Chapter 4 CONTEMPORANEOUS EXCHANGE

• Jurisdiction: United States

Chapter 4 CONTEMPORANEOUS EXCHANGE

The Statute

Section 547(c)(1) of the Bankruptcy Code states:

(c) The trustee may not avoid under this section a transfer —

(1) to the extent that such a transfer was —

(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and
(B) in fact a substantially contemporaneous exchange....

Some courts have inferred a standard of 10 days between the transfer and the value given for the transfer in order for the exchange to be considered "contemporaneous," borrowing from the pre-BAPCPA version of § 547(e)(2), which has resulted in a circuit split. Adding to the disparity is the fact that § 547(e)(2) was amended by BAPCPA to change the time period from 10 to 30 days.

First Circuit

1. Collins v. Greater Atl. Mortg. Corp. (In re Lazarus), 478 F.3d 12 (1st Cir. 2007).

The First Circuit vacated and remanded the district court that had affirmed the bankruptcy court's denial of the trustee's motion for summary judgment. Greater Atlantic Mortgage Corporation (GAMC) refinanced a mortgage originally held by Washington Mutual. The new mortgage was recorded 15 days after the funds were paid to satisfy the earlier mortgage. The debtor filed a chapter 7 case, and the trustee sought to avoid the GAMC mortgage as a preferential transfer. GAMC asserted the contemporaneous-exchange defense under § 547((c)(1), arguing that the 15 days between payment and recording was intended to be contemporaneous and was, in fact, substantially contemporaneous. The First Circuit ruled that the first portion of § 547(c)(1) was satisfied. The transfer of the Lazarus's grant of the mortgage to GAMC was intended to be contemporaneous exchange for new value given to the debtor (the loan to Lazarus from GAMC used to pay off Lazarus' debt to Washington Mutual). The court, however, found that the exchange was not "substantially contemporaneous." The failure to perfect within 10 days created a transfer that the court found was not substantially contemporaneous. The court explained: "True, the later 10-day grace period was an arbitrary compromise — mechanical deadlines almost always are — and can result in losing security even where no one was prejudiced. But such deadlines have the benefit of being specific and avoiding litigation about actual prejudice. This was the approach Congress chose. To enlarge the 10-day deadline for secured interests is to undo Congress' choice."⁹⁶

The First Circuit's rationale was based largely on a specific concern that consensual lienors should not be able to use § 547(c)(1) to perform an end-run on § 547(e)(2), since Congress had targeted the latter provision directly at later-perfected consensual liens in order to "combat secret liens and protect those who might lend in ignorance of the mortgage," whereas § 547(c)(1) had been aimed at the broader, more generic issue of delayed payment for goods when a check or other credit payment had been used in the exchange by the debtor. Section 547(e) has since been amended, with the 10-day grace period at play in Lazarus having been replaced with a 30-day grace period. Under the rationale in Lazarus, therefore, the rule might be stated as follows: If a consensual lienor delays perfecting its lien such that the antecedent debt element in § 547(b)(2) is met by virtue of § 547(e)(2), the contemporaneous exchange defense under § 547(c)(1) will never be available to insulate the transfer of the lien.⁹⁷

Second Circuit

1. Van Dyck/Columbia Printing v. Katz, 289 B.R.

304 (D. Conn. 2003).

Promissory notes due on demand, but payable in full in 13 months, were not intended by the parties as a contemporaneous exchange. Moreover, repayment periods, the shortest of which was 27 days, were too extended to be considered substantially contemporaneous. The court found that the parties intended the loans to be paid promptly, and the notes themselves contained language that the debts were due on demand. The court reasoned, however, that a loan structure of monthly installments was persuasive evidence that the parties could not have intended the promissory notes to be contemporaneous transfers.

2. In re Air Vermont Inc., 45 B.R. 817 (D. Vt. 1984).

A security interest that became effective 11 days after an initial credit advance of $100,000 was, "in fact, substantially contemporaneous" and fell within the protection of § 547(c)(1). In this case, the creditor advanced new credit to the debtor on Jan. 12, 1984, in exchange for a security interest in the debtor's accounts receivable. The security interest was executed on Jan. 6, 1984, and became effective when the financing statement was recorded with Vermont's Secretary of State.

