United States: Eighth Circuit Expands Subsequent New Value Preference Defense In Cases Involving Three-Party Relationships

A bankruptcy trustee or chapter 11 debtor-in-possession has the power under section 547 of the Bankruptcy Code to avoid a transfer made immediately prior to bankruptcy if the transfer unfairly prefers one or more creditors over the rest of the creditor body. However, not every payment made by a debtor on the eve of bankruptcy can be avoided merely because it appears to be preferential. Indeed, section 547 provides several statutory defenses to preference liability. The Eighth Circuit Court of Appeals recently addressed one such defense to preference avoidance—the "subsequent new value" exception. In Stoebner v. San Diego Gas & Electric Co. (In re LGI Energy Solutions, Inc.), 2014 BL 76796 (8th Cir. Mar. 20, 2014), the court, in a matter of first impression, ruled that "new value" (either contemporaneous or subsequent) for purposes of section 547(c) can be provided by an entity other than the transferee.

Avoidance of Preferential Transfers

A fundamental goal underlying U.S. bankruptcy law is equality of distribution among similarly situated creditors. To that end, the automatic stay generally prevents creditors from acting to collect on their debts after a debtor files for bankruptcy. In addition, section 547(b) of the Bankruptcy Code provides for avoidance of transfers made by an insolvent debtor within 90 days of a bankruptcy petition filing (or up to one year, if the transferee is an insider) to or for the benefit of a creditor on account of an antecedent debt where the creditor, by reason of the transfer, receives more than it would have received if, assuming the transfer had not been made, the debtor were liquidated in chapter 7.

Section 547(c) contains nine exceptions to avoidance of a preference. Of these, the three defenses most commonly invoked by commercial creditors are the "contemporaneous exchange" defense (section 547(c)(1)), the "ordinary course payment" defense (section 547(c)(2)), and the "subsequent new value" defense (section 547(c)(4)).

Section 547(c)(4) provides as follows with respect to the subsequent new value defense:

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—

  1. not secured by an otherwise unavoidable security interest; and
  2. on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor[.]

Thus, even where a creditor has received a preferential transfer, the transferee may offset against the preference claim any subsequent unsecured credit that was extended to the debtor. The purpose of the exception is to encourage creditors to continue working with troubled businesses. See Jones Truck Lines, Inc. v. Full Serv. Leasing Corp., 83 F.3d 253, 257 n.3 (8th Cir. 1996). "It recognizes that the 'new value' effectively repays the earlier preference, and offsets the harm to the debtor's other creditors. . . . Accordingly, 'the relevant inquiry under section 547(c) (4) is whether the new value replenishes the estate.' " Savage & Assoc., P.C. v. Level (3) Communications (In re Teligent, Inc.), 315 B.R. 308, 315 (Bankr. S.D.N.Y. 2004) (internal citations omitted).

"New value" is defined in section 547(a)(2) of the Bankruptcy Code to include, among other things, "money or money's worth in goods, services, or new credit." In other words, a creditor must establish that it provided the debtor with "something new that is of tangible value." In re Fuel Oil Supply & Terminaling, Inc., 837 F.2d 224, 230 (5th Cir. 1988).

The issue addressed by the Eighth Circuit in LGI Energy is whether the language "such creditor gave new value" in section 547(c)(4) means that, in order to shield a transfer from avoidance, the "new value" provided to the debtor following the transfer must have come from the recipient of the challenged transfer, as distinguished from a third party.

LGI Energy

LGI Energy Solutions, Inc., and an affiliate (collectively, "LGI") performed bill payment services for clients that were large utility customers. Pursuant to contracts between LGI and its customers, LGI periodically sent each customer a spreadsheet detailing its payment obligations under invoices that LGI received from the utilities that provided services to the customer. After the customer sent a check payable to LGI for the aggregate amount due, LGI deposited the funds into its own commingled bank accounts and then sent checks drawn on those accounts to the utility companies. Even though the utilities sent bills for LGI's customers to LGI, the utilities had no contracts with LGI.

Over a three-week period in November 2008, LGI paid two utility providers approximately $258,000 for utility services provided to LGI customers. After those transfers, the utilities continued to provide services to the customers and sent new invoices to LGI. LGI continued to bill the customers, which sent checks totaling $297,000 to LGI for the payment of the invoices. LGI never paid any of those funds to the utilities.

