Tenderloin Health v. Bank of the West

FOR PUBLICATION

UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

IN RE TENDERLOIN HEALTH, FKA No. 14-17090
Continuum HIV Day Services, AKA
Tenderloin Health Incorporated, D.C. No.
Debtor, 4:13-cv-03992-
JSW

E. LYNN SCHOENMANN, Trustee,
Plaintiff-Appellant, OPINION

v.

BANK OF THE WEST,
Defendant-Appellee.

Appeal from the United States District Court
for the Northern District of California
Jeffrey S. White, District Judge, Presiding

Argued and Submitted October 18, 2016
San Francisco, California

Filed March 7, 2017
2 IN RE TENDERLOIN HEALTH

Before: A. WALLACE TASHIMA and MILAN D.
SMITH, JR., Circuit Judges, and EDWARD R.
KORMAN, * District Judge.

Opinion by Judge Milan D. Smith, Jr.;
Concurrence by Judge Korman

SUMMARY **

Bankruptcy

The panel reversed the district court’s order affirming the
bankruptcy court’s summary judgment in favor of the
defendant in an adversary proceeding brought by a chapter 7
bankruptcy trustee.

The trustee sought to recover for the bankruptcy estate a
$190,595.50 loan payment debtor Tenderloin Health made
to defendant Bank of the West within ninety days of the
filing of the bankruptcy petition. The bankruptcy court
concluded that the trustee failed to satisfy the “greater
amount test,” pursuant to 11 U.S.C. § 547(b)(5), by
demonstrating that by virtue of that payment, the Bank
received more than it otherwise would have in a hypothetical
chapter 7 liquidation where the challenged transfer had not
been made. The bankruptcy court reasoned that the Bank

*
The Honorable Edward R. Korman, United States District Judge
for the Eastern District of New York, sitting by designation.
**
This summary constitutes no part of the opinion of the court. It
has been prepared by court staff for the convenience of the reader.
 IN RE TENDERLOIN HEALTH 3

had a right of setoff, and the debtor’s account contained at
least $190,595.50 on the petition date.

The trustee asserted that in the hypothetical liquidation,
the trustee would avoid a $526,402.05 deposit, leaving less
than $190,595.50 in the debtor’s account, even allowing for
the Bank’s right of setoff.

The panel held that courts may account for hypothetical
preference actions within a hypothetical chapter 7
liquidation when such an inquiry is factually warranted, is
supported by appropriate evidence, and the action would not
contravene an independent statutory provision. The panel
concluded that the $526,402.05 deposit would constitute an
avoidable preference in the hypothetical liquidation at issue.
The panel therefore reversed the district court’s judgment in
favor of the Bank and directed that the action be remanded
to the bankruptcy court further proceedings.

District Judge Korman concurred in part and concurred
in the judgment. He concurred in the decision to reverse and
remand to the bankruptcy court and joined all but Part II of
the majority opinion, addressing the hypothetical
liquidation. Judge Korman agreed that, under the
circumstances of this case, applying § 547(b)(5)’s “greater
amount” test required the court to construct a hypothetical
liquidation, and that in so doing, the court could consider
whether a reasonable trustee would bring and win a
preference action within the hypothetical chapter 7
proceedings. He wrote that he could not, however, join in
the liquidation constructed by the majority because he could
not agree that the entirety of the $526,402.05 deposit was
itself a preferential transfer subject to clawback under
11 U.S.C. § 547.
4 IN RE TENDERLOIN HEALTH

COUNSEL

Dennis Davis (argued), Goldberg Stinnett Davis & Linchey,
Petaluma, California, for Plaintiff-Appellant.

James A. Tiemstra (argued) and Lisa Lenherr, Tiemstra Law
Group PC, Oakland, California, for Defendant-Appellee.

OPINION

M. SMITH, Circuit Judge:

In this preference action, plaintiff-appellant E. Lynn
Schoenmann (Schoenmann), the trustee in bankruptcy, seeks
to recover for the bankruptcy estate a $190,595.50 loan
payment debtor Tenderloin Health (Tenderloin) made to
defendant-appellee Bank of the West (BOTW) within ninety
days of the filing of Tenderloin’s chapter 7 bankruptcy. To
succeed, Schoenmann must demonstrate that by virtue of
that payment BOTW received more than it otherwise would
have in a hypothetical chapter 7 liquidation where the
challenged transfer had not been made. This inquiry,
required by 11 U.S.C. § 547(b)(5), is called the “greater
amount test.”

The bankruptcy court granted BOTW’s motion for
summary judgment, finding Schoenmann could not satisfy
section 547(b)(5), because BOTW had a right of setoff, and
Tenderloin’s account contained at least $190,595.50 on the
petition date. Schoenmann asserts that in the hypothetical
liquidation, the trustee would avoid a $526,402.05 deposit,
leaving less than $190,595.50 in Tenderloin’s account, even
allowing for BOTW’s right of setoff.
 IN RE TENDERLOIN HEALTH 5

In order to resolve the issues presented in this case, we
address whether courts may entertain hypothetical
preference actions within section 547(b)(5)’s hypothetical
chapter 7 liquidation, and if so, whether the $526,402.05
deposited in this case would meet the definition of an
avoidable preference.

We conclude that courts may account for hypothetical
preference actions within a hypothetical chapter 7
liquidation when such an inquiry is factually warranted, is
supported by appropriate evidence, and the action would not
contravene an independent statutory provision. We are also
satisfied that the $526,402.05 deposit in this case would
constitute an avoidable preference in the hypothetical
liquidation at issue here.

We therefore reverse the district court’s judgment in
favor of BOTW and direct that this action be remanded to
the bankruptcy court for further proceedings.

FACTUAL AND PROCEDURAL BACKGROUND

In May 2009, BOTW extended a $200,000 line of credit
to Tenderloin, a walk-in clinic serving AIDS patients in San
Francisco. BOTW loaned another $100,000 to Tenderloin
two years later. The loans were secured by Tenderloin’s
personal property, including its deposit accounts with
BOTW.

In late 2011 or early 2012, Tenderloin elected to wind up
its affairs. In carrying out that election, it sold its only real
property for $1,295,000. The escrow on that sale closed on
June 13, 2012. Tenderloin used the proceeds of that sale to
execute two transactions that same day. First, it paid BOTW
$190,595.50 from escrow to satisfy fully its outstanding loan
obligations (debt payment). Next, it moved the rest of its net
6 IN RE TENDERLOIN HEALTH

sale proceeds—$526,402.05—from escrow into its BOTW
deposit account (the deposit).

On July 20, 2012, Tenderloin filed for chapter 7
bankruptcy. Ninety days prior to filing, its account
contained approximately $173,015.00. 1 That sum shrunk to
$52,735.11 on the date of the two disputed transfers, but
grew to $576,603.03 immediately after the deposit.
Tenderloin then spent some of its funds in the days preceding
its bankruptcy, so the account contained $564,115.92 on the
petition date. If we subtract from that sum the amount of the
disputed deposit—$526,402.05—Tenderloin’s account
would have contained only $37,713.87 on the petition date.

Schoenmann sued BOTW on December 12, 2012,
alleging that the debt payment was preferential, and subject
to avoidance under 11 U.S.C. § 547(b). The bankruptcy
court granted BOTW’s motion for summary judgment on
July 31, 2013, concluding that Schoenmann could not show
that BOTW received more than it would have in a
hypothetical liquidation where the debt payment had not
been made. Schoenmann appealed to the district court
pursuant to 28 U.S.C. § 158(a)(1). The district court
affirmed, and Schoenmann timely appealed to our court.