The court first clarified that a secured loan transaction may be an exchange within the meaning of § 547(c)(1). Furthermore, the court cited In re Ar-nett⁹⁸ for the notion that when a delay in perfection of a security interest that extends beyond the 10-day grace period is satisfactorily explained, the statute should not prevent the courts from being able to determine that the transaction was substantially contemporaneous. On this basis, the court held that the 11 -day delay between the day the security interest was executed and the date on which it was perfected did not cause the exchange to not be, "in fact, substantially contemporaneous."

3. F & S Central Manufacturing Corp. v. Buildex Inc., 53 B.R. 842 (Bankr. E.D.N.Y. 1985).

The debtor was a wholly owned subsidiary of the creditor, a parent company to which it was indebted in the amount of $3.249 million. In a buy/sell transaction, the creditor agreed to sell the debtor to a third party. As part of the agreement, the debtor would pay the creditor $1.499 million, and the creditor agreed to subordinate the remaining $1.75 million owed to it. Shortly after the transaction closed, the debtor filed its bankruptcy petition.

The court held that the modification agreement whereby the creditor agreed to subordinate $1.75 million of the amount owed to it could constitute "new value" in the form of money or money's worth in new credit. The court recognized that as a general rule "to the extent that the creditor can demonstrate that its agreement to modify the terms of the debtor's obligation gave the debtor money or money's worth in new credit ... there is no reason to avoid the transfer."⁹⁹

4. Candor Diamond Corp. v. Matmon Gem Co., 44 B.R. 195 (Bankr. S.D.N.Y. 1984).

On numerous occasions, the debtor and the creditor bought and sold diamonds, and the creditor would deliver diamonds to the debtor in exchange for promissory notes. The promissory notes were payable at stated dates that ranged from 48 days to six months, but the creditor immediately negotiated the notes to the bank in exchange for cash. The debtor filed for bankruptcy, and the trustee sought to avoid the transactions that had occurred during the preference period. The creditor argued that payment by note was similar to payment by check and thus was not avoidable.

The court disagreed. It noted that the legislative history of § 547(c)(1) recognizes that "for the purposes of this paragraph [§ 547(c)(1)]," a transfer involving a check is "intended to be contemporaneous."¹⁰⁰ It explained that payment by check is different than a payment by note. First, Congress had contemplated a delay of only a few days to a month in the presentment of a payment by check. In this case, notes were presented for payment at dates ranging from 48 days to six months. The time factor was an important difference in viewing the notes as credit transactions as opposed to cash transactions. Second, the court cited significant differences between the expectations of a creditor who accepts payment by check and a creditor who accepts payment by note. Note that payments incorporate interest rates to compensate for time and default risk, but no such compensation is built into payments by check. Finally, the court stated that the congressional intention for treating checks like cash was recognition of the commercial reality that checks are customarily used in lieu of cash in the ordinary course of business. "In contrast, notes are not ordinarily exchanged for goods in the marketplace." Therefore, payment by note is not contemporaneous.¹⁰¹

5. In re Duffy, 3 B.R. 263 (Bankr. S.D.N.Y. 1980).

Here, the court explained that an extension of credit, via forbearance from a creditor's right to repossess collateral property, does not constitute "new value." In this case, the debtor was the lessee of an automobile. Shortly before filing for bankruptcy, the debtor made a $400 payment to the creditor/lessee, and the trustee sought to avoid the transfer.

The creditor conceded that the payment was a preferential transfer, but it argued that by not repossessing the rented vehicle it had extended new value to the debtor in exchange for the payment. The court disagreed. It reasoned that the creditor/lessee's extension of credit was merely a substitution of its right to reclaim possession immediately for a right to reclaim possession for nonpayment at some future date. A mere substitution of an existing obligation is expressly excluded from the definition of "new value" in § 547(a)(2). Furthermore, the court noted that accepting the creditor's claim was antithetical to the preference concept of equal distribution to creditors because the claimed "extension of credit," allowing the debtor a continued right to drive the rental vehicle, did not enhance the value of the debtor's estate. Hence, the lessee's forbearance did not offset the diminution to the estate caused by the preference payment, therefore it could not fall under the contemporaneous-exchange exception to avoidance.

6. Geltzer v. Fleck (In re ContinuityX Inc.), 569 B.R. 29 (Bankr. S.D.N.Y. 2017).

This case illustrates the defense's application where transfers are made on account of prior services rendered by a third party. Here...