In June of last year, retailer Whitehall Jewelers filed for Bankruptcy in the United States Bankruptcy Court for the District of Delaware.  Last month, 14 months after filing for bankruptcy, Whitehall filed over 90 adversary actions in Delaware seeking to recovery payments the company made to various creditors during the 90 days prior to its filing for bankruptcy.

Debtors in bankruptcy (or their assignee) routinely seek to recover what they allege are “avoidable transfers” from the creditors who received payments as the debtor slides into bankruptcy.  While “ordinary course of business” and “new value” are core defenses frequently relied upon by defendants in a preference action, there are less common defenses that should not be overlooked.

This post will look briefly at the “mere conduit” defense.  Although the mere conduit defense is not always available to certain creditors, it is helpful to have an understanding of how the mere conduit defense has been applied by bankruptcy courts in both the District of Delaware and other jurisdictions.

The Elements of a Preference Action

Congress provides a debtor in bankruptcy with a cause of action for preference payments pursuant to section 547(b) of the United States Bankruptcy Code.  Under section 547(b), a debtor in bankruptcy may “avoid any transfer of an interest of the debtor in property (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor for such transfer was made; (3) made while the debtor was insolvent; (4) made (A) on or within 90 days before the date of the filing of the petition …”

Mere Conduit Defense

Congress also provided parties who received alleged “preference payments” with several defenses.  The “mere conduit” defense is set forth under section 550(a)(1) of the Bankruptcy Code and provides an exception to a debtor’s ability to recover preferential transfers:

Except as otherwise provided in this section, to the extent a transfer is avoided under section … 547 … the [debtor] may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from –

(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made …

Application of the Mere Conduit Defense

Courts deciding whether to apply the mere conduit defense look to whether the defendant who allegedly received the preferential transfers had “dominion and control” over the payments.  U.S. Interactive v. Sampson Travel Agency (In re U.S. Interactive), 321 B.R. 388, 395 (Bankr. D. Del. 2005).  For a defendant to establish the mere conduit defense, it must show that the payments received from the debtor “merely slipped through his hands to another party.”  Id., citing Bailey v. Big Sky Motors, Ltd. (in re Ogden), 314 F.3d 1190, 1196 (10th Cir. 2002);  see also, Christy v. Alexander & Alexander of New York Inc., (In re Finley, et al.), 130 F.3d 52, 58 (2d Cir. 1997).  If the defendant had the right to put the money to its use as it saw appropriate, the mere conduit defense does not apply.  Official Comm. of Unsecured Creditors v. Guardian Ins. 401 (In re Parcel Consultants, Inc.), 287 B.R. 41, 46 (Bankr. D. N.J. 2002).

In U.S. Interactive, the court found that the defendant, a travel agent, did not satisfy the mere conduit defense because the defendant was able to deposit the funds into its own checking account and do with the money as it saw fit.  Instead, what is required to satisfy the mere conduit defense is evidence that the initial recipient of the payments lacked the power to decide who to pay with the funds.  The decision in U.S. Interactive suggests that if the initial recipient of the money received from the debtor is required to deposit the funds in a separate account (versus its general operating account), and those funds are subsequently forwarded to a third party, the defense may apply.


Clearly, the mere conduit defense has limited application to parties who are defending a preference action.  However, for those defendants whose circumstances show they lacked “dominion and control” over the payments, and instead forwarded the payments to a third party,  the defense can be a valuable tool in reducing or eliminating exposure in a preference action.