Key Takeaways

• Pre-petition payments made pursuant to a contract that the debtor later assumes cannot be avoided as preferences as a matter of law.
• This defense attacks the trustee’s ability to plead a preference under section 547(b)(5) of the Bankruptcy Code and can be raised on a motion to dismiss, before any ordinary-course or new-value analysis begins.
• Always review the file and/or bankruptcy docket for assumption, assignment, and sale orders before treating ordinary-course and new-value defenses as the only options.

A preference action is one of the most devastating things a vendor can receive. Despite often losing money due to the bankruptcy (in the form of pre-petition amounts owed), sometimes a debtor or trustee will demand the return of every payment received by the vendor in the ninety days prior to the bankruptcy filing, payments the vendor earned simply by performing its obligations. In many cases, the assumption is that a preference defendant’s realistic options are limited to two affirmative defenses pursuant to section 547(c) of the Bankruptcy Code: the ordinary course of business defense and the subsequent new value defense. Both defenses place the burden squarely on the defendant, and both are fact-intensive exercises requiring payment histories, industry data, and a mathematical analysis of paid and unpaid invoices. However, a recent decision from the Northern District of Iowa is a reminder that the ordinary course and new value defenses are not the only way to dismiss a preference action and end up owing nothing. Some cases rest entirely on whether the trustee can plead a preference at all pursuant to section 547(b) of the Bankruptcy Code. In Childers v. PeriGen, Inc. (In re Mercy Hospital, Iowa City, Iowa), Adv. No. 25-09086, 2026 WL 2029171 (Bankr. N.D. Iowa July 13, 2026), the bankruptcy court held that pre-petition payments made pursuant to a contract the debtor later assumed and assigned cannot be avoided as preferences as a matter of law, and the court dismissed the complaint before even looking at any of the section 547(c) defenses.

The Five Elements of a Preference Claim

Pursuant to section 547(b) of the Bankruptcy Code, a trustee may avoid a transfer of the debtor’s property if the transfer was: (1) to or for the benefit of a creditor; (2) on account of an antecedent debt; (3) made while the debtor was insolvent; (4) made within ninety days of the petition; and (5) one that enabled the creditor to receive more than it would have received in a hypothetical chapter 7 liquidation had the transfer not been made. The fifth element was at issue in the Mercy case. As the Seventh Circuit explained in In re Superior Toy & Manufacturing Co., 78 F.3d 1169, 1171 (7th Cir. 1996), “when the trustee brings a § 547(b) preference suit, the court is required to determine what each creditor would have received if the estate was liquidated and distributed to the creditors as provided in chapter 7 on the date that the bankruptcy petition was filed, and whether the creditor in question received more than his fair share.” In the typical case, a vendor holding an unsecured claim receives pennies on the dollar, so this element is rarely in dispute.

How Assumption Under Section 365 Changes the Analysis

However, there is some nuance with respect to this element. In fact, pursuant to section 365 of the Bankruptcy Code, a trustee or debtor in possession may assume (continue performing) or reject (discontinue performance) an executory contract. Relevant to this case, a contract may only be assumed if the debtor cures existing defaults. An assumed contract therefore is essentially unaffected by the bankruptcy and the contract counterparty is entitled to payment in full. A rejected contract, on the other hand, leaves the counterparty with a pre-petition damages claim. Thus, whether a preference defendant can rely on section 547(b)(5) of the Bankruptcy Code as a “quasi-defense” depends on whether its contract was assumed or rejected.

Mercy Hospital illustrates how using section 547(b)(5) works in practice. In August 2023, Mercy Hospital filed a chapter 11 bankruptcy in the United States Bankruptcy Court for the Northern District of Iowa. Before the filing, the hospital and PeriGen, Inc., a software vendor, were parties to a Software License and Support Agreement. Shortly after filing, the debtor assumed the agreement pursuant to section 365 and assigned it to the University of Iowa, the eventual purchaser of the hospital. Years later, the liquidation trustee sued PeriGen to avoid and recover $28,347.75 in payments made in the ninety days prior to the filing. One major issue in the Mercy case was that the debtor did not owe PeriGen anything at the time of assumption, so no cure payment was required when the contract was assumed. PeriGen moved to dismiss, arguing that payments made pursuant to a contract later assumed and assigned cannot be preferential as a matter of law.

The Facts and Holding in Mercy Hospital

The court agreed and joined what it described as the majority position. See, e.g., Superior Toy & Manufacturing Co., 78 F.3d at 1176 (holding that “a chapter 7 trustee cannot bring a preference suit to recoup payments made pursuant to a validly assumed executory contract”). The trustee asked the court to ignore the majority rule, claiming that the liquidation analysis stops at the filing date and cannot take post-petition events such as assumption into account. The trustee could not simultaneously bar the court from considering post-petition events and rely on one to classify the defendant. Mercy, 2026 WL 2029171, at *3 (“The assumption order removed the Defendant from [the class of general unsecured creditors] by the operation of law under section 365”). Second, the trustee’s theory was circular. Because the debtor paid PeriGen in full before filing, no cure was owed at assumption, but had the payments not been made, the estate would have been required to cure them in full pursuant to section 365(b), and PeriGen would have faced no preference exposure at all. In other words, making PeriGen return the payments would create a circular result; the estate would simply need to pay the same funds back to PeriGen as cure. The court dismissed the complaint and, because the defect was legal, denied leave to amend.

Practical Steps for Preference Defendants

For a party that has just received a preference complaint, the lesson is to look at whether the trustee can adequately plead a preference cause of action pursuant to section 547(b) of the Bankruptcy Code, despite the instinct to immediately reach for the ordinary course and new value defenses (note that in many cases those will be the only tools available). But the first question should be what happened to your contract after the petition was filed. If the agreement was assumed, whether by the reorganized debtor or as part of a section 363 sale to a purchaser, this issue can be raised on a motion to dismiss, and requires no mathematical analysis and no discovery. This “defense” has teeth even in those cases where the contract-counterparty was paid current before the filing and no cure amount ever changed hands. If instead the contract was rejected, or simply expired, the conventional section 547(c) defenses remain the best option, and the defendant is forced into a mathematical analysis and negotiation.

Simply put, before reaching any affirmative defenses, the threshold issue is whether the trustee can prove all five elements of a preference under section 547(b). In cases involving an assumed contract, that burden frequently cannot be met. Recipients of a preference demand should review the case docket closely before conceding that ordinary course and new value are the only potential defenses. FactorLaw regularly defends preference actions and can assess whether an assumption-based defense, or any other, is available.

By: Sean P. Williams