JURISDICTION AND STANDARD OF REVIEW

We have jurisdiction pursuant to 28 U.S.C. § 158(d)(1).
“We review de novo the district court’s judgment in the
appeal from the bankruptcy court, and apply the same de
novo standard of review the district court used to review the
1
There appears to be a factual dispute concerning the amount in
Tenderloin’s deposit accounts on the date ninety days preceding the
filing of its bankruptcy. We need not resolve this dispute because the
difference in the amounts is not material to the outcome.
 IN RE TENDERLOIN HEALTH 7

bankruptcy court’s summary judgment.” Suncrest
Healthcare Ctr. LLC v. Omega Healthcare Inv’rs (In re
Raintree Healthcare Corp.), 431 F.3d 685, 687 (9th Cir.
2005).

ANALYSIS

Section 547(b) permits a bankruptcy trustee to recover
for the benefit of the bankruptcy estate preferential payments
from a debtor to a creditor made within the ninety days
preceding the filing of a bankruptcy. 11 U.S.C. § 547(b). To
“avoid” such a payment, the trustee must show, among other
things:

(5) that [it] enables such creditor to receive
more than such creditor would receive if—

(A) the case were a case under chapter 7
of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of
such debt to the extent provided by the
provisions of this title.

11 U.S.C. § 547(b)(5) (emphasis added).

This element—11 U.S.C. § 547(b)(5)—constitutes the
so-called “greater amount test,” which “requires the court to
construct a hypothetical chapter 7 case and determine what
the creditor would have received if the case had proceeded
8 IN RE TENDERLOIN HEALTH

under chapter 7” without the alleged preferential transfer. 2
Alvarado v. Walsh (In re LCO Enters.), 12 F.3d 938, 941
(9th Cir. 1993) (LCO). Schoenmann challenges the
$190,595.50 debt payment, claiming that section 547(b)(5)
is satisfied in this case if BOTW “received a greater amount
than it would have if the [debt payment] had not been made
and there had been a hypothetical chapter 7 liquidation as of
the petition date.” Batlan v. TransAmerica Commercial Fin.
Corp. (In re Smith’s Home Furnishings, Inc.), 265 F.3d 959,
963 (9th Cir. 2001) (Smith).

The bankruptcy court determined that BOTW did not
receive more than it would have in a hypothetical liquidation
because it maintained a right of setoff that entitled it to full
payment, and Tenderloin’s deposit account held the requisite
amount of funds on the petition date. Schoenmann argues,
however, that the trustee would avoid the $526,402.05
deposit in a hypothetical liquidation, such that the deposit
account would contain only $37,713.87 on the petition date,

2
It may at first blush seem incongruous to ask what the creditor
would have received if “the case were a case under chapter 7,” given that
this matter is in fact a chapter 7 liquidation. The reference to chapter 7,
however, defines the character of the hypothetical bankruptcy, which is
then used as a point of comparison to see if the pre-petition payments
rendered the preferred creditor better off. We have previously
recognized that a preference action is permissible under section 547(b),
even when filed in conjunction with a chapter 7 liquidation. See, e.g.,
USAA Fed. Savings Bank v. Thacker (In re Taylor), 599 F.3d 880, 885‒
88 (9th Cir. 2010) (affirming decision concerning a preference action
brought in the course of a chapter 7 liquidation); Busseto Foods, Inc. v.
Charles Laizure (In re Laizure), 548 F.3d 693, 695 (9th Cir. 2008)
(chapter 7 trustee brought preference action); Wood v. Stratos Prod.
Dev., LLC (In re Ahaza Sys., Inc.), 482 F.3d 1118, 1122 (9th Cir. 2007)
(same).
 IN RE TENDERLOIN HEALTH 9

a sum far less than the $190,595.50 BOTW actually
received, even allowing for its right of setoff.

BOTW objects to Schoenmann’s analysis for two
reasons. First, BOTW insists it is impermissible to entertain
a hypothetical preference action within a hypothetical
liquidation. Second, BOTW claims that the deposit made by
Tenderloin into its deposit account would not meet the
definition of an avoidable preference. We find neither
argument persuasive.

I. Section 547(b)(5) Does Not Forbid Courts from
Considering Hypothetical Preference Actions.

The text of the Bankruptcy Code, its legislative history,
and current practice in the bankruptcy courts all support the
conclusion that courts may entertain hypothetical preference
actions within hypothetical chapter 7 liquidations. Further,
our holding in LCO does not pose an obstacle to this
conclusion.

A. Text and Legislative History

Statutory interpretation begins with the text. Pakootas v.
Teck Cominco Metals, Ltd., 830 F.3d 975, 980 (9th Cir.
2016). “If the meaning of the text is unambiguous, the
statute must be enforced according to its terms.” Id.

Here, section 547(b)(5) permits the trustee to avoid any
transfer within ninety days of bankruptcy that enables the
creditor “to receive more than such creditor would receive
if—(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and (C) such creditor
received payment of such debt to the extent provided by the
provisions of this title.” 11 U.S.C. § 547(b)(5) (emphasis
added). The phrase “provisions of this title” appears to refer
10 IN RE TENDERLOIN HEALTH

to the totality of Title 11 of the Code, which includes the
preference provisions appearing in section 547.
Accordingly, the text clearly does not directly forbid courts
from considering hypothetical preference actions within a
hypothetical chapter 7 liquidation. However, since the
statute treats the issue globally, our understanding will be
refined by considering the legislative history of section
547(b)(5).

Section 547 was included in the Bankruptcy Reform Act
of 1978. 3 Pub. L. No. 95-598, 92 Stat. 2549 (1978).
Describing element 547(b)(5), the Senate Committee Report
states “the transfer must enable the creditor . . . to receive a
greater percentage of his claim than he would receive under
the distributive provisions of the bankruptcy code.” S. Rep.
No. 95-989, at 87 (1978), reprinted in 1978 U.S.C.C.A.N.
5787, 5873 (emphasis added). The phrase “distributive
provisions” might be thought to narrow the hypothetical
liquidation to disbursement under chapter 7, but the very
next sentence clarifies the meaning of the phrase:
“Specifically, the creditor must receive more than he would
if the case were a liquidation case, if the transfer had not been
made, and if the creditor received payment of the debt to the
extent provided by the provisions of the code.” Id. (emphasis
added). The House Report echoes this language: “A
preference is a transfer that enables a creditor to receive
payment of a greater percentage of his claim against the
debtor than he would have received if the transfer had not
been made and he had participated in the distribution of the
assets of the bankrupt estate.” H.R. Rep. No. 95-595, at 177

3
The preference provisions first appeared as sections 60a and 60b
of the Bankruptcy Act of 1898. See The Bankruptcy Act of 1898 § 60,
Ch. 541, 30 Stat. 544, 562 (1898). The Bankruptcy Reform Act of 1978
superseded those provisions but retained the same basic elements.
 IN RE TENDERLOIN HEALTH 11

(1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6138. The
phrase “participate[s] in the distribution” leaves room to
assume the hypothetical chapter 7 trustee might initiate
preference actions in conjunction with the “distribution” of
the assets of the estate.

Evidence bearing more directly on this question appears
in the paragraphs that follow the general overview of section
547(b)(5). The reports provide

The phrasing of the final element changes the
application of the greater percentage test
from that employed under current law.
Under this language, the court must focus on
the relative distribution between classes as
well as the amount that will be received by
the members of the class of which the
preferee is a member. The language also
requires the court to focus on the allowability
of the claim for which the preference was
made. If the claim would have been entirely
disallowed, for example, then the test of
paragraph (5) will be met, because the
creditor would have received nothing under
the distributive provisions of the bankruptcy
code.

H.R. Rep. No. 95-595 at 372 (emphasis added); accord S.
Rep. No. 95-989 at 87. By invoking “allowability,” which
refers generally to whether payment of a claim would violate
some independent provision of the Bankruptcy Code, the
report suggests it is appropriate to consider whether a
hypothetical claim would be affected by the preference
provisions. There are numerous cases that refer to the
greater amount test as implicating the “distributive
12 IN RE TENDERLOIN HEALTH

provisions” of the Code, 4 but in light of this history, we
cannot exclude section 547 from the hypothetical chapter 7
“distribution.”

