Nick Sears, Defeating the Preference System: Using the Subsequent New Value Defense and Administrative Expense Claims to ?double Dip?

• Citation: Vol. 28 No. 2
• Publication year: 2011

DEFEATING THE PREFERENCE SYSTEM: USING THE SUBSEQUENT NEW VALUE DEFENSE AND ADMINISTRATIVE EXPENSE CLAIMS TO “DOUBLE DIP”

INTRODUCTION

The Bankruptcy Code (Code) provides a mechanism called “preference avoidance” through which a creditor can be forced to disgorge payments received from a debtor during the ninety days prior to the filing of the debtor’s bankruptcy case.1 A preferential transfer is “[a] prebankruptcy transfer made

by an insolvent debtor to or for the benefit of a creditor, thereby allowing the creditor to receive more than its proportionate share of the debtor’s assets.”2 To defend against disgorgement, a creditor may assert that it gave the debtor “subsequent new value” in the form of goods shipped by the creditor to the

debtor that balance out the net effect to the debtor’s estate from the creditor’s preference.3 The Code also allows a creditor to receive priority payment from the debtor’s estate for goods shipped twenty days before the bankruptcy filing.4 What if a creditor could ensure that it keep its preferences and receive a priority position on payments owed to it? Would that comply with the policy goals behind the Code?

The argument for using the same goods as both an administrative expense and as subsequent new value appeared for the first time in In re Commissary Operations.5 In In re Commissary Operations, the bankruptcy court for the Middle District of Tennessee allowed a creditor to claim both a subsequent new value defense and an administrative expense for the same goods.6

1. 11 U.S.C. § 547(b) (2006) (“Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property . . . made on or within 90 days before the date of the filing of the petition . . . .”).

2. BLACK’S LAW DICTIONARY 1217 (8th ed. 2004).

3. 11 U.S.C. § 547(c)(4) (“The trustee may not avoid under this section a transfer to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the

   debtor . . . .”).

4. Id. § 503(b)(9) (“After notice and a hearing, there shall be allowed administrative expenses . . . including the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”).

5. Commissary Operations, Inc. v. Dot Foods, Inc. (In re Commissary Operations, Inc.), 421 B.R. 873, 879 (Bankr. M.D. Tenn. 2010).

6. Id.

   However, less than a year later, the bankruptcy court for the Northern District of Georgia encountered the same argument in the 2010 case TI Acquisition, LLC v. Southern Polymer and concluded to the contrary.7 Both courts reached their conclusions by viewing the matter from the perspective of the creditor.8 The first court justified its decision as being based on a plain language interpretation of the Code and pursued a formalistic approach in distinguishing the case from earlier decisions.9 In contrast, the second court put stronger emphasis on policy and took a functionalist approach to the Code, concluding that allowing a creditor to assert both a subsequent new value defense and an administrative expense for the same goods would upset the bankruptcy policy goal of equality among creditors.10

   
   

   This Comment will refer to the use of the § 547(c)(4) subsequent new value defense for the same goods that a creditor claims a § 503(b)(9) administrative expense for as “double dipping,” a term used by some in the bankruptcy community to describe this issue.11 This Comment addresses two primary

   issues: whether courts should allow creditors to double dip and, if not, what legal tools judges and lawyers can use to fight the practice.

   
   

   It may be years before the appellate courts answer these questions. Some commentators have argued that district courts, charged with overseeing the decisions of the bankruptcy courts, “neglect their bankruptcy appeals” and simply “rubber stamp the bankruptcy court.”12 Frequently, creditors do not

   appeal bankruptcy decisions. Given the need for speedy resolution of bankruptcy issues, the matter may become moot by the time the creditor gets to the district court, much less the courts of appeals. Thus, resolution of the issue in higher courts might be years away.

   
   

7. TI Acquisition, LLC v. S. Polymer, Inc. (In re TI Acquisition, LLC), 429 B.R. 377, 385 (Bankr. N.D. Ga. 2010).

8. See generally In re TI Acquisition, 429 B.R. 377; In re Commissary Operations, 421 B.R. 873.

9. See In re Commissary Operations, 421 B.R. at 878–79.

10. See In re TI Acquisition, 429 B.R. at 385. See generally H.R. REP. NO. 95-595, at 177–79 (1978),

    reprinted in 1978 U.S.C.C.A.N. 5785, 6138–40.

11. See, e.g., Rudolph J. Di Massa Jr. & Laura D. Bonner, ‘Double Dipping’ New Value Defense and Administrative Expense Claims, LEGAL INTELLIGENCER, May 7, 2010, available at http://www.duanemorris.

    com/articles/double_dipping_new_value_defense_administrative_expense_claims_3666.html.

