Wednesday, January 28, 2015

New Value - An Often-Overlooked Preference Defense (Stephen Stapleton)

By Steve Stapleton

New Value - An Often-Overlooked Preference Defense This article is the second in a continuing series on defenses to preference claims.  Below is the hypothetical fact pattern we will be using throughout the series.  Future articles on preference defenses will be highlighted in subsequent Cowles & Thompson newsletters. The facts:  You are owed a substantial sum of money – one million dollars -- on a pre-existing obligation.  But the debtor is having nascent financial issues.  Although he was paying like clockwork – 30 days net -- he still owes $800,000 and has paid you nothing for the last 60 days.  You demand payment in full.  And that’s what you get: payment in full.  Satisfied he is good for the monies owed, you perform additional services and now he owes you another $600,000.  Two months later, the debtor having paid nothing on the subsequent invoices, you receive a notice advising you that he’s filed chapter 7.  Two years later, the chapter 7 trustee says that you received a preference and demands that you pay back, in ten days, the $800,000 that you had previously received two years earlier.  So now you’re potentially out $1.4 million.  Assuming the debtor is not paying his creditors in full, under the facts above, you’ve received a preference.  The question now is whether you have a valid defense. The preference provisions of the Bankruptcy Code provide, with certain exceptions, that transfers made by a debtor to a creditor on a pre-existing obligation within 90 days of the bankruptcy filing are preferential.  As such, they can be recovered.  Among the defenses available to creditors who have received such transfers is the new value defense.  That defense generally provides that the trustee may not recover a transfer to the extent the creditor gave new value to the debtor after the debtor received the alleged preference payment.  Thus, three requirements for such a defense is that the creditor must first have received the initial transfer that is recoverable as a preference.  Second, the creditor must subsequently advance new value to the debtor on an unsecured basis.  Third, the debtor must not have paid that advance of new value; generally, payment of the subsequent new value is the death knell for the new value defense. But assume the debtor receives an order from the court after filing bankruptcy authorizing the payment to you as a critical vendor.  The amounts due are paid and you are made whole.  However, the chapter 7 trustee offers you a case called In re Kiwi International Air, Inc., 344 F.3d 311 (3d Cir. 2003) (see footnote 1 below) which says that the court has to account for material events occurring after the bankruptcy in performing a preference analysis.  Do you still get to keep your new value defense even though you’ve been paid? In a case of first impression, the Third Circuit Court of Appeals said yes.(see footnote 2 below)  Relying “on the context and policy of the [Bankruptcy] Code, rather than [its] specific language,” the Third Circuit held that one of the policies of the Code is to ‘treat fairly a creditor” who provides new value.  The policy of equality of distribution among creditors of the debtor was not enacted so as “to ensure equitable treatment of creditors but rather is intended to encourage creditors to deal with troubled businesses.”  Thus, “a critical vendor who provided new value during the preference period need not be treated the same as” one who didn’t.  Where the bankruptcy court issued an order authorizing the post-petition payment, it would impair the Code’s policies to undermine that order.  While Kiwi advises that post-petition events may influence a preference analysis, it is the context and policy of the Bankruptcy Code which must first be considered.  It is that policy and context which will determine how much influence such post-petition events will have.
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  1. The author of this article was involved in the Kiwi appeal to the Third Circuit Court of Appeals.
  2. In re Friedman’s (Friedman’s Liquidating Trust v. Roth Staffing Companies LP), No. 13-1712 (3d Cir., Dec. 24, 2013).

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