B. Current Practice Under the Bankruptcy Code

The view that courts may consider hypothetical
preference actions within hypothetical chapter 7 liquidations
is bolstered by the fact that bankruptcy courts are doing
precisely that under two other provisions of the code.

Section 1129(a)(7)(A)(ii) requires bankruptcy courts to
determine what creditors would receive under a hypothetical
chapter 7 liquidation, and then compare that amount to what
the same creditors would receive under a chapter 11
reorganization. It provides that a bankruptcy court may
confirm a chapter 11 plan only if each holder of an impaired
claim “will receive or retain . . . property of a value, as of the
effective date of the plan, that is not less than the amount that
such holder would so receive or retain if the debtor were
liquidated under chapter 7 of this title on such date.”
11 U.S.C. § 1129(a)(7)(A)(ii). Although “[t]he hypothetical
liquidation analysis must be based on evidence and not
assumptions in order to meet the best interests of creditors
test,” Collier on Bankruptcy ¶ 1129.02 n.98 (Alan N.

4
See, e.g., Guttman v. Constr. Program Grp. (In re Railworks
Corp.), 760 F.3d 398, 402 (4th Cir. 2014) (stating that under section
547(b)(5), a transfer “must enable the creditor to receive a greater
percentage of its claim than it would under the normal distributive
provisions in a liquidation case under the Bankruptcy Code”);
Kimmelman v. Port Auth. of N.Y. & N.J. (In re Kiwi Int’l Air Lines, Inc.),
344 F.3d 311, 321 (3rd Cir. 2003) (observing a “trustee could not satisfy
§ 547(b)(5) because the pre-petition payments did not improve the
creditor’s position under the distributive provisions of the Bankruptcy
Code”).
 IN RE TENDERLOIN HEALTH 13

Resnick & Henry J. Sommer eds., 16th ed. 2016)
[hereinafter “Collier”] (citing In re Mcorp Fin., Inc.,
137 B.R. 219, 228‒29 (Bankr. S.D. Tex. 1992)), “a trustee’s
avoiding powers in a hypothetical chapter 7 case may []
affect the analysis,” id. ¶ 1129.02.

For instance, in In re Affiliated Foods, Inc., 249 B.R. 770
(Bankr. W.D. Mo. 2000), the court found the statute
“requires an estimation of the value of all of the bankruptcy
estate’s assets, including such hard to determine values as
disputed and contingent claims, the potential disallowance
of claims (under § 502(d)), the probability of success and
value of causes of action held by the estate, and, in this case,
potential preference actions.” Id. at 788 (internal citation
omitted). Likewise, in In re Sierra-Cal, 210 B.R. 168
(Bankr. E.D. Cal. 1997), the court found “all provisions
applicable in a chapter 7 liquidation are to be taken into
account when the court determines what sums would be paid
to whom in a hypothetical liquidation.” Id. at 174. It then
applied two avoidance provisions in the hypothetical
liquidation using the facts and testimony in the record. See
id. at 174‒75 (concluding “a competent chapter 7 trustee
would be able to recover against [the creditor] under § 544
and § 549”).

Chapter 13 has a comparable “best interest of the
creditors” test that requires the same comparison. Section
1325(a)(4) requires a bankruptcy court to confirm a chapter
13 plan if, among other things, “the value, as of the effective
date of the plan, of property to be distributed under the plan
. . . is not less than the amount that would be paid on such
claim if the estate of the debtor were liquidated under
chapter 7 of this title on such date.” When administering
this provision, “court[s] must consider property that would
be likely to be recovered by a chapter 7 trustee’s use of the
14 IN RE TENDERLOIN HEALTH

avoiding powers.” Collier ¶ 1325.05; see also In re Larson,
245 B.R. 609, 614 (Bankr. D. Minn. 2000) (finding that in
the hypothetical liquidation, the court “must look not only at
the Debtor’s assets as listed on his schedules, but [it] must
also consider the recovery of assets by the trustee through
fraudulent transfer and preference actions”).

Lastly, we note that several courts have applied
hypothetical setoff analyses under section 553 within
hypothetical chapter 7 liquidations. See Durham v. SMI
Indus. Corp., 882 F.2d 881, 884 (4th Cir. 1989) (“SMI would
have been entitled to assert its right of setoff under section
553(a) post-petition if the check exchange had not been
executed before Continental’s petition was filed since both
debts were incurred pre-petition.”); Braniff Airways, Inc. v.
Exxon Co., U.S.A., 814 F.2d 1030, 1040 n.11 (5th Cir. 1987)
(“The fact that a setoff never actually took place does not
affect the analysis. The issue is whether Exxon
hypothetically had the right to a setoff, and because of this
right it was secured and therefore the payment received from
Braniff was not a voidable preference.”); Mason & Dixon
Lines, Inc. v. St. Johnsbury Trucking Co. (In re Mason &
Dixon Lines, Inc.), 65 B.R. 973, 976 (Bankr. M.D.N.C.
1986) (“In the case at bar, had the debtor not made the
payment to the creditor carrier, the creditor could have offset
the debt prepetition pursuant to section 553 or if the 30 days
elapsed postpetition had the offset amount as a secured claim
under section 506(a).”); Lingley v. Contractors Grp., Inc. (In
re NEPSCO, Inc.), 55 B.R. 574, 576 (Bankr. D. Maine 1985)
(“Had the debtor in this case not paid CGI the $6,221.56
prior to the filing of the Chapter 7 petition, CGI would have
been entitled to a right of setoff under 11 U.S.C. § 553(a).”).
True, hypothetical setoff analyses, unlike preference actions,
do not require that we assume a party will initiate an
adversary proceeding. That said, it would be odd to permit
 IN RE TENDERLOIN HEALTH 15

bankruptcy courts conducting hypothetical liquidations to
look only to section 553, while ignoring other chapter 5
provisions, like section 547.

C. Our Prior Holding in LCO poses no bar.

In response, BOTW relies on our decision in LCO, which
held “the hypothetical chapter 7 analysis required by
§ 547(b)(5) must be based on the actual facts of the case.”
12 F.3d at 940. Since Schoenmann has not challenged the
deposit in Tenderloin’s actual liquidation, BOTW asserts we
may not permit such a challenge in a hypothetical
liquidation. A close reading of LCO reveals that this
argument is misguided because it improperly relies on the
decision’s broad language divorced from the context of the
case.

In LCO, the debtor, LCO Enterprises, leased commercial
space from a company named Lincoln. Id. LCO fell behind
in paying rent and filed for chapter 11 bankruptcy, leading
LCO and Lincoln to restructure their relationship. Id.
Specifically, they changed the terms of the lease agreement,
and LCO disclosed the terms of the revised agreement in its
chapter 11 plan. Id. LCO then faced the decision of whether
it would assume or reject the lease in bankruptcy. Id.
Importantly, under chapter 11, the debtor-in-possession
(LCO) stands in the shoes of the trustee. 11 U.S.C. § 1107.
Additionally, if the debtor was in default on an unexpired
lease before filing for bankruptcy, the lease may not be
assumed “unless, at the time of assumption,” the trustee
cures the default and provides adequate assurance of future
performance. 11 U.S.C. § 365(b)(1)(A)‒(C). LCO, as
trustee, assumed the revised lease and cured the default, in
compliance with section 365(b). LCO, 12 F.3d at 942. The
reorganization plan was eventually confirmed by the
bankruptcy court. Id. at 940.
16 IN RE TENDERLOIN HEALTH

Two months after confirmation, a chapter 11 trustee was
appointed to pursue any preferential payments. Id. The
trustee sued to recover several rent payments LCO
transmitted to Lincoln in the ninety days preceding the filing
of its bankruptcy. Id. The action turned on the “greater
amount test”; i.e., whether Lincoln received more than it
otherwise would have in a hypothetical chapter 7 liquidation
as of the petition date where the prepetition rent payment had
not been made. Id. at 941.

