A New Type of Government Refund: Criminal Restitution Payments Recoverable as Preferential Transfers

15 Aug A New Type of Government Refund: Criminal Restitution Payments Recoverable as Preferential Transfers

From the 9th Circuit last week, a decision providing creditors and their representatives with a potentially new source of preferential recoveries: pre-petition criminal restitution payments.

Jeffrey and Faye Silverman – electrical contractors – were indicted in 2005 for fraud and underpayment of workers’ compensation insurance premiums.  In March of that year, they paid the California State Compensation Insurance Fund $101,531 in restitution as part of a plea agreement and their court-ordered sentence.  Less than 60 days later, they sought relief under Chapter 7.

Their trustee sought recovery of the restitution payment from the State Fund under the theory that the payment was a preferential transfer under Section 547(b) of the Bankruptcy Code.

Both sides moved for summary judgment.  For its part, the State Fund argued that Section 547(b) doesn’t apply to criminal restitution payments, citing Kelly v. Robinson, 479 U.S. 36 (1986) and Becker v. County of Santa Clara (In re Nelson), 91 B.R. 904 (N.D. Cal. 1988).  Kelly held that criminal restitution payments are non-dischargeable under Section 523(a)(7).  Nelson extended Kelly to hold that payments on such non-dischargeable obligations are not recoverable as preferences.

The Bankruptcy Court for the Central District of California was not persuaded – nor was the District Court, which heard the matter on appeal following entry of summary judgment in the trustee’s favor.

The Ninth Circuit agreed.  Finding that criminal restitution payments are, in fact, subject to the preference statute, the Ninth Circuit held that State Fund enjoyed no “judicial exception” to Section 547(b)’s reach.  In the 3-judge panel’s view, an obligation’s non-dischargeability is separate and distinct from recovery of its pre-petition payment as a preference.  Further, the restitution payments to State Fund were “to or for the benefit of” State Fund within the contemplation of Section 547(b)(1) – State Fund’s arguments to the contrary notwithstanding.

The decision is an important one for creditors’ representatives and committees seeking possible additional sources of recovery where the debtor has been attempting to resolve criminal problems pre-petition.