Chapter 7 Subsequent New Value Defense & Contemporaneous Exchange for New Value Defense

• Jurisdiction: United States

Chapter 7 Subsequent New Value Defense & Contemporaneous Exchange for New Value Defense

Like the ordinary-course-of-business defenses discussed in the preceding chapters, the subsequent new value defense and the contemporaneous exchange for new value defense both allow creditors to reduce their preference exposure if certain conditions are met and are intended to encourage creditors to continue doing business with companies on the verge of insolvency.

Generally, a creditor may satisfy the subsequent-new-value defense under 11 U.S.C. § 547(c)(4) by demonstrating that it provided unsecured new value to the debtor by selling goods and/or providing services to the debtor on credit terms after the occurrence of an alleged preference. To successfully assert the contemporaneous-exchange defense under 11 U.S.C. § 547(c)(1), a creditor must demonstrate that the parties intended the transfer at issue to be a contemporaneous exchange, the exchange was actually contemporaneous, and the exchange was for new value. Critical to both defenses is the term "new value," which courts typically interpret as requiring a "material benefit" to the debtor such that there is ultimately an enhancement of the bankruptcy estate.²⁴⁹

Subsequent New Value

In addition to encouraging creditors to continue working with financially troubled companies, the subsequent new value defense is "designed to ameliorate the unfairness of allowing the trustee to avoid all transfers made by a debtor to a creditor during the preference period without giving any corresponding credit for advances of new value that benefitted the debtor."²⁵⁰ In relevant part, § 547(c)(4) provides that the trustee or debtor in possession may not avoid a transfer "to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor ... (A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor."²⁵¹

Pursuant to § 547(c)(4), new value can be either tangible or intangible. One ruling by the U.S. Bankruptcy Court for the Eastern District of New York in particular offers a detailed explanation of this point. In In re Brown Publishing Co., the court explains that when Brown (the debtor) made three transfers to Hudson (the creditor) for the benefit of its subsidiary, Utah Business Publishers, during the preference period,

Brown received tangible and intangible indirect benefits from the Transfers. Despite the fact that Brown and Utah were separate legal entities, Brown and Utah operated as a single economic unit. Brown retained all of the income generated by Utah and paid all of Utah's obligations. Each time the cash was swept out of Utah's bank account and into Brown's account, which happened on a regular basis, Brown received a measurable benefit. Brown used the funds generated by Utah's operations to pay down Brown's working capital line and expand its borrowing base. In addition to these benefits, Brown reaped the benefit of Utah's increasing value. By paying Hudson, Brown ensured that Utah's publications would be printed on time and without interruption, preserving Utah's goodwill and reputation, and increasing the amount Brown ultimately received upon the sale.²⁵²

Accordingly, the court held that Hudson provided Brown with subsequent, unsecured new value and therefore was entitled to an offset of the alleged preference payments.²⁵³

The timing of alleged preferential transfers relative to the delivery of new value is a crucial factor under § 547(c)(4), since only new value provided after the preference payment may be credited against the preference amount.²⁵⁴ New value is generally deemed to have been extended at the time goods are actually shipped from the creditor's premises or at the time services are actually rendered. An alleged preference payment is typically deemed complete on the date of delivery (i.e., receipt by the creditor) and not clearance. Where goods are shipped or services are provided on the same day that a creditor receives an alleged preference payment, the creditor will typically argue that the new value was extended after receipt of the alleged preference, thereby reducing its preference exposure. Given that this is an affirmative defense, however, it is the creditor's burden to prove that the new value was provided after the payment was received.