The trustee argued that in a hypothetical liquidation, “a
hypothetical chapter 7 trustee might have rejected the lease,”
giving Lincoln an unsecured claim for its shortfall in rent,
rather than the full payment it received when the lease was
assumed and the default was cured. Id. at 942. The trustee
also said the court “should exercise its own independent
judgment as to whether, if the court were administering the
estate under chapter 7, it would have assumed or rejected the
lease” at the time of the chapter 11 bankruptcy. Id. We
rejected these arguments, holding “[t]he phrase
‘hypothetical chapter 7’ . . . does not mean that the
bankruptcy court can construct its own hypothetical from
whole cloth or from only some of the facts.” Id. at 944.
Rather, “the hypothetical chapter 7 analysis required by
§ 547(b)(5) must be based on the actual facts of the case.”
Id. at 940. Since the lease had been assumed, “the
[bankruptcy] court could neither speculate that there was no
lease nor assume that the lease was rejected.” Id. at 944.
Those assumptions simply did not “reflect[] the facts at any
time.” Id. Moreover, under section 365(b), once the lease
was assumed, the requirement to cure any default was
mandated. This gave Lincoln a secured claim for all
outstanding prepetition rent in the hypothetical liquidation,
 IN RE TENDERLOIN HEALTH 17

so it did not receive more than it otherwise would,
precluding satisfaction of the greater amount test. 5

Importantly, we also noted that if we deviated from the
actual facts in the case, and assumed that the hypothetical
chapter 7 trustee had rejected the lease, the trustee would be
allowed to recover payments it was obligated to make to
Lincoln to cure the default pursuant to section 365(b). Id. at
943. In other words, straying from the actual facts would
permit Ҥ 547(b) to circumvent the requirements of
§ 365(b).” Id. To avoid such a statutory collision, we held
“[t]he [t]rustee cannot have his leased property and his rent
payments, too.” Id. at 943‒44.

Mindful of this context, it is apparent that LCO required
fidelity to the actual facts in the case because to hold
otherwise under those circumstances would have violated an
independent statutory provision of the Bankruptcy Code.
Section 365(b) requires the trustee to pay the landlord all
outstanding rent when a lease is assumed, but a preference
action would permit the trustee to recover the very
prepetition rent payments it owes the landlord under that
provision. In light of this conflict, we conclude that LCO
must be narrowly construed. To that end, courts that have
followed LCO’s holding have done so when presented with
the same statutory collision scenario. See In re Kiwi Int’l Air
Lines, Inc., 344 F.3d at 314 (“[T]he assumption of a contract
under 11 U.S.C. § 365 bars a preference claim by a
trustee.”); In re Superior Toy & Mfg. Co., 78 F.3d 1169,
1174 (7th Cir. 1996) (“Section 547 and § 365 are mutually
exclusive avenues for a trustee. A trustee may not prevail

5
“If a creditor is fully secured, a prepetition transfer to him is not
preferential because the secured creditor is entitled to 100% of his
claim.” LCO, 12 F.3d at 941.
18 IN RE TENDERLOIN HEALTH

under both. Nor may a subsequent trustee pursue one course,
when her predecessor has pursued another.”).

Adding further support for the interpretation that LCO
requires fidelity to the actual facts only when doing
otherwise would violate an independent statutory provision,
the opinion explicitly relies on the Eleventh Circuit’s
decision in Seidle v. GATX Leasing Corporation, 778 F.2d
659 (11th Cir. 1985). See LCO, 12 F.3d at 943. There, a
creditor held a chattel mortgage on a debtor’s aircraft which
secured payments due under a note. Seidle, 778 F.2d at 660.
The debtor made partial payments on the note within the
ninety day period preceding its chapter 11 bankruptcy. Id.
Once in bankruptcy, the debtor and creditor entered into a
court-approved stipulation under 11 U.S.C. § 1110,
obligating the debtor to cure its default in exchange for the
debtor’s continued use of the aircraft. Id. at 661. The trustee
later sued to recover as preferential the prepetition payments
made on the note. Id. The court rejected the preference
action because the trustee was seeking to recover payments
it was obligated to make under the court-approved
stipulation. See id. at 665 (“Pursuant to the section 1110
stipulation, a creditor is entitled to unpaid pre-petition
payments, as defaults; a trustee may not later thwart the
effect of the statute by challenging the validity of these
transfers as preferences.”). As in LCO, if the court assumed
a hypothetical trustee would have rejected the stipulation, it
would be permitting a preference action that would
undermine an independent statutory provision—section
1110.

In sum, LCO does not bar us in this case from assuming
in a hypothetical liquidation that the hypothetical trustee
would sue to recover the $526,402.05 deposit. Unlike in
LCO, permitting such an action would not violate any other
 IN RE TENDERLOIN HEALTH 19

statutory provision, and it is consistent with the text and
legislative history recited above. 6 Having established that
section 547(b)(5) does not forbid courts from entertaining
hypothetical preference actions, we next must determine if
the deposit in this case would meet the definition of an
avoidable preference.

6
Additionally, though BOTW is correct that we are permitting the
hypothetical trustee to do something the actual trustee did not do, the
actual trustee had no incentive to challenge the deposit when the
bankruptcy was filed. BOTW turned over the $564,276.83 in
Tenderloin’s accounts on November 12, 2012. The trustee then brought
this action in the bankruptcy court roughly one month later. These facts
are significant because the voluntary turnover to the trustee of the
property subject to a creditor’s right of setoff generally precludes any
subsequent claim of setoff by the creditor. See Citizens Bank of Md. v.
Strumpf, 516 U.S. 16, 20 (1995) (noting that requiring a creditor
immediately to turnover funds on account “would divest the creditor of
the very thing that supports the right of setoff”); In re Mauch Chunk
Brewing Co., 131 F.2d 48, 49 (3d Cir. 1942) (finding that when trustee
withdrew funds from account with bank’s knowledge of bankruptcy
filing, bank’s acquiescence was “tantamount to renunciation of its
privilege of setoff”). If BOTW loses this preference action, it might be
able revive its right of setoff given “court[s] may remedy the effect of an
inadvertent, involuntary or improper dissipation of the creditor’s
interest.” COLLIER ¶ 553.07; see also In re Archer, 34 B.R. 28, 31
(Bankr. N.D. Tex. 1983) (finding where bank had mistakenly turned over
property it did not intentionally waive its right of setoff). Still, even
allowing for that possibility, it would not be reasonable to assume the
trustee had an incentive to challenge the deposit from the outset of this
proceeding. BOTW had turned over the funds that supported the right
of setoff, so there was little reason for the trustee to fear BOTW would
later assert such a right if the preference action was successful and the
bank disgorged the debt payment.
20 IN RE TENDERLOIN HEALTH

II. In the Hypothetical Liquidation, the Trustee
Would Avoid the Deposit as a Preference.

Schoenmann concedes BOTW would have a right of
setoff in the hypothetical liquidation.7 BOTW asserts it
would exercise that right sometime after the bankruptcy
petition was filed. In that scenario, if we permit the
hypothetical preference action, BOTW will have received

7
“The right of setoff (also called ‘offset’) allows entities that owe
each other money to apply their mutual debts against each other, thereby
avoiding the absurdity of making A pay B when B owes A.” Newbery
Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 1392, 1398 (9th Cir. 1996)
(quotation marks omitted). There is no federal right of setoff, but “11
U.S.C. § 553(a) provides that, with certain exceptions, whatever right of
setoff otherwise exists is preserved in bankruptcy.” Citizens Bank of Md.
v. Strumpf, 516 U.S. 16, 18 (1995). California law recognizes a bank’s
right to setoff against a depositor’s account. Kruger v. Wells Fargo
Bank, 11 Cal. 3d 352, 357–58 (1974). Accordingly, BOTW’s right of
setoff is preserved in the hypothetical liquidation if it meets the
requirements of section 553. Three conditions must be shown: “(1) the
debtor owes the creditor a prepetition debt; (2) the creditor owes the
debtor a prepetition debt; and (3) the debts are mutual.” United States v.
Carey (In re Wade Cook Fin. Corp.), 375 B.R. 580, 594 (B.A.P. 9th Cir.
2007). In a hypothetical liquidation as of the petition date, these
requirements are met. Tenderloin, the debtor, would owe BOTW, the
creditor, a prepetition debt because the alleged preferential transfer
would not have taken place, meaning the loan balance ($190,595.50)
would be outstanding. BOTW would owe Tenderloin a prepetition debt
arising from the deposit of the property sale proceeds. See Strumpf, 516
U.S. at 21 (explaining banks obtain title to deposited funds subject to a
promise to pay the depositor); Bank of Marin v. England, 385 U.S. 99,
101 (1966) (“The relationship of bank and depositor is that of debtor and
creditor, founded upon contract.”). Finally, the debts are mutual because
they involve obligations owed between the same parties.
 IN RE TENDERLOIN HEALTH 21

more as a result of the debt payment than it would have
received in a hypothetical chapter 7 liquidation. 8

