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Court: New Value Need Not Remain Unpaid to Limit Preference Liability

By Rudolph J. Di Massa, Jr. and Drew S. McGehrin
October 4, 2018
The Legal Intelligencer

Court: New Value Need Not Remain Unpaid to Limit Preference Liability

By Rudolph J. Di Massa, Jr. and Drew S. McGehrin
October 4, 2018
The Legal Intelligencer

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photo of Skip Di Massa

Rudolph J. Di Massa Jr.

photo of Drew Mcherin

Drew S. McGehrin

In Kaye v. Blue Bell Creameries (In re BFW Liquidation), 899 F.3d 1178 (11th Cir. 2018), the U.S. Court of Appeals for the Eleventh Circuit found that a liability for an allegedly preferential transfer may be reduced by the amount of new value given, regardless of whether that new value has already been repaid by the debtor before its bankruptcy filing. Joining the Fourth, Fifth, Eighth and Ninth Circuit courts of appeals, the ruling coming out of the Eleventh Circuit provides an additional defense to creditors in preference actions, limits a valuable tool for bankruptcy trustees and debtors in recovering estate funds, and may significantly impact business relationships between vendors and financially distressed purchasers.

Background

Bruno’s Supermarkets, LLC, the debtor in this case, operated more than 60 grocery store chains throughout Alabama and Florida. Before filing for bankruptcy, Blue Bell Creameries sold ice cream and related products to Bruno’s on credit. Bruno’s typically remitted payment to Blue Bell twice per week, but as its sales started to decline in the period leading up to its bankruptcy filing, it began making payments on less-regular intervals, especially during the 90 days before the filing of its bankruptcy petition. In those 90 days, Bruno’s issued 13 payments to Blue Bell totaling $563,869.37. During the same period, Blue Bell continued to provide product to Bruno’s.

On Feb. 9, 2009, Bruno’s filed a petition for bankruptcy protection with the U.S. Bankruptcy Court for the Northern District of Alabama and, in September 2009, the bankruptcy court confirmed the debtor’s plan of liquidation. In accordance with the plan, the bankruptcy court appointed William Kaye as liquidating trustee for the debtor’s estate. Kaye was tasked with, among other responsibilities, bringing any avoidance actions that might exist against creditors of the debtor. Accordingly, he filed an adversary proceeding against Blue Bell under Section 547(b) of the Bankruptcy Code, seeking avoidance of the 13 allegedly preferential transfers totaling $563,869.37 made to Blue Bell within the 90 days before the petition date.

Blue Bell asserted numerous defenses to the trustee’s claims, including that it had provided subsequent “new value” to the debtor, thereby shielding the transfers under Section 547(c)(4) of the Bankruptcy Code. In analyzing this defense, the bankruptcy court concluded that Blue Bell was in fact entitled to an offset against its preference liability, but only to the extent that any new value that Blue Bell had extended to Bruno’s remained unpaid by Bruno’s as of the petition date. In so ruling, the bankruptcy court relied on an earlier opinion of the Eleventh Circuit in Charisma Investment v. Airport Systems (In re Jet Florida System), 841 F.2d 1082 (11th Cir. 1988) wherein the court stated that Section 547(c)(4) had “generally been read to require … that the new value must remain unpaid.” Because Bruno’s had repaid the majority of these Blue Bell invoices, the bankruptcy court concluded that only a small portion (that which remained unpaid) could be utilized to offset Blue Bell’s preference liability. Accordingly, the bankruptcy court allowed the trustee to claw back $438,496.97 of the $563,869.37. Blue Bell appealed to the district court, and the parties then jointly requested that the appeal be heard directly by the Eleventh Circuit.

Opinion of the Court of Appeals

Chief among the appellate court’s tasks in this decision was to clarify its methodology with respect to the new value defense to a preference action. In that context, there are two competing approaches: the “remains unpaid” approach and the “subsequent advance” approach. The “remains unpaid” approach permits new value extended after a preferential payment to be utilized to offset a creditor’s liability for such preference, but only to the extent that such new value was not already paid by the debtor before the petition date. By contrast, the “subsequent advance approach” permits preference liability to be offset by subsequent new value even if such new value was paid for by the debtor pre-petition, but only if the offset was implemented “with preferences that were not ‘otherwise unavoidable.’” In other words, so long as the payment for the new value would itself be recoverable as a preference, that payment would not be a barrier to the subsequent new value defense.

The appellate court began its inquiry into this issue by first examining whether the finding it had made in Jet Florida that Section 547(c)(4) “generally [requires that] … new value … remain unpaid,” relied on by the bankruptcy court, constituted dictum or binding precedent. Ruling that the finding in the Jet Florida case was indeed merely dictum as it “was never at issue in the case and it played no role in [the court’s] decision or reasoning,” the court determined that it was free to re-examine this issue.

The court next examined the plain language of the preference statute. It noted that Section 547(c)(4) “makes no mention of any requirement that any new value provided by a creditor remain unpaid.” To the contrary, the language requires only that: any new value given by the creditor not be secured by an otherwise unavoidable security interest; and the debtor must not have made an otherwise unavoidable transfer to or for the benefit of the creditor on account of the new value given. Consequently, the court held that all new value given by Blue Bell could be used to offset any preferential payments made to Bruno’s during the preference period.

In so holding, the Eleventh Circuit “found common ground with” the Fourth, Fifth, Eighth and Ninth circuits on this issue, with only the U.S. Court of Appeals for the Seventh Circuit ruling to the contrary in In re Prescott, 805 F.2d 719 727-28 (7th Cir. 1986). In that case, “without much discussion,” that court found Section 547(c)(4) required that new value remain unpaid in order for the creditor to successfully invoke the “new value” defense.

The appellate court also reviewed the statutory and legislative history relevant to this provision, which it found to further bolster its holding. The court noted that section 547(c)(4)’s predecessor statute, section 60(c) of the Bankruptcy Act of 1898, explicitly required that the “amount of any new credit remain[] unpaid” in order for a creditor to successfully invoke this defense. Because the 1978 amendment to this section (through the enactment of Bankruptcy Code Section 547(c)(4)) replaced and omitted the “new credit remaining unpaid” language, the court found that “one can plausibly infer that, by replacing section 60(c)’s ‘remaining unpaid’ language with new language that omits any such requirement, Congress intended to eliminate Section 60(c)’s requirement that new value remain unpaid, and to replace that requirement with something substantively different.”

Finally, the appellate court opined that policy considerations also supported its holding. According to the court, its holding would encourage creditors to extend credit and other services to financially distressed companies without the fear that payments received in satisfaction of such accommodations would then later be clawed back in bankruptcy. Indeed, the court opined that by requiring that such new value remain unpaid, it would hinder such policy objectives.

Conclusion

In Blue Bell Creameries, the U.S. Court of Appeals for the Eleventh Circuit strengthened a defendant’s ability to assert a new value defense in a preference action and potentially retain funds it received from a debtor within the preference period. Stakeholders in the bankruptcy process should take note of this decision, as it portends an increasingly uniform approach to the analysis of the new value defense in preference actions, and will influence the manner in which such actions are initiated, prosecuted and defended.

While such a finding may very well encourage the continued business relationship between vendors and financially troubled companies whose financial health is worsening, it also has the potential to backfire. For example, vendors cognizant of a customer’s deteriorating financial condition may be inclined to modify their payment terms to require the customer to pay for product in advance; such a requirement would adversely impact the debtor’s cash flow and accelerate its slide towards bankruptcy.

Additionally, some might read the court’s decision as granting something of a fortuitous windfall to creditors “fortunate” enough to have been paid for the new value that they extended: compared to creditors whose new value remains unpaid, they are certainly better off. This may, in turn, implicate arguments that such a result runs contrary to policy considerations of fairness and the equality of treatment of similarly situated creditors.

Therefore, while the appellate court’s decision advances certain policy considerations, it may also strain others, all of which are issues that creditors and vendors to financially distressed companies must take into consideration throughout the course of their business dealings.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Drew S. McGehrinan associate at the firm,  practices in the areas of commercial finance, financial restructuring and bankruptcy. 

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.