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”.

Starting over after business failure: your debts can follow you if you get it wrong

We have seen a lot of business owners whose businesses are failing and who want to start over. That is not as simple as it sounds, and doing it wrong could result in the old creditors coming after the new business and its owners.

Usually, the owners want to just start up the same business, with the same customers at the same location with the same owners. That is a recipe for problems. The problems come from two principles.

The first is successor liability. The second is that business owners operating a firm in the “zone of insolvency” have a “fiduciary duty” (or an obligation to serve as a trustee) to their creditors. A detailed discussion of these principles is beyond the scope of this article.

Starting Over After Business Failure

In New Jersey, a new business can have successor liability for the debts of the old if a court finds that a “de facto merger” occurred, or if the business is the “mere continuation” of the old. This means that the old creditors can pursue the new business for payment, providing they can convince a court that this is the case. Courts look for the following to show a defacto merger/mere continuation:

1. the new business has the same ownership, management, personnel, physical location, assets and/or general business operations as the old one;

2. the old business shuts down suddenly at about the time the new business starts up.

3. the new business or its owners assume some but not all debts of the old business, especially those ordinarily needed to continue business;

4. the new business holds itself out to the public as continuing the old business.

Any time business owners start a new business under a new name, successor liability is a risk. There are steps that can be taken to minimize the risk. Each case is different, and a detailed review by a knowledgeable and experienced bankruptcy or business attorney is needed, in advance of any such move.

The second trap is fiduciary liability of business owners. Violating this duty could expose the business owners to a later lawsuit and debts that might not be dischargeable in a personal bankruptcy. Simply put, business owners are held to a high standard of care towards their creditors when a business is failing. They have a duty to maximize the value of the business, and to not take steps which benefit themselves unfairly at the expense of creditors or which treat creditors unfairly. This does not mean that business owners are not entitled to be paid for their services, or that they have to put more of their own money into the failing business.  But lining their own pockets, or transferring assets to themselves or others without the company getting fair value in exchange; engaging in preferential treatment of certain creditors; or making false statements to creditors are some of the “no-no’s” to avoid. Again, this is not a complete list and what can or should be done is very fact sensitive and requires careful review by an experienced attorney. As always, careful planning and advice are critical

Business owners are entitled to try to start over, but without careful planning and the right advice, the result could be that the old debts beleager the new business

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