Hypothetical Post-Petition Setoff

“Where a creditor fails to exercise its right of setoff prior
to the filing of the petition it does not lose the right, but must
proceed in the bankruptcy court by means of a complaint to
lift the automatic stay so as to be allowed to exercise its
already existing right to offset.” Durham v. SMI Indus.
Corp., 882 F.2d 881, 884 (4th Cir. 1989) (internal quotation
marks omitted). In accordance with that procedure, in the
post-petition scenario BOTW would move to lift the stay,
submit a proof of claim, and then argue its right of setoff
entitles it to receive $190,595.50. “Mandatory claim
disallowance under § 502(d),” however, “is one Bankruptcy
Code provision that applies in chapter 7 liquidations.” In re
Sierra-Cal, 210 B.R. at 173. “It requires that the court
disallow ‘any claim’ of any entity from which property is

8
The result would not be different even if BOTW were to argue that
it would exercise its hypothetical setoff right prior to the filing of the
petition. Prepetition setoffs are generally challenged in three ways, only
one of which would apply here. Section 553(b) provides that if a creditor
exercises a setoff within ninety days of the bankruptcy, the trustee may
recover the amount by which the creditor improved its position between
the ninetieth day before the filing and the date of the bankruptcy. See 11
U.S.C. § 553(b). Ninety days before filing, Tenderloin’s accounts
contained approximately $173,015.00. We also must assume that
BOTW would elect to setoff the full $190,595.50. BOTW would thus
improve its position by $17,580.50 under this scenario. The trustee
would be able to recover that amount from BOTW. At bottom, if BOTW
exercised its hypothetical setoff right prior to the filing of the petition, it
still received more in reality than it would in the hypothetical liquidation
because it actually received $190,595.50, but would receive only
$173,015.00 in the hypothetical.
22 IN RE TENDERLOIN HEALTH

recoverable by a trustee, or that is the transferee of an
avoidable transfer, unless and until the property is turned
over and the transfer is paid.” 9 Id. Pursuant to this
provision, the bankruptcy court likely would decide the
trustee’s hypothetical preference action before allowing
BOTW’s claim. It therefore would consider whether the
deposit satisfies the elements of section 547(b).

The Section 547(b) Elements.

As previously noted, section 547(b) requires that the
“transfer” be (1) to or for the benefit of a creditor, (2) for or
on account of an antecedent debt, (3) made while the debtor
was insolvent, (4) made within 90 days of the bankruptcy,
and (5) one which permits the creditor to receive more than
it would in a hypothetical liquidation where the challenged
payment had not been made. 11 U.S.C. § 547(b)(1)‒(5).
BOTW argues that in the hypothetical preference action it
would no longer be a “creditor,” the deposit would not be
“for or on account of an antecedent debt,” and the deposit
would not constitute a “transfer.” 10 We disagree.

In the hypothetical liquidation where the debt payment
had not been made, BOTW would still be a creditor because
it would be owed the $190,595.50 it loaned to Tenderloin.
9
“The § 502(d) disallowance is in the nature of an affirmative
defense to a proof of claim and does not provide independent authority
for affirmative relief against the creditor.” In re Sierra-Cal, 210 B.R. at
173.

10
BOTW does not dispute the other section 547(b) elements, and
they appear to be satisfied. The deposit was made on June 13, 2012, so
it occurred within ninety days of the filing of the petition. 11 U.S.C.
§ 547(b)(4)(A). In the absence of the deposit, BOTW would not have
been able to setoff the full $190,595.50, so the trustee could satisfy the
“greater amount test.” Id. § 547(b)(5).
 IN RE TENDERLOIN HEALTH 23

Though it is a closer question, the deposit also would be “for
or on account of an antecedent debt.” True, Tenderloin
transferred the $526,402.05 in proceeds having already
satisfied its preexisting debt, but the 1978 revision to the
bankruptcy statute defined preferences “solely with respect
to a payment’s effect on the size of the debtor’s estate.”
Marathon Oil Co. v. Flatau (In re Craig Oil Co.), 785 F.2d
1563, 1566 (11th Cir. 1986); see also Vern Countryman, The
Concept of a Voidable Preference in Bankruptcy, 38 Vand.
L. Rev. 713, 748 (1985) (“The function of the preference
concept is to avoid prebankruptcy transfers that distort the
bankruptcy policy of distribution. Transfers that do distort
this policy do so without regard to the state of mind of either
the debtor or the preferred creditor.”). 11 By that measure, in
the hypothetical liquidation, the deposit would have the
effect of diminishing the funds available to Tenderloin’s
creditors because it would increase the size of BOTW’s
secured claim against the bankruptcy estate. The deposit
would also constitute a “transfer” under the terms of the
Bankruptcy Code. It would subject the funds to BOTW’s
security interest, give BOTW title to the funds, and deplete
the assets available for distribution to Tenderloin’s creditors.
Tenderloin therefore would be “disposing of or parting with
. . . an interest in property.” 11 U.S.C. § 101(54)(D); see
also Bernard v. Sheaffer (In re Bernard), 96 F.3d 1279, 1282
(9th Cir. 1996) (finding that “depositing money into a bank

11
Notably, a debtor’s subjective intent may be relevant in
determining the applicability of an affirmative defense. See, e.g., 11
U.S.C. § 547(c)(2) (providing there is no preference where a payment
was made according to ordinary business terms); In re Craig Oil Co.,
785 F.2d at 1566 (“[A] creditor’s state of mind is now immaterial in
finding a preference. . . . It does not follow from the above that a debtor’s
state of mind or motivation is likewise immaterial in applying the
preference exception of § 547(c)(2).”).
24 IN RE TENDERLOIN HEALTH

account is a transfer” and correspondingly concluding that
withdrawing money from a bank account is a transfer).

Arguing to the contrary, BOTW invokes New York
County National Bank v. Massey, 192 U.S. 138 (1904).
There, the Supreme Court observed that

a deposit of money to one’s credit in a bank
does not operate to diminish the estate of the
depositor, for when he parts with the money
he creates at the same time, on the part of the
bank, an obligation to pay the amount of the
deposit as soon as the depositor may see fit to
draw a check against it. It is not a transfer of
property as a payment, pledge, mortgage, gift
or security.

