In a decision likely to encourage continued supplier sales to distressed entities, the Eleventh Circuit in Auriga Polymers Inc. v. PMCM2, LLC1 joined the Third Circuit,2 the only other circuit to directly address the issue, finding that post-petition payments for the value of property received by a debtor within 20 days before the date of the petition, permitted by 11 USC 503(b)(9), do not diminish a creditor’s defense of “subsequent new value” preference.
I. Preferences in a nutshell
A preference is a cause of action permitted by Section 547(b) of the Bankruptcy Code.3 Under Section 547(b), a trustee or debtor-in-possession4 may avoid any “transfer” of a interest of the debtor in property that: (i) is for the benefit of a creditor or for the benefit of a creditor, (ii) is in respect of a previous debt owed by the debtor before such transfer was made ,5 (iii) is made while the debtor was insolvent,6 (iv) is made no later than 90 days before the date the petition is filed7 and (v) allows the creditor to receive more than that creditor would have received in a Chapter 7 bankruptcy if the transfer had not been made8. a restless entity a dubious outlook. Fortunately, Section 547(c) of the Bankruptcy Code offers some protections to a debtor’s imprudent counterparties. One such protection is the subsequent “new value” defense provided under Section 547(c)(4) of the Bankruptcy Code.
II. The New Later Value Defense
The subsequent new value defence, embodied in Section 547(c)(4) of the Bankruptcy Code, is intended to protect creditors who have provided the debtor with new value after receiving an otherwise avoidable preferential transfer. A creditor must prove three elements for the subsequent new value defense: (i) that the creditor gave new value after receiving the transfer, (ii) that the new value was not secured by otherwise unavoidable security, and ( (iii) that the obligor has not made an otherwise unavoidable transfer to the obligee or for the benefit of the obligee by reason of the new value. If the creditor can satisfy these elements, then he can reduce the preferential exposure of the new subsequent value delivered to the debtor. For several years, this seemingly simple defense suffered from several contradictory decisions.
Majority rule is illustrated by the decision of the Fifth Circuit in Matter of Toyota of Jefferson, Inc., and is best demonstrated in the context of an example9. In Toyota of Jefferson, the trustee in bankruptcy challenged the district court’s decision limiting the amount of his preference recovery to $90,169.10 During the preference period: (i) the debtor made a payment of $30,830 $.75 on a loan from the creditor, (ii) the creditor advanced to the debtor an additional amount of $82,993.00, (iii) the debtor repaid the $82,993.00, (iv) the creditor advanced an additional $90,169.00 and (v) finally, the debtor repaid the $90,169.00.11 The trustee in bankruptcy argued that the creditor should not be entitled to reduce its risk of preference with either either of the two advances made during the preferential period because the debtor had repaid these In other words, the debtor argued that the creditor should not be allowed to reduce its preferential exposure, in accordance with Article 547(c)(4), because the subsequent news will The payment provided is not res unpaid.13 The Fifth Circuit rejected this statement, noting that the proper question was not whether the subsequent new value remained unpaid, but whether refunds were not “otherwise unavoidable”.14 The Court then went on to upheld the district court’s decision. that the creditor’s preferential exposure was $90,169.00, as no new subsequent value existed to reduce the exposure for this payment.15
The minority rule stemmed from dicta in the now infamous Third Circuit notice in New York City Shoes. transferred.17 lower courts in holding that there was a rebuttable presumption that a postdated check had not been transferred on the date of delivery.18 The Third Circuit went on to find that the creditor was not entitled to a new defense of subsequent value because the presumption records.19 Despite this narrow ruling, a number of courts have taken dicta from the view suggesting that new subsequent value provided by a creditor must remain unpaid. This had the unfortunate effect of creating, essentially, a second analysis of the new value. The typical new value analysis, as exemplified by Toyota of Jefferson, takes a tally of potential preferential payments by the obligor and subsequent new value provided by the creditor, with preferential exposure being the end result of the tally. the New York City Shoes dicta used a different new value analysis that erased, rather than offset, any new value provided by the creditor to the extent that it was paid. The table below illustrates the majority and minority analyzes using Toyota payments from Jefferson.
