Chapter 5 NEW VALUE

• Jurisdiction: United States

Chapter 5 NEW VALUE

The Statute

Section 547(c)(4) of the Bankruptcy Code states:

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

(4) 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 —

(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....

Subsequent Advances of New Value (§ 547(c)(4))

Section 547(c)(4) was enacted to encourage creditors to continue to sell on credit to companies experiencing financial difficulty. The new value rule "avoids penalizing creditors who, even though they have knowledge of the debtor's insolvency, extend fresh credit after receiving a preferential payment."¹⁴²

The safe harbor of § 547(c)(4) finds its origins in the Bankruptcy Act of 1898 (the "Act"), § 60(c). Under the Act, unpaid new value was netted out against alleged preferential transfers for the entire 90-day preference period. Under the "net result rule," the total shipments or sales during the 90 days are netted against the total payments, and the creditor is preferred only to the extent that payments exceed shipments.

When the Bankruptcy Code was enacted in 1978, Congress stated in the legislative history that the net-result rule was being codified into § 547(c)(4).¹⁴³ In spite of this, however, the language of § 547(c)(4) does not support the net-result rule, and a number of courts have not followed it.¹⁴⁴ Instead, these courts hold that each alleged preferential transfer must be set off against subsequent new value. Immediately after the enactment of the Code, courts began to examine whether the "subsequent new value" needed to be subsequent only to the immediately prior transfer or whether new value could be credited against all prior transfers. One of the first cases to examine this issue was Thomas Garland Inc. v. Union Elec. Co.¹⁴⁵ The Garland court held that "[e]ach dollar of the preferential payment may be set off against each dollar of new value, but the setoff may not be greater than dollar for dollar." Shortly after Garland, the District of Maine held in Leathers v. Prime Leather Finishes Co. that only the preferential payment immediately preceding the new value was entitled to the new value credit.¹⁴⁶ Courts addressing the issue adopt either the Garland or Leathers view. Currently, the majority of courts follow the Garland court's approach.¹⁴⁷ Thus, in most jurisdictions, new value may be credited against all prior preferential transfers so long as the "preferential exposure" does not become a negative number and the excess new value remaining after this netting may not be used to offset a subsequent preference.¹⁴⁸

The question of whether new value must remain completely unpaid to be credited against a prior preferential transfer remains unanswered. Currently, eight circuits have ruled on the issue: two supporting the position that the new value must remain unpaid,¹⁴⁹ and six holding that the new value need not remain unpaid and that the proper focus is on determining whether the estate has been "replenished" by the transfer of new value. The First,¹⁵⁰ Second, Sixth and Tenth Circuits have not ruled on the issue. It appears at the time of publication that several of the bankruptcy judges in the Third Circuit have distinguished the early ruling in New York City Shoes Inc. v. Bentley Inc.¹⁵¹ holding that new value must remain unpaid to be used as a defense.¹⁵²

The following is a summary of the leading cases in each circuit addressing the "subsequent new value" defense.¹⁵³ A chart summarizing the circuit holdings on the new-value defense is found in Appendix II.

First Circuit

1. Leathers v. Prime Leather Finishes Co., 40 B.R. 248 (D. Me. 1984).

The District of Maine affirmed the bankruptcy court in holding that § 547(c)(4) is a subsequent advance rule, thus new value can only be netted against a previous preferential transfer and not against subsequent transfers. The district court held that the bankruptcy court's method of isolating transfers by the debtor within the preference period and netting each against the value of shipments made by the creditor after that transfer but before the next was proper. In other words, the creditor may only offset the immediately preceding preference. The court stated that "the proper mode of analysis is that after each preferential payment, an assessment must be made as to how much property the creditor restored to the debtor before the next preferential payment was made."¹⁵⁴

The Maine District Court also addressed the date by which a transfer is made. The trustee argued that it was the date the check is honored by the bank. The court held, however, that for purposes of the exception of § 547(c)(1), (c)(2) and (c)(4), it is the date the check is "delivered" to the creditor.¹⁵⁵ Subsection 547(c)(4) was intended to "encourage creditors to continue doing business with troubled businesses. Dating a transfer from the date of receipt of a check by the creditor best implements this purpose, for it does not penalize a creditor who advances new value (this keeping the debtor's business viable) in reliance on payment of a prior debt by check."¹⁵⁶