Id. at 147 (emphasis added). For several reasons, we are not
persuaded by BOTW’s invocation of Massey. As previously
noted, “[i]n 1978, Congress fundamentally restructured
bankruptcy law by passing the new Bankruptcy Code.”
Begier v. Internal Revenue Service, 496 U.S. 53, 63 (1990).
Among other changes, Congress elected to expand the
Code’s definition of the term “transfer.” 12 S. Rep. No. 95-

12
In 1904, a transfer was defined “to include the sale and every other
and different method of disposing of or parting with property, or the
possession of property, absolutely or conditionally, as a payment, pledge,
mortgage, gift, or security.” Massey, 192 U.S. at 146; see also The
Bankruptcy Act of 1898 § 1, Ch. 541, 30 Stat. 544, 545 (1898). Today,
the parting may be with a mere “interest in property” and need not be
done “as a payment, pledge, mortgage, gift, or security.” See 11 U.S.C.
§ 101(54); Smiley v. First Nat’l Bank of Belleville (Matter of Smiley),
864 F.2d 562, 565 (7th Cir. 1989) (“[W]e find that the narrow definition
of ‘transfer’ . . . can no longer be the law since the Bankruptcy Reform
Act took effect.”).
 IN RE TENDERLOIN HEALTH 25

989 at 27; accord H.R. Rep. No. 95-595 at 314. Pursuant to
the revision, “any transfer of an interest in property is a
transfer, including a transfer of possession, custody, or
control even if there is no transfer of title, because
possession, custody, and control are interests in property.”
Id. Applying that definition, the committee reports state
squarely that “[a] deposit in a bank account or similar
account is a transfer.” Id. The Massey court had no occasion
to contemplate these amendments; it considered only the
Bankruptcy Code’s former and narrower definition of
“transfer.”

We, however, had occasion to consider the revised
definition of “transfer” in Bernard v. Sheaffer, 96 F.3d at
1282. There, the debtors withdrew money from an account
and placed it in a safe. Id. at 1281. They argued that
withdrawals did not constitute transfers because the assets
“merely changed form.” Id. at 1282. We held that the
debtors’ argument “fail[ed] to take proper account of the
Bankruptcy Code’s definition of ‘transfer,’ which is
extremely broad.” Id. (emphasis in original). Recognizing
that title passes to the bank when funds are deposited, we
said the debtors owned only “claims against their bank.” Id.
at 1283. “When they withdrew from their accounts,”
however, “they exchanged debt for money” and thus “parted
with property, satisfying the Code’s definition of transfer.”
Id. “Under the holding in Bernard, there is no ambiguity
around the definition of a transfer; withdrawals and deposits
into bank accounts clearly qualify.” A & H Ins., Inc. v. Huff
(In re Huff), No. 12‒05001‒BTB, 2014 WL 904537, at *6
(9th Cir. B.A.P. Mar. 10, 2014). As is the case here, a
deposit “exchange[s] money for debt . . . result[ing] in a
‘parting with’ property under the holding in Bernard as a
matter of law.” Id.; see also Batlan v. Bledsoe (In re
Bledsoe), 569 F.3d 1106, 1113 (9th Cir. 2009) (invoking
26 IN RE TENDERLOIN HEALTH

Bernard’s interpretation of “transfer” in the context of
another section of the Bankruptcy Code). 13

Next, even though “[a] debtor’s bank deposit ordinarily
constitutes a transfer of the debtor’s property to the title and
possession of the bank,” some courts nonetheless have asked
“whether this ‘transfer’ is of a kind [that] section 547
invalidates.” Collier ¶ 547.03[1][b] (emphasis added)
(citing New Jersey Nat’l Bank v. Gutterman (In re Applied
Logic Corp.), 576 F.2d 952 (2d Cir. 1978); Katz v. First
Nat’l Bank of Glen Head, 568 F.2d 964 (2d Cir. 1977)).
Though we doubt such an inquiry is warranted when
deciding whether a transaction constitutes a transfer, 14 even
assuming it is, the asserted standard is met here.

13
Massey is also factually distinguishable. Here, unlike in Massey,
the accounts were pledged as security on an antecedent loan, and the
deposit itself would render BOTW fully secure. Cf. Smith, 265 F.3d at
964 (“[P]ayments that change the status of a creditor from partially
unsecured to fully secured at the time of petition may be preferential.”);
Porter v. Yukon Nat’l Bank, 866 F.2d 355, 359 (10th Cir. 1989) (finding
transfer preferential where “the effect of the transfer was to change the
status of the Bank from that of a partially unsecured creditor to that of a
fully secured creditor”). It is also worth noting that the Supreme Court
instructs us to look to the “actual effect” of the deposit in bankruptcy,
Palmer Clay Prods. Co. v. Brown, 297 U.S. 227, 229 (1936), and as
explained further below, the deposit would deplete the estate’s assets.
The concurrence is simply incorrect in stating that the deposit “made no
difference to the bank’s security position.” BOTW’s security interest
only attached because the deposited funds were transferred out of
escrow.

14
Both of the cited decisions were decided prior to the 1978
amendments to the Bankruptcy Code. In addition, the “diminution of
estate” doctrine is used “to determine whether property that is transferred
belongs to the debtor,” not whether a transaction constitutes a transfer.
See Adams v. Anderson (In re Superior Stamp & Coin Co.), 223 F.3d
 IN RE TENDERLOIN HEALTH 27

The pertinent question is whether the deposit depletes the
assets of the estate available for distribution to creditors. See
Begier, 496 U.S. at 58 (stating that the preference provision
is designed to “preserve the property includable within the
bankruptcy estate”). 15 On the specific facts of this case, as
noted before, the deposit would have that effect. No
bankruptcy creditor had an interest as far as we are aware in
Tenderloin’s real property. Moreover, if the deposited funds
had not been transferred—and therefore remained in
escrow—they would have passed to the estate and thus to
other creditors. Through the deposit, however, one
creditor—BOTW—gained a beneficial interest in the funds.
BOTW also became indebted to Tenderloin for $564,115.92,
and correspondingly increased its right to exercise a setoff
for the full amount of its loan. The deposit therefore
represents the kind of pre-petition “transfer” that the
preference provisions target. See, e.g., Meoli v. The
Huntington Nat’l Bank (In re Teleservices Grp., Inc.), 469
B.R. 713, 744‒47 (W.D. Mich. 2012) (stating that “Massey
has become an anachronism” and finding that a deposit in a

1004, 1007 (9th Cir. 2000). To the extent that BOTW insists the deposit
was not a transfer “of an interest of the debtor in property,” see id., that
argument has been waived, Officers for Justice v. Civil Serv. Comm’n,
979 F.2d 721, 726 (9th Cir. 1982). Finally, the concurrence concedes
that the deposit is a “transfer,” but insists it is not the right kind of transfer
because Massey allegedly controls when determining “what makes a
preference.” We are convinced that satisfying the elements of § 547(b)
“makes” a transfer “a preference,” and the concurrence does not disagree
that those elements would be satisfied here.

15
The key aspect of this investigation is not whether the exercise of
a setoff right depletes the estate’s assets, see Concurrence at 3, as that
necessarily is true in every case. The question is whether the deposit
depletes the estate’s assets because deposits do not always afford the
bank a right of setoff, nor are deposit accounts always pledged as security
for a loan.
28 IN RE TENDERLOIN HEALTH

bank account pledged as collateral for a loan fits the
definition of an avoidable transfer); Ivey v. First Citizens
Bank & Trust Co., 539 B.R. 77, 87 n.14 (M.D.N.C. 2015)
(noting that in Teleservices “a part of the transfers were
deposits into bank accounts that themselves served as
security for the line of credit that the defendant bank
extended to debtor. Therefore, whether or not the bank
actually exercised its rights against the accounts, the deposits
themselves created an actual or potential diminution of the
estate by subjecting the funds to the bank’s power under this
credit agreement” (citation omitted)).