LGI ceased operating in December 2008. Shortly afterward, involuntary chapter 7 petitions were filed against LGI in Minnesota. After entry of orders for relief in the consolidated cases, the chapter 7 trustee sued the utility providers to avoid as preferential the $258,000 in payments made by LGI. Although the challenged transfers were made to satisfy LGI's antecedent obligations to its utility customers—the transfers were made "for the benefit" of the customers—the trustee elected not to sue these primary creditor beneficiaries. The utilities invoked section 547(c)(4)'s subsequent new value defense.

The bankruptcy court concluded that the utilities were "creditors" under third-party and trust beneficiary principles, even though no contractual relationship existed between the providers and LGI. In addition, the court construed the language "such creditor" in section 547(c)(4) to mean that new value for purposes of the exception must have been provided to, or for the benefit of, LGI by the utilities, rather than to LGI's customers. Accordingly, the bankruptcy court ruled that the $297,000 in services provided by the utilities to LGI's customers did not qualify as new value furnished to LGI subsequent to the $258,000 in payments LGI made to the utilities within 90 days of the bankruptcy petition date.

A bankruptcy appellate panel reversed the ruling in part on appeal. The appellate panel agreed with the bankruptcy court's conclusion that the utilities were creditors despite the absence of a contract with LGI. However, relying on Jones Truck Lines, the court disagreed with the bankruptcy court's reading of "such creditor" to preclude new value provided to a debtor by a third party:

Jones Truck Lines can be harmonized with the [reference to "such creditor" in section 547(c)(4)] by interpreting it as a recognition that in tripartite relationships where the [preferential] transfer to a third party [here, the utility] benefits the primary creditor [here, the utility customer], new value can come from that [primary] creditor, even if the third party is a creditor in its own right.

The trustee appealed to the Eighth Circuit.

The Eighth Circuit's Ruling

A three-judge panel of the Eighth Circuit affirmed.

At the outset, the court severely criticized the trustee's approach in suing the utilities instead of LGI's customers, who could have warded off any liability by means of section 547(c)(4) because they clearly provided post-transfer value to LGI. According to the court, "This approach does fundamental violence to the 'prime bankruptcy policy of equality of distribution among creditors.' " If the utilities were required to return the preferential payments to LGI, the Eighth Circuit wrote, "the estate is 'doubly replenished' entirely at the expense of only two creditors, [LGI's customers], who got no benefit for their subsequent new value and will continue to be liable to the utilities for their unpaid invoices."

The Eighth Circuit distanced itself from the lower courts' determination that the utilities were "creditors" who received a transfer or its benefit within the meaning of section 547(b)(1). Because the utilities did not raise this issue on appeal, however, the Eighth Circuit noted merely that "it seems open to serious question . . . and [the ruling] should not be considered Eighth Circuit precedent."

The court faulted the trustee's reliance on In re Musicland Holding Corp., 462 B.R. 66 (Bankr. S.D.N.Y. 2011), for the proposition that "such creditor" in section 547(c)(4) must "in all circumstances" be construed as "limiting subsequent new value to that personally provided by the creditor the trustee elects to sue to recover the preferential transfer." In Musicland, the Eighth Circuit explained, the court denied the preference defendant's claim of an offset for subsequent new value provided by another creditor who, unlike in LGI Energy, "neither received nor benefitted [sic] from the preferential transfer." Here, the Eighth Circuit emphasized, both LGI's customers and the utilities benefited from LGI's preferential payments to the utilities.

The Eighth Circuit agreed with the bankruptcy appellate panel that Jones Truck Lines adequately refuted the trustee's position. In Jones Truck Lines, the Eighth Circuit ruled that payments made by a debtor-employer to benefit plans to satisfy its obligations to pay pension and welfare benefits were excepted from preference liability to the extent that the employees provided the debtor with post-transfer new value in the form of services. The court's analysis was directed principally toward new value in the context of the contemporaneous exchange defense in section 547(c)(1). Even so, the Jones Truck Lines court went on to address the related subsequent new value defense under section 547(c)(4). The court wrote that "[i]f [the debtor] received no contemporaneous new value for the weekly payments [to the benefit funds], then it necessarily received subsequent new value for each payment (except the last one) because its employees continued working." Jones Truck Lines, 130 F.3d at 327.