2. DeGiacomo v. Draper Knitting Co. (In re Jannel Indus.), 245 B.R. 757 (Bankr. D. Mass. 2000).

The bankruptcy court discounted Leathers by stating that the court had not explained why it took the position that new value can only be applied to the immediately preceding preference payment. The court also emphasized that this issue was not the principal issue on appeal in Leathers and that the background of the case was so confusing that it was unclear whether Leathers even addressed the issue presented in Jannel. The district court recognized that the majority position allows a creditor "to carry forward preferences until they are exhausted by subsequent advances of new value."¹⁵⁷ The district court also noted that the majority of courts have rejected the Leathers approach for any combination of four reasons: (1) it places limitations on the creditor's right of setoff not found in the statutory language; (2) the trustee's proposed interpretation would be tantamount to treating the preferential transfer and subsequent unsecured advances as a substantially contemporaneous exchange, coverage of which is already provided for in § 547(c)(1); (3) the policy of permitting new value to be applied to any prior preferential transfer encourages creditors to assist financially troubled debtors; and (4) creditors look to a debtor's entire repayment history, not just one isolated transaction, when deciding whether to advance new credit.

3. Keydata Corp. v. Boston Edison Co. (In re Keydata Corp.), 37 B.R. 324 (Bankr. D. Mass. 1983).

The Massachusetts Bankruptcy Court stated that "[f]or § 547(c)(4) to apply, three requirements must be met: The creditor must have extended the new value after receiving the preference; the new value must have been unsecured; and the new value must remain unpaid. Under this formula, the value of the utility service provided to the debtor after the preference payment for earlier service may be offset against the preference payment, as long as the new value remains unpaid."¹⁵⁸

4. In re PMC Marketing Corp., 518 B.R. 150 (B.A.P. 1st Cir. 2014).

The First Circuit's Bankruptcy Appellate Panel adopted the "emerging trend" that "payment by a debtor for new value only neutralizes the creditor's new value defense if that payment is unavoidable." "[T]he new value defense is available, despite payment, if the payment was an avoidable transfer." The court remanded the case back to the bankruptcy court because the bankruptcy court failed to consider material facts.

Second Circuit

1. Buchanwald Capital Advisors LLC, Trustee of the Pameco Corp., et al. Liquidation Trust v. Metl-Span I. Ltd. (In re Pameco Corp.), 356B.R. 327 (Bankr. S.D.N.Y. 2006).

The debtor was a distributor of HVAC equipment, and the creditor was a producer and supplier of metal products. Both debtor and creditor were involved in a pre-petition construction project. The creditor shipped products to the construction site on Dec. 30, 2002. On Dec. 31, the creditor sent an invoice to the debtor for $25,943 with a due date of Jan. 30, 2003. The debtor failed to make the payment. The creditor called the debtor several times in an effort to obtain the payment. On Feb. 28, 2003, the debtor wrote a check in the amount of $25,943 but subsequently stopped payment on the check. On March 12, 2003, the creditor requested payment by cashier's check, and on March 21, 2003, the defendant recorded a construction lien claim against the premises in the amount of $25,943. Finally, on March 28, 2003, the debtor issued a check for $25,943, which cleared on April 7, 2003. The creditor released its lien on April 16, 2003.

The creditor asserted numerous defenses to the avoidance of the payment, including that the release of the lien was subsequent new value. The court noted that the relevant inquiry was whether the new value replenished the estate and required the creditor to demonstrate that the debtor received new value in the form of "money or money's worth in goods, services or new credit or release by a transferee of property previously transferred to such transferee...."¹⁵⁹ There was no proof that the release of the lien on the premises provided new value to the debtor's estate. Accordingly, the transfer was avoidable.

2. Katz v. Ida K. Stark Trust (In re Van Dyck/Columbia Printing), 289 B.R. 304 (D. Conn. 2003).

In this case, the court recognized that Congress clearly contemplated the new-value defense to apply to more than one exchange and that limiting the defense to one transfer is at odds with the purpose of encouraging creditors to continue to work with troubled debtors. The court found that the bankruptcy court's failure to carry forward...