The implication of the above is that if BOTW sought to
exercise its right of setoff after the petition was filed, the
hypothetical preference challenge to the deposit would still
be successful. As a consequence, Tenderloin’s account
functionally would contain $37,713.87 on the petition date,
a sum far less than the $190,595.50 BOTW received, even
allowing for its right of setoff. 16 Under the hypothetical

16
We decline to adopt the post-petition setoff analysis suggested by
the concurrence. First, though there is no question that setoffs are
governed by section 553, the trustee has never argued that it would
challenge a hypothetical post-petition setoff. Instead, Schoenmann
asserts only that the hypothetical trustee would challenge the deposit as
an avoidable preference. Next, while the exercise of a setoff results in a
permissible preference because it does not constitute a transfer under the
Bankruptcy Code, COLLIER ¶ 553.09[1][a], here we have a pre-petition
transfer that renders a creditor fully secure, and thus it is not immune
from preference liability. See supra at 27 n.13. Lastly, though the
concurrence applies section 553(b) to a hypothetical post-petition setoff,
the plain language of the statute indicates that section 553(b) applies only
to pre-petition setoffs. See 11 U.S.C. § 553(b)(1) (stating that “if a
creditor offsets a mutual debt owing to the debtor against a claim against
the debtor on or within 90 days before the date of the filing of the petition,
then the trustee may recover from such a creditor the amount so offset”
subject to certain conditions (emphasis added)); see also Collier ¶
 IN RE TENDERLOIN HEALTH 29

facts, the trustee could demonstrate that the elements of
section 547(b)(5) would be met. 17

CONCLUSION

We hold that courts may entertain hypothetical
preference actions within section 547(b)(5)’s hypothetical
liquidation when such an inquiry is factually warranted,
supported by appropriate evidence, and so long as the
hypothetical preference action would not result in a direct
conflict with another section of the Bankruptcy Code.

Here, the undisputed facts demonstrate that BOTW
received two transfers simultaneously within ninety days of
Tenderloin’s bankruptcy. We are also satisfied that in a
hypothetical liquidation where the debt payment had not
been made, the hypothetical bankruptcy trustee would
challenge as preferential the $526,402.05 deposit, as would
any reasonable bankruptcy trustee. Once we permit such a
hypothetical preference action, Schoenmann can
demonstrate that BOTW received more as a result of the debt
payment than it would in a hypothetical chapter 7
liquidation. As a consequence, the trustee can prove each

553.09[2][c] (“The better result is to limit section 553(b) to setoffs
actually taken prepetition. In addition to remaining true to the language
of the text, that result is consistent with the underlying purpose of section
553, which it to encourage creditors not to take setoffs by generally
preserving their setoff rights.”).

17
BOTW mentions in passing one hypothetical affirmative
defense—that the bank “would not be liable pursuant to 11 U.S.C.
§ 550.” Since BOTW does not develop the argument, however, we
decline to reach it. See W. Watersheds Project v. Kraayenbrink, 632 F.3d
472, 499 (9th Cir. 2010); Int’l Healthcare Mgmt. v. Hawaii Coalition for
Health, 332 F.3d 600, 609 (9th Cir. 2003).
30 IN RE TENDERLOIN HEALTH

required element of his claim, and BOTW has not shown it
is entitled to judgment as a matter of law.

We REVERSE the district court’s judgment in favor of
BOTW. BOTW’s summary judgment motion is therefore
DENIED, and the matter is REMANDED to the district
court with directions to remand the matter to the bankruptcy
court for further proceedings consistent with this opinion.
Appellee shall bear costs on appeal. Fed. R. App. P.
39(a)(3).

REVERSED and REMANDED.

KORMAN, District Judge, concurring in part and
concurring in the judgment:

I concur in the decision to reverse and remand to the
bankruptcy court, and join all but Part II of the majority
opinion. I agree that, under the circumstances of this case,
applying 11 U.S.C. § 547(b)(5)’s “greater amount” test
requires us to construct a hypothetical liquidation, and that
in so doing, we may consider whether a reasonable trustee
would bring and win a preference action within the
hypothetical Chapter 7 proceedings. I cannot, however, join
in the liquidation that the majority constructs in this case,
because I cannot agree that the entirety of the $526,402.05
deposit was itself a preferential transfer subject to clawback
under 11 U.S.C. § 547.

The majority is correct that Bernard v. Sheaffer, 96 F.3d
1279 (9th Cir. 1996), binds us to begin with the premise that
a bank deposit is a “transfer” under the modern Bankruptcy
 IN RE TENDERLOIN HEALTH 31

Code, see also Maj. Op. at 23–26. 1 But the ultimate issue is
not merely whether Tenderloin’s deposit was a transfer, but
whether it was a preferential one. On the latter question, the
majority’s position runs headlong into Justice Brandeis’s
seminal opinion in New York County National Bank v.
Massey, 192 U.S. 138, 147 (1904). The majority does not
ignore Massey; nevertheless, its treatment of that case almost
totally elides what Massey has to say about the central
question presented here.

Instead of engaging Massey’s analysis of what makes a
preference, the majority opinion focuses at length on
whether, in light of the expanded definition of “transfer” that
Congress adopted in 1978, Massey still means that deposits
are not transfers. The trouble is that Massey never meant that
at all. The Massey Court “never said that customer deposits
were not transfers.” Meoli v. The Huntington Nat’l Bank (In
re Teleservices Grp., Inc.), 469 B.R. 713, 745 (Bankr. W.D.
Mich. 2012) (emphasis added), cited at Maj. Op. at 27–28.
Rather, it said that such deposits were not preferential within
the meaning of the bankruptcy laws solely because they
create a right of setoff in a creditor. Massey, 192 U.S. at 147
(“[A] deposit of money . . . in a bank does not operate to
diminish the estate of the depositor.” (emphasis added)).

The question is whether Massey’s holding, that the
creation of a setoff right does not suffice to make a
preference, has survived Congress’s creation of the
contemporary scheme governing preferences and setoff. In

1
The circuits are divided on this question. See Ivey v. First Citizens
Bank & Trust Co. (In re Whitley), — F.3d —, 2017 WL 416964, at *3–
5 (4th Cir. 2017) (noting the split and reaffirming the Fourth Circuit’s
pre-1978 position that deposits into one’s own bank account ordinarily
are not “transfers”).
32 IN RE TENDERLOIN HEALTH

that respect, the Massey Court faced a similar statutory
landscape to the one we do now. The 1898 Act provided that
an insolvent debtor’s transfer was preferential only if it
“enable[d] any one of his creditors to obtain a greater
percentage of his debt than any other of such creditors of the
same class.” § 60(a), 30 Stat. 544, 562. Nevertheless, it
expressly authorized the setoff of mutually owing debts
without providing an exception applicable when a setoff
would improve the bank’s position. Id. § 68(a), 30 Stat. at
565. The Court held that the preservation of setoff indicated
Congress’s intent that the creation and exercise of a setoff
right exist as an exception to the Act’s definition of a
preferential transfer. Massey, 192 U.S. at 147. After all,
setoff (and the creation of a setoff right) always favors
offsetting creditors, who “receive[] a preference in the fact
that, to the extent of the set-off [right], [they are] paid in
full.” Id. As Justice Brandeis explained, to “enlarge the
scope of the statute defining preferences so as to prevent set-
off in cases coming within the terms of [the provision
authorizing setoff]” would “defeat” Congress’s choice to
preserve setoff under those terms. Id.

In enacting the 1978 Act, or any of the numerous
subsequent amendments to the Bankruptcy Code, Congress
could have included the creation or exercise of a setoff right
in the roster of transactions that are avoidable under § 547,
but it did not. Instead, it preserved the basic feature of the
1898 Act on which Massey relied—the treatment of
preferential transfers and setoff rights in separate provisions
subject to different rules. Like § 68(a) of the 1898 Act, § 553
of the post-1978 Code is an entirely separate provision that
subjects setoffs, exclusively, to different rules than those
applicable to the recovery of preferences generally. See, e.g.,
Woodrum v. Ford Motor Credit Co. (In re Dillard Ford,
Inc.), 940 F.2d 1507, 1512 (11th Cir. 1991).
 IN RE TENDERLOIN HEALTH 33

Because that structure is unchanged, to hold that the
creation of a setoff right that the Code preserves under the
terms of § 553 may be preferential under § 547 would, as in
Massey, “operate to enlarge the scope of the statute defining
preferences so as to prevent [the exercise of] set-off in cases
coming within the terms of [§ 553].” As in Massey, a
preference is still defined as a transfer that leaves the
receiving creditor better off than it otherwise would have
been. See 11 U.S.C. § 547(b)(5), see also Maj. Op. at 27
(“The pertinent question is whether the deposit depletes the
assets of the estate available for distribution to creditors.”).
Setoff rights are still preserved, subject to more forgiving
limitations than transfers generally. Compare 11 U.S.C.
§ 553(b) with § 547(b). 2 And as a matter of economic reality,
the creation and exercise of those rights still advantage some
creditors in a way that would—but for Massey’s limiting
construction—meet the hornbook definition of a preference.