In LGI Energy, the Eighth Circuit concluded that, even if not controlling, Jones Truck Lines provides persuasive authority contradicting the trustee's "inequitable" interpretation of the term "such creditor" in section 547(c)(4):

Our decision is limited to the circumstances presented by this case, for the statute is complex. We hold that, in three-party relationships where the debtor's preferential transfer to a third party benefits the debtor's primary creditor, new value (either contemporaneous or subsequent) can come from the primary creditor, even if the third party is a creditor in its own right and is the only defendant against whom the debtor has asserted a claim for preference liability. As § 547(b) makes avoidable a transfer "for the benefit of a creditor," it both serves the purposes of § 547 and honors the statute's text to construe "such creditor" in the § 547(c)(4) exception as including a creditor who benefitted [sic] from the preferential transfer and subsequently replenished the bankruptcy estate with new value.

Outlook

LGI Energy is a positive development for those doing business with financially troubled entities because it expands the scope of the subsequent new value defense to encompass payment relationships involving multiple parties. In one sense, the ruling can be viewed as an instance of judicial activism directed at harmonizing the Bankruptcy Code with the realities of complex financial transactions. A handful of other courts have similarly concluded that new value provided by a third party in similar three-party transactions is adequate for the transaction at issue to fall within the exceptions provided by sections 547(c)(1) and 547(c)(4). See, e.g., In re H&S Transp. Co., 939 F.2d 355, 358–60 (6th Cir. 1991); Fuel Oil Supply, 837 F.2d at 231; Holmes Environmental, Inc. v. Suntrust Banks, Inc. (In re Holmes Environmental, Inc.), 287 B.R. 363, 386 (Bankr. E.D. Va. 2002).

However, it could be argued that the Eighth Circuit's decision was motivated more by equitable and policy considerations than by a careful examination of the plain meaning of section 547(c)(4). The court stated in no uncertain terms that it viewed the trustee's preference litigation strategy as "do[ing] fundamental violence" to the policy of equality of distribution. The problem with the court's approach is that, even though the result may have been seen as fair, it glosses over the specific language of section 547(c)(4) and related provisions in the statute. Section 547(c)(1) and section 547(c)(4) share the concept of "new value" as a defense to preference liability. The former exempts from avoidance a transfer made as "a contemporaneous exchange for new value given to the debtor," whereas the latter shields a transfer to the extent that "after such transfer, such creditor gave new value" (emphasis added). Thus, section 547(c)(1) does not specify by whom new value can be provided, but section 547(c)(4) clearly provides that "such creditor"—i.e., the transferee—must be the source.

When Congress makes a distinction of this nature between two subsections of the same statute, it is presumed to have intended that they be implemented differently. Other courts have reached this conclusion with respect to sections 547(c)(1) and 547(c)(4), ruling that only the former allows new value to be provided by a third party. See, e.g., Manchester v. First Bank & Trust Co. (In re Moses), 256 B.R. 641, 652 (B.A.P. 10th Cir. 2000); Gray v. Chace (In re Boston Publishing Co.), 209 B.R. 157, 174 (Bankr. D. Mass. 1997) (same).

In LGI Energy, the Eighth Circuit did not conclude that the language of section 547(c)(4) is ambiguous and therefore did not offer a rationale for declining to apply it literally. Nor, in its opinion, did the court examine the legislative history of section 547(c) in an effort to discern why lawmakers chose to use different wording in sections 547(c)(1) and 547(c)(4). As such, even though the outcome may have been fair, the ruling does not provide an ideal road map for invoking the subsequent new value defense in other cases involving three-party relationships.

The court in this case could have elected a pathway more consonant with the literal terms of section 547(c)(4) that nevertheless reached the same result. As the Eighth Circuit noted, the ruling below that the utilities were "creditors" of LGI was "open to serious question." A conclusion that the utilities were not in fact creditors of LGI—given that the parties had no contractual relationship— would have resulted in no preference liability, while simplifying the resolution of the case considerably.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mark G. Douglas
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions