Post petition payments and the “New Value” defense to preference suits-Third Circuit Court of Appeals holds they do not affect the outcome

One of the simplest ways for a defendant to defeat a preference lawsuit in bankruptcy is to show that after the defendant received the payments that the suit is trying to recover, it gave “new value” to the debtor which remained unpaid (or was paid by another avoidable payment). The defense, codified at 11 USC 547(c)(4), is intended to avoid penalizing creditors who continue to deliver value to a struggling debtor in the months leading up to bankruptcy. In essence, a creditor who, though paid, delivers new goods or value for which it remained unpaid can offset that “new” value against the amount it otherwise would have to pay back. The beauty of this defense is that the proofs are simple and the result has a mathematical certainty.

In a December 2013 ruling, the Third Circuit Court of Appeals in In re Friedmans’s Inc. held that whether “new value” was given is determined as of the Petition date, and that payments the creditor/defendant received after that date which reduced its unpaid balance are not a factor in applying the defense. The creditor, Roth Staffing, had supplied staffing services to the debtor. In the 90 days pre-bankruptcy, it had been paid $81,997 but had thereafter supplied over $100,000 in new services that were unpaid on the Petition filing date. By itself, this would be a complete defense to a preference action, since Roth had added more value than it had been paid for and as a result was worse off on the Petition date then before receiving payments. What made the case unusual is that post-petition, the debtor obtained a “Critical Vendor” order that authorized it to pay down Roth’s debt, in order to encourage Roth to keep the flow of critical staffing continuing. Under this order, Roth received another $72,413.00.

The debtor’s successor in interest filed a preference action against Roth. The issue was whether Roth had a complete defense based on the unpaid $100,000 when the bankruptcy was filed, or whether this was reduced by the $72,413 in additional payments it had received after the bankruptcy filing. The Third Circuit, affirming the District Court, held that Roth had no liability since as of the Petition date its payments received were less than the new value it had provided. In a matter of first impression on this issue, it held that the $72,413 paid post-petition was properly disregarded for purposes of the “new value” defense.

The Court supports its holding in a lengthy and interesting analysis of the preference statute and the policies behind it. For anyone facing a preference action and intending to use the “new value” defense, the case is a “must-read”.

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