Decades later, the Third Circuit finally recognized the New York City Shoe language as dicta.29 Uncertainties persist. For example, under the minority approach, what if the subsequent new value remains unpaid until the debtor declares bankruptcy, but is then paid after the petition? What would happen if, according to the majority approach, the subsequent new value was paid for after the petition by a transfer that was “otherwise unavoidable?” Enter section 503(b)(9).
III. The Impact of 503(b)(9) Administrative Claims on the Subsequent New Value Defense
Section 503(b)(9) allows a creditor to claim administrative costs for the value of property received by the debtor during the 20-day period prior to bankruptcy. Since administrative expense claims must be paid in full to confirm a reorganization plan, they are, in a sense, unavoidable transfers. In this context, the question is whether a creditor’s subsequent new value defense is diminished to the extent that such creditor receives payment under section 503(b)(9) in respect of such new value. ? The Eleventh Circuit in Auriga held that payment of 503(b)(9) administrative expense claims did not diminish a creditor’s subsequent new value defense.
IV. Enter Charioteer
In Auriga, the debtor was a major manufacturer and distributor of carpets and hard surface flooring and the creditor was a vendor who supplied the debtor with certain materials. After filing for bankruptcy, the debtor confirmed a plan of liquidation vesting all of its assets, including the rescission actions, in a liquidation trust.32 During the 90-day period before the debtor filed for bankruptcy, the debtor paid the creditor more than $2.2 million and the debtor received more than $3.523 million in property during this period.33 The creditor filed an administrative claim for expenses pursuant to 503(b) (9) for property transferred within 20 days of the debtor filing for bankruptcy and received payment in the amount of $273,38234 (the difference between the full administrative expense claim of $694,502 and the $421,119 disputed) during the bankruptcy proceedings.35 The creditor immediately filed a general unsecured claim for the remaining unpaid goods delivered more than 20 days before the issue date.36
The liquidator filed a lawsuit, seeking to avoid the $2.2 million in pre-petition payments as preferences under section 547(b).37 The liquidator and creditor entered into a stipulation whereby the parties agreed that the $2.2 million in payments were all avoidable preferences, but that all such payments except $421,119 were protected by the creditor’s new later value defense. also use it as part of its subsequent new value defence.39 Thus, the case was limited to the narrow question of whether payment of a 503(b)( 9) constituted an “otherwise unavoidable transfer” negating an element of the obligee’s subsequent new value defence.
The bankruptcy court, consistent with its decision in an earlier challenge brought by the liquidator, held that funds held in reserve to pay 503(b)(9) claims are “otherwise unavoidable” transfers. for purposes of a 547(c)(4) defense, and cannot be used to offset preference liability.41 The bankruptcy court, in reaching this decision, pointed to the silence of 547(c )(4) as to whether the “otherwise unavoidable” transfer takes place before or after the request. 42
The Eleventh Circuit vacated, noting that the bankruptcy court’s reliance on its previous decision in In re BFW Liquidation43 was misplaced given that the court never said anything about the timing of the “otherwise unavoidable” transfers in that case. 44 The court held that post-petition payments made under section 503(b)(9) are not “otherwise unavoidable” transfers for purposes of the new section 547 subsequent value defense. (c)(4).45 In reaching this conclusion, the Court held that a number of the elements of Section 547 suggested that the relevant transfers must be a pre-petition, including: (i) the title of the law, (ii) the requirement that new value be given to the pre-petition (suggesting that otherwise unavoidable transfers must also take place before the petition), (iii) that the statute of limitations begin to run on the date of the request and (iv) that the “transf ert” is to be presumed to have the same meaning throughout Section 547(c)(4).46 The Eleventh Circuit joins the Third Circuit as the only two circuits to have d have directly addressed this issue and have all two concluded that payment of 503(b)(9) administrative expense claims does not prevent goods delivered within 20 days of the date of the claim from having new subsequent value.
While the Eleven’s Circuits decision in Auriga and the Third Circuit decision in In re Friedman’s Inc. should reassure non-debtor suppliers and commercial sellers, remember that the remaining Circuits have yet to weigh in on this issue.