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Eleventh Circuit’s Ruling Strengthens Creditors’ New Value Defense to Preference

Business Law

The 11th Circuit in Kaye v. Blue Bell Creameries Inc. (In re BFW Liquidation LLC), 2018 WL 3850101, 17-13588 (11th Cir. Aug. 14, 2018), joined the majority of circuit courts in ruling that the new value defense to a preference action is not limited to value that remains unpaid at the time of filing. This decision, issued August 14, 2018, is welcome news to creditors as it should result in a significant reduction in preference exposure when dealing with financially troubled debtors that ultimately file for bankruptcy protection.

Before discussing the decision, a brief overview of preference actions is helpful for context. A preference action is a lawsuit typically brought by a trustee (or a debtor in possession) of a bankruptcy estate to recover payments made by the debtor to a creditor during the 90 days immediately preceding the date of filing a bankruptcy petition, which is referred to as the preference period. The policy reason behind allowing a trustee to “claw back” these preferential payments is to promote equality of creditor treatment by reducing the incentive of aggressive collection actions by creditors who are concerned about the financial stability of their debtor, which can often force the debtor into bankruptcy, and to avoid debtors preferring certain creditors over others and selectively making payments.

While there are a number of potential defenses to a preference action, the 11th Circuit’s recent opinion focuses on the “new value” defense. A new value defense may be available if a creditor can show that it provided goods or services to the debtor after a preference payment was made by the debtor (i.e., a payment within 90 days of filing). The value of the new goods or services provided by the creditor can then be used to offset the amount of re-payment that the creditor is liable for in a preference action.

Prior to the decision in Kaye, the 11th Circuit had three basic requirements in order for a creditor to have a valid new value defense to a preference action: 1) the creditor provided new value to the debtor subsequent to the preference payment; 2) the new value was unsecured by collateral of the debtor; and 3) the new value remained unpaid at the time of filing. The Kaye decision revisited the third requirement and determined that, based on the plain language of the Bankruptcy Code, as well as relevant policy considerations, the new value defense is not limited to subsequent advances of credit that remain unpaid on the filing date.

Section 547(c) of the Bankruptcy Code addresses the new value defense and states that:

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

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(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….1

The court noted in the Kaye opinion that “nothing in the language of 547(c)(4) indicates that an offset to a creditor’s preference liability is available only for new value that remains unpaid.”2 Therefore, if a creditor has been preferred and afterward gives the debtor further credit without security of any kind, the full amount of such new credit may be offset against the amount that would otherwise be recoverable from it in a preference action regardless of whether it remained unpaid at the time of the filing.

The 11th Circuit’s discussion of the policy considerations behind not requiring new value to remain unpaid provides insight on what impact the court’s decision will have on both creditors and debtors.

A principal goal of the preference provisions in the Bankruptcy Code is to encourage creditors to continue extending credit to financially troubled entities while discouraging a panic-stricken race to the courthouse. As noted by the court, if the code required new value to remain unpaid to assert a defense to preference, a prudent vendor would be foolish to continue delivering goods to a financially distressed debtor because he would merely be increasing his bankruptcy loss (because the vendor may have to return the entirety of payments it had received for the goods).

Overall, the 11th Circuit’s decision provides creditors a sturdier shield from potential preference liability that may increase their willingness to continue conducting business with struggling debtors. Creditors continuing to extend credit to financially struggling companies will no longer be subject to greater exposure of clawbacks for receiving payments on account of such further extensions of credit if the debtor files for bankruptcy protection.

 

1 11 U.S.C. 547(c)(4).

2 Kaye, 2018 WL 3850101 (2018).

 

 

Photo of Scott UnderwoodSCOTT UNDERWOOD chairs Buchanan Ingersoll & Rooney’s national bankruptcy and insolvency practice.

 

 

 

Photo of Steven ClineSTEVEN CLINE is an associate in the firm’s litigation department, with a substantial focus upon bankruptcy and insolvency matters.

This column is submitted on behalf of the Business Law Section, Michael B. Chesal, chair, and Paige Greenlee, editor.

Business Law