12. Commission Considers Venue, Jurisdiction, Appellate Changes at February Meeting, 15 AM. BANKR. INST. J., Apr. 1996, at 1, 13; see also Jennifer M. D’Angelo, Comment, If You Can’t Beat Them, Join Them: Inclusive Joinder and the Filtering of Article III Status into the Bankruptcy Courts, 22 EMORY BANKR. DEV. J. 603, 610 (2006) (noting that, between 1978 and 1984, the Emergency Rule had stripped bankruptcy judges of

    Article III power, but that bankruptcies continued “with the bankruptcy courts deciding almost everything and with review by the district judges usually being little more than a cursory ‘rubber stamp’ procedure” (quoting CHARLES JORDAN TABB, THE LAW OF BANKRUPTCY § 4.2, at 227–28 (1997))).

    This Comment will focus on two options that a bankruptcy court should use to prevent double dipping: (1) ban double dipping outright, or (2) use

    § 502(d) to disallow an administrative expense claim until the creditor has

    disgorged the preference.

    
    

    In re Circuit City Stores held that § 502(d) could be used to disallow

    § 503(b)(9) administrative expense claims by virtue of the fact that § 503(b)(9) claims arose prior to the petition date, making those seeking to double dip “creditors” under the Code.13 Because the § 503(b)(9) claimants were considered creditors, the Bankruptcy Court reasoned that they must file a proof of claim.14 In filing the proof of claim, the administrative expense claimant is brought into compliance with § 501(a) and thus § 502(a).15 Therefore, the Court determined that § 502(d) can be used to disallow proofs of claims by

    § 503(b)(9) creditors.16 The Circuit City court reasoned that “[t]he goals of equitable distribution and efficiency support the conclusion that § 502(d) may

    be employed to temporarily disallow the [c]laimant’s [c]laims.”17

    
    

    Although In re Circuit City allowed § 502(d) disallowance of § 503(b)(9) administrative expense claims, the scope of the decision remains unclear. The court employed certain modifiers in its framing of the issue that might be used in the future to limit its holding. Namely, the court distinguished between

    transfers that are avoidable and those that are “potentially recoverable.”18

    
    

    However, requests to use § 502(d) to disallow a § 503(b)(9) administrative expense claim have been denied by many bankruptcy courts that have noted that nothing in § 502(d) explicitly pertains to § 503(b)(9).19 Further, at least one bankruptcy court has suggested that § 502(d) is only applicable to prepetition claims.20 This court reasoned that § 503(b)(9) claims are not

    
    

13. In re Circuit City Stores, Inc., 426 B.R. 560, 571 (Bankr. E.D. Va. 2010).

14. Id.

15 See 11 U.S.C. §§ 501(a), 502(a) (2006).

1. In re Circuit City Stores, 426 B.R. at 571.

2. Id.

3. Id. at 566.

4. See, e.g., S. Polymer, Inc. v. TI Acquisition, LLC (In re TI Acquisition, LLC), 410 B.R. 742, 750 (Bankr. N.D. Ga. 2009); In re Plastech Engineered Prods., Inc., 394 B.R. 147, 162 (Bankr. E.D. Mich. 2008); Roberds, Inc. v. Broyhill Furniture (In re Roberds, Inc.), 315 B.R. 443, 476 (Bankr. S.D. Ohio 2004); Beasley Forest Prods., Inc. v. Durango Ga. Paper Co. (In re Durango Ga. Paper Co.), 297 B.R. 326, 330–31 (Bankr.

   S.D. Ga. 2003); In re Lids Corp., 260 B.R. 680, 683–84 (Bankr. D. Del. 2001); Camelot Music, Inc. v. MHW Adver. & Pub. Relations, Inc. (In re CM Holdings, Inc.), 264 B.R. 141, 157–58 (Bankr. D. Del. 2000).

5. See, e.g., In re TI Acquisition, 410 B.R. at 751 (reasoning that § 503(b)(9) claims are administrative

   expenses and not prepetition claims and, therefore, not subject to disallowance under § 502(d)).

   
   

   prepetition claims.21 Section 503(b)(9) claims are unique because they are administrative expenses—typically reserved for postpetition claims—but arise out of prepetition activities.22 Bankruptcy courts should categorize § 503(b)(9) claims as prepetition contingent claims, the underlying substance of which

   arises from prepetition activities but whose status as an administrative expense is contingent on particular activity from the debtor. The particular activity from the debtor in this situation would be the filing of bankruptcy within twenty days of having received a shipment of goods from the creditor.

   
   

   For courts that permit the use of § 502(d) to disallow a § 503(b)(9) claim, the only option is to forbid double dipping altogether. However, the Code does not explicitly prevent a creditor from claiming both § 547(c)(4) subsequent new value in the context of a preference action and a § 503(b)(9)

   administrative expense for the same goods.23 It seems that formalism does not

   resolve the issue.

   
   

   The goal of this Comment is to advocate against allowing creditors to double dip in bankruptcy proceedings and to give courts tools to prevent creditors from doing so. Permitting double dipping will lead to unequal treatment among creditors in bankruptcy proceedings and, on rare occasions, allow savvy debtors to protect favored creditors in the weeks leading up to bankruptcy filings.

   
   

   This Comment will use two different proceedings from one bankruptcy case pending in the...