In re Gulf Fleet Holdings Inc. is illustrative. In that case, Adriatic Marine (the creditor) delivered new value to the debtor in the form of leased offshore supply vessels over a period from Feb. 27 to March 16, 2010.²⁵⁵ The debtor made two payments by check to Adriatic, the first delivered on March 3rd and the second delivered on March 10th. While the court ruled in the favor of Adriatic on the first payment,²⁵⁶regarding the second payment the court ruled that "the new value defense would only apply to the new value provided after the March 10th check was delivered to Adriatic, not the date the check was signed or the date the check posted."²⁵⁷ However, because Adriatic failed to carry its burden of proving delivery before March 15 (the date the check ultimately posted to its bank account), the court found that it was entitled to a reduction only for the new value provided on or after that date.²⁵⁸

While some courts have held that only the payment immediately preceding the extension of new value may be included for purposes of the new value defense, the majority of courts allow a creditor to deduct new value from the payment immediately preceding the extension of new value, as well as all prior preference payments.²⁵⁹ The rationale for such a ruling is that nothing in the language of § 547(c)(4) limits the application of the new value defense to the immediately preceding payment only.

Third-party payments to a creditor generally prevent the use of the new value defense because they have the effect of depleting the estate of the debtor, as if the debtor had made the payment directly. There are, however, exceptions. For example, in In re Sparrer Sausage Co., Jason's Foods (the creditor) was reimbursed through an insurance claim.²⁶⁰ The court held that "[t]he insurer owed Spar-rer nothing that would be diminished because of its payment to Jason's.... Looking to the effect on the estate, the new value contributed by Jason's was indeed unpaid."²⁶¹ Accordingly, "since the net effect of the new value payments was restoration of the estate," the Court found that Jason's was entitled to rely on the new value defense.²⁶²

"Remains Unpaid" Approach vs. "Subsequent Advance" Approach

Currently there exists a "jurisdictional split regarding the interpretation and application of § 547(c)(4)(B)."²⁶³ More specifically, while some courts have concluded that § 547(c)(4)(B) "should be read to mean that new value must remain unpaid at the end of the preference period in order to be used as a defense to a preferential claim," others have found that this section "does not contain a 'remains unpaid' requirement, rather the court must determine if 'subsequent advances' were made by the creditor."²⁶⁴

Courts adopting the "remains unpaid" approach reason that there is no benefit to the estate where the new value has been paid by the debtor pre-petition. In other words, such courts have held that "[n]ew value that has been paid by the debtor prior to the petition date is not eligible for offset under section 547(c)(4) because paid new value does not represent the return of a preferential transfer to the estate."²⁶⁵ It may be further argued that if a creditor is entitled to assert paid new value as part of its new value defense, it will receive a double recovery because it has been, first, paid for the new value and, second, permitted to use the new-value defense to reduce its preference exposure.

Nonetheless, the "emerging trend" among courts is in favor of the alternative "subsequent advance" approach, under which "the new value defense is available, despite payment, if the payment was an avoidable transfer."²⁶⁶ Courts adopting this approach note that there is no practical distinction between a creditor that has been paid for new value in a transfer that is avoidable as a preference and a creditor that has not been paid at all in advance of the petition date.

New Value Given Post-Petition

Although a few courts have ruled that unpaid invoices for post-petition services rendered by a creditor may be counted as new value, "[t]he vast majority of courts that have considered this issue have concluded that new value advanced after the petition date should not be considered in a creditor's new value defense."²⁶⁷ In a recent case in Delaware, for example, the trustee argued that more than half of the invoices relied upon by the debtor related to post-petition services and therefore were not eligible for inclusion in the creditor's new-value defense.²⁶⁸ The court agreed, finding that "only services provided pre-petition" may be included under § 547(c)(4).²⁶⁹

New Value Returned or Paid by Debtor Post-Petition

Courts are also divided on the issue of whether a debtor's post-petition return of goods or payment for new value reduces the amount of the new value defense. In In re Friedman's Inc., for example, the U.S. Court of Appeals for the Third Circuit ruled that a post-petition payment made to the defendant in a preference action on account of pre-petition invoices did not affect the ability of the defendant to use the pre-petition invoices as new value to reduce its preference lia-bility.²⁷⁰ After noting that the issue was one of first impression in the Third Circuit, the court specifically held that "where 'an otherwise unavoidable transfer' is made after the filing of a bankruptcy petition, it does not affect the new value defense."²⁷¹

The court in Friedman's did recognize that "a number of courts have come out the other way on the issue before" it.²⁷² It concluded, however...