution payments.
Keep in mind what is really at stake in this type of case. If the insurer had prevailed, it would have walked away with $101,531, the debtors would have owed $101,531 less to the insurer, and the remaining creditors would have received none of the $101,531. Under the 9th Circuit’s holding, the insurer shares the $101,531 with the other creditors, and, because its claim is not dischargeable in the bankruptcy case, it is permitted to recover its remaining debt from assets acquired by the debtors after they file for bankruptcy.
The 9th Circuit got this case right. The debtors emerge with a large nondischargeable debt, so one has to wonder why they did not wait 91 days to file for bankruptcy. If they had waited, the payment would not have been avoidable as a preference. As they say, timing is everything.