United States: Liability For Preferential Transfer May Be Reduced By Subsequent New Value

Originally published by Delaware Business Court Insider

In a preference action, one of the most common defenses is the so-called subsequent new value (SNV) defense under 11 U.S.C. Section 547(c)(4). Under Section 547(c)(4), to the extent that a creditor gives to the debtor new value subsequent to an avoidable transfer, the defendant's liability is reduced in the amount of such SNV. The policy behind the defense is clear. Creditors should be encouraged to continue to provide goods and services to a struggling company. Further, the defense avoids the harsh result that would arise if a debtor were permitted to recover all preferential transfers without giving credit for SNV, which the creditor provided to the debtor.

Although the concept of the defense is simple, in application, courts have been divided on whether SNV may serve a defense only so long as it remains unpaid. The U.S. Court of Appeals for the Third Circuit had stated in New York City Shoes v. Bentley International (In re New York City Shoes), 880 F.2d 679, 680 (3rd Cir. 1989), that SNV must be unpaid. However, the court later characterized this statement as dicta in Friedman's Liquidating Trust v. Roth Staffing (In re Friedman's), 738 F.3d 547, 550-551) (3rd Cir. 2013). Nevertheless, courts have continued to rely on New York City Shoes to require that SNV remain unpaid.

Further, confusion has arisen as a result of the requirement that, for a creditor to prevail, the debtor must not have made an "otherwise unavoidable" transfer to or for the benefit of such creditor on account of such SNV. Courts have held that any payment for SNV must itself be subject to avoidance as a preference under Section 547 and that application of the SNV defense requires an analysis of whether payments for any SNV are shielded by other preference defenses identified in Section 547. (See e.g., Wahoski v. Xymid LLC (In re Pillowtex0), 416 B.R. 123 (Del Bankr. 2009) (per Carey, J.).)

In Miller v. JNJ Logistics LLC (In re Proliance International), No. 11-52514 (CSS), (Bankr. D. Del. Aug. 14, 2014), U.S. Bankruptcy Judge Christopher S. Sontchi of the District of Delaware considered both issues in analyzing an SNV defense. In Proliance, the trustee sought to avoid and recover preferential transfers from the defendant. The defendant asserted an SNV defense in connection with both paid and unpaid SNV. The defendant moved for summary judgment on its defense and the trustee countermoved for summary judgment, arguing that the defense does not apply to paid SNV and that, by moving for summary judgment, the defendant conceded that payments made for SNV were, themselves, preferential transfers.

Sontchi followed his earlier rulings in In re Sierra Concrete Design, 463 B.R. 302 (Bankr. D. Del. 2012), and In re Vaso Active Pharmaceuticals, 500 Bankr. 384 (Bankr. D. Del. 2013), and held that paid SNV may support an SNV defense. However, he departed from U.S. Bankruptcy Judge Kevin J. Carey's opinion in Pillowtex. He noted that the trustee had sufficiently pleaded a cause of action under Section 547 to recover all payments to the defendant (including those pre-petition payments for SNV) and concluded that the SNV payments were therefore otherwise avoidable. Unlike Carey, he did not require an analysis of whether these payments were subject to a preference defense (e.g., an "ordinary course of business defense" under 11 U.S.C. Section 547(c)(2)).

Sontchi's decision in Proliance is helpful to preference defendants in at least two ways. First, the decision affirms that paid SNV supports a defense under Section 547(c)(4). Second, the decision does not require a defendant to concede that payments for SNV are otherwise avoidable as preferences (i.e., it is sufficient if the trustee has pleaded a prima facie case). Such a concession could give rise to liability in the event that the Third Circuit subsequently holds that SNV must remain "unpaid."

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington office. Licensed to practice in Delaware, Pennsylvania and New York, he primarily represents Chapter 11 debtors.

Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions, and Delaware corporate and alternative entity law.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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