As Del Monte’s second day hearing approaches on 4 August, the question of whether Dechert on behalf of a minority group of creditors chooses to pursue the company’s pre-bankruptcy LME litigation settlement as a preference under section 547 of the Bankruptcy Code is likely top of mind for many creditors.

In 9fin’s previous article on the topic (found here), we explore the definition of a preference under the Bankruptcy Code, whether this type of settlement is considered “antecedent debt,” potential defenses available and the Bankruptcy Code’s safe harbor provisions.

Part of asserting a preference — as mentioned in the previous article — requires proving all elements of 547(b), while not falling under any of the exceptions listed in 547(c) or (i). In 547(b), “interest of the debtor in property” is not defined, however, according to Colliers, The Supreme Court interpreted the term to mean “property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings.”

Consequently, one could attack the assumption that the property transferred belonged to the debtor in the first place. Facts at hand in Del Monte include the following: (1) the settlement was funded through an increment to the new first lien first out facility by certain lenders who participated in the LME and (2) that Del Monte did not contribute monetarily to the new term loan that was raised specifically to fund the settlement.

One such defense brought to 9fin’s attention is the “Earmarking Doctrine.”

The earmarking doctrine is “a judge-made equitable doctrine that does not appear in the Bankruptcy Code.” The earmarking doctrine, which according to Colliers (excerpted from a relevant memorandum) is “a widely accepted exception to section 547,” provides that “when a third person makes a loan to a debtor specifically to enable that debtor to satisfy the claim of a designated creditor, the proceeds never become part of the debtor’s assets, and therefore no preference is created.” The rationale is that one creditor has been substituted for another and “the assets from the third party were never in the control of the debtor.”

While the earmarking doctrine is intended to be construed narrowly, the Del Monte LME settlement payment would appear likely to fit the mold. The incremental loan extended by the participating lenders that the debtors received was specifically for the purpose of paying off the settlement, and the funds were used for the purpose. Accordingly, following the logic of the earmarking doctrine, those funds were never part of the estate. Although the incremental term loan here increased the company’s total debt by around $20m (understood to be net of the repayment of the term loan due 2029 in full) this would likely not have any effect on the earmarking doctrine analysis which turns on whether the company had control over the money being paid as a settlement.

Whether we can attest to Colliers’ description that this is a “widely accepted exception” is another matter.

Del Monte’s second day hearing will be held on 4 August at 10am ET.

The full docket can be found here.