Concededly, Massey interpreted the text of a different
statute than the one before us today. Nevertheless, the
ultimate question in any statutory interpretation case is the
intent of Congress, and the Supreme Court has instructed
that “Congress is presumed to be aware of a[] . . . judicial

2
Indeed, the bankruptcy judge in Meoli v. The Huntington Nat’l
Bank (In re Teleservices Grp., Inc.), 469 B.R. 713 (Bankr. W.D. Mich.
2012), quoted by the majority, was discussing § 553(b)’s effect on the
treatment of setoffs when it labeled Massey an “anachronism.” Id. at 746,
quoted at Maj. Op. at 27–28. Its point was not that Congress no longer
intended the law governing setoffs to function as an exception to the law
governing preferences generally, but that the enactment of § 553(b) had
“addressed preferential setoffs,” by providing special terms on which
they, although not subject to § 547, could be clawed back. Id. at 745–46.
In any case, the court in Meoli had no cause to consider whether the
creation or exercise of a setoff right could render a transfer preferential—
the transfers at issue in Meoli were voidable not because they were
preferential, but because they were fraudulent. See id. at 747.
34 IN RE TENDERLOIN HEALTH

interpretation of a statute and to adopt that interpretation
when it re-enacts a statute without change.” Lorillard v.
Pons, 434 U.S. 575, 580 (1978). There is no indication that
Congress meant to disrupt Massey’s bedrock holding when
it enacted a new bankruptcy law, but preserved the structure
that formed the essential basis for the Supreme Court’s
analysis. In such circumstances, we should be mindful not
only of Congress’s intent, but of the fact that “only [the
Supreme] Court may overrule one of its precedents.” See
Thurston Motor Lines, Inc. v. Jordan K. Rand, Ltd., 460 U.S.
533, 535 (1983) (per curiam).

In a footnote, the majority opinion also argues that this
case is distinguishable from Massey because “the accounts
were pledged as security on an antecedent loan, and the
deposit itself would render BOTW fully secure.” Maj. Op. at
26 n.13. Certainly, the creation of a new lien would have
made a preferential transfer. Nevertheless, the fact that
Tenderloin took the funds out of escrow and deposited the
money made no difference to the bank’s security position.
All of Tenderloin’s personal property was subject to the
same floating lien, including its general intangibles. Those
included Tenderloin’s contractual right to be paid the funds
out of escrow. See In re Merten, 164 B.R. 641, 643 (Bankr.
S.D. Cal. 1994). Tenderloin’s interest in those funds would
have been identically encumbered, and BOTW identically
secured, if the money had stayed in escrow indefinitely, or
transferred out of escrow and into a safe in Tenderloin's
offices.

Because Massey’s reasoning applies with the same force
today as it did in 1904, I cannot join in the majority’s holding
that the $526,402.05 deposit was a preference subject to
attack under § 547. I would have the hypothetical
bankruptcy court treat Tenderloin’s account as containing
 IN RE TENDERLOIN HEALTH 35

the full $564,115.92 as of the petition date, and proceed to
apply 11 U.S.C. § 553 to determine what portion of that
amount BOTW could set off against Tenderloin’s
$190,595.50 debt. 3

Section 553 does not preserve setoff rights without
limitation. Rather, creditors may only set off subject to the
strictures imposed by § 553(b), a “miniature preference
provision akin to [§ 547].” Eckles v. Petco Inc., Interstate (In
re Balducci Oil Co., Inc.), 33 B.R. 847, 852 (Bankr. D. Colo.
1983). Much like § 547(b) does for transfers, § 553(b)
directs us to apply an improvement-of-position test—it
disallows setoff to the extent that the creditor was better
secured on the date of setoff than it was on the first day it
became undersecured (or 90 days before bankruptcy, if an
insufficiency existed at the start of the preference period).

To be sure, there is some question whether § 553(b)
applies to limit actual post-petition setoffs. See COLLIER ON
BANKRUPTCY ¶ 553.09[2][c] (noting division of authority).
But as the Fifth Circuit has noted, the safeguards of § 553(b)
are unnecessary post-petition in an actual liquidation, where
the need to proceed by application to lift the automatic stay
gives the bankruptcy judge an opportunity to weigh the

3
The majority opinion faults me for analyzing the permissibility of
a post-petition setoff when the trustee has not raised the issue (having
relied whole-hog on its argument that the deposit itself was a preference).
Maj. Op. at 28–29 n.16. This case raises the important question of how
to measure the preferential impact of commonplace bank deposits, which
will often turn on the permissible extent of a hypothetical post-petition
setoff. “It is important that we address the proper legal standards” for
bankruptcy courts to apply in addressing the ultimate issue presented
here, and we may reach questions “intimately bound up with” that issue,
though not raised by the parties, in order to do so. See Kolstad v. Am.
Dental. Ass’n, 527 U.S. 526, 540 (1999).
36 IN RE TENDERLOIN HEALTH

equities of allowing or denying the creditor’s claim. Braniff
Airways, Inc. v. Exxon Co., U.S.A., 814 F.2d 1030, 1041 n.13
(5th Cir. 1987).

By contrast, in a hypothetical liquidation, there is no
such gatekeeper to protect other claimants. There is of course
no actual bankruptcy judge available to exercise discretion
in such a case, and it would push the already somewhat
strained boundaries of our hypothetical analysis too far to
exercise our own discretion, sitting as a three-headed
hypothetical bankruptcy judge, weighing the imaginary
equities of a fantasy liquidation. The majority asserts that
this adds a new variable to what is supposed to be a
controlled experiment, Maj. Op. at 28–29 n.16, but so would
exercising our own discretion—by substituting our
judgment for that of the real bankruptcy judge.

We cannot construct a hypothetical bankruptcy judge to
review a hypothetical application to lift the stay. So to
analyze a hypothetical post-petition setoff without applying
§ 553(b) would allow preference defendants to “have it both
ways” by avoiding both the statutory improvement-in-
position test and the bankruptcy court’s equitable oversight.
Braniff Airways, 814 F.2d at 1041 n.13. Like the Fifth
Circuit, I would “decline to let [BOTW] have it both ways,”
and hold that if it wants to defend a preference action by
relying “on a pre-petition right to setoff pursuant to [§] 553,
it must comply with . . . [§] 553(b).” Id.

The ensuing analysis is straightforward. Section 553(b)
directs that an offsetting creditor cannot improve its secured
position relative to where it stood on the date of the first
insufficiency. At all relevant times, Tenderloin owed BOTW
$190,595.50. Adopting the majority’s working assumption
that on the 90th day before the petition, Tenderloin's bank
balance was $173,015.00, this left an insufficiency of
 IN RE TENDERLOIN HEALTH 37

$17,580.50 relative to its debt. Assuming that Tenderloin’s
debt balance remained unchanged through the petition date,
§ 553(b) would allow BOTW to recover at most
$173,015.00 in a hypothetical post-petition setoff. I assume
that, like any diligent creditor, the bank would take as much
as it could, claiming that amount in full.

Since BOTW received $190,595.50 during the 90 days
before bankruptcy, but only would have received
$173,015.00 in a hypothetical liquidation, the trustee has
made out a prima facie case that the $17,580.50 difference is
voidable as a preference. So like the majority, I would
reverse the judgment below and send the case back to the
bankruptcy court for further proceedings. I would further
instruct the bankruptcy court to limit further proceedings to
considering BOTW’s affirmative defenses, and then—to the
extent that those do not carry the day on remand, and after
resolving any factual dispute as to the amount of
Tenderloin’s account balances on the relevant dates—to
enter judgment for the trustee in the amount given by
applying the foregoing analysis.