United States: Bankruptcy Court Reinforces New Value Defense to Preference Claims

In Bogdanov v. Avnet Inc. (In re Amherst Techs. LLC ), the U.S. Bankruptcy Court for the District of New Hampshire followed the majority of circuits in holding, in connection with the defense of a § 547 preference action: (1) that "new value" is given when a creditor provides some actual value to the estate; (2) that new value need not remain unpaid in order to allow the preference defendant to offset the new value against previous payments; and (3) that an otherwise preferential payment used to pay antecedent debt may nonetheless be shielded by subsequently advanced new value. In so holding, the court addressed issues consequential to the availability and terms of credit for businesses nearing insolvency, but that continue to divide the courts of appeals.

According to the opinion in this case, the Chapter 7 trustee filed an adversary proceeding to avoid allegedly preferential payments under § 547(b) against Avnet Inc. Avnet sought to shield the payments it had received using the ordinary course of business and new value defenses of § 547(c)(2) and (4), respectively. While the court found that the payments were not made in the ordinary course of the debtor's business, it concluded that these payments did qualify for the new value defense. In reaching this conclusion, the court joined the majority of courts interpreting the new value defense broadly in three respects: First, "new value" within the meaning of § 547(a)(2) does not require that the payments and new value exchanged during the preference period result in a net material benefit to the estate, but simply that the creditor provide actual value in the form of "money's worth in goods, services, or new credit"; second, new value need not remain unpaid, meaning that where new value extended by the creditor is paid for by the debtor within the preference period, this does not necessarily preclude the creditor from offsetting that new value against prior payments; and third, a payment that is applied against antecedent debt may itself be shielded by subsequent new value, so long as the creditor's "shield" is the new value defense.

Circuit Split's Background

The overarching goal of the Bankruptcy Code's several preference defenses is to encourage a creditor to continue dealing with a distressed business by ensuring that the creditor will be duly compensated for any value it contributes to a business that may be sliding into bankruptcy. However, the means of achieving that end are not completely settled in the case of the new value defense.

Initially, § 60(c) of the Bankruptcy Act created a "net result" or "material benefit" test. This approach simply nets out all of the exchanges during the preference period, taking the sum of all the debtor's payments to the creditor and subtracting the sum of all of the creditor's new value contributions to the debtor: To the extent the preferences exceed new value, they are avoidable.

This approach proved problematic, in that it systematically understated the total avoidable preference amount by including in the calculation new value that had been advanced within the 90 day preference period before the creditor received any payments within that period. The Bankruptcy Code addressed this issue by providing in § 547(c)(4) that new value advanced before any preferential payment will not be counted as an offset; in order to be eligible, new value must be advanced after an otherwise preferential payment is made. Though a strong consensus has formed around the "subsequent advance" rule, disagreement remains as to the mechanics of its application.

At the heart of the debate is the question of whether new value that is paid for by the debtor may still be applied to offset previous payments, or whether the new value must remain unpaid in order to be counted for purposes of § 547(c)(4). Three of the U.S. Courts of Appeals (3rd, 7th and 11th circuits) require that value remain unpaid, while four (4th, 5th, 8th and 9th circuits) do not. This leaves five (1st, 2nd, 6th 10th and D.C. circuits) as yet undetermined. In the absence of controlling precedent in the 1st Circuit, the Bankruptcy Court for the District of New Hampshire ruled on the issue.

Facts of the Case

On July 20, 2005, Amherst Technologies LLC filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, the opinion said. The case was then converted to one under Chapter 7. The 90 day preference period dated from the petition dates back to April 20, 2005. From the beginning of the preference period through July 13, 2005, the debtor paid Avnet $8,120,406 on outstanding invoices dating from Dec. 31, 2004, to July 1, 2005. During the same period, Avnet supplied goods to the debtor and its customers in the amount of $7,019,112.

Of the nearly 300 checks the debtor wrote to Avnet during the preference period, all but nine were for invoices more than 60 days old, the opinion said. Subject to a payment arrangement negotiated in the months leading up to the preference period, the debtor paid Avnet $1.92 for every $1.00's worth of goods shipped from April through late June. The Chapter 7 trustee sought to avoid these payments as preferences. Avnet defended the payments under both the ordinary course of business and new value exceptions contained in § 547 of the code.

Issues Before the Court

The court found that the payments fell outside the ordinary course of the debtor's business, and thus were not shielded under § 547(c)(2). The court next examined the new value exception of § 547(c)(4), and focused on three issues: (1) whether "new value" within the meaning of the statute imposes a "material benefit" requirement, i.e., whether the provision of new value must have the effect of a net benefit to the estate, or whether the simple provision of "money's worth in goods, services, or new credit" allows the creditor to avail itself of the new value defense; (2) whether new value must remain unpaid in order to shield a previous payment; and (3) whether the "otherwise unavoidable" requirement of § 547(c)(4) precludes the creditor from using new value to offset against payments by the debtor already applied to invoices for goods delivered to the debtor.

Parties' Arguments and Court's Analysis

First, the trustee argued that Avnet did not provide the debtor with new value; in effect, that there was no material benefit bestowed on the debtor because the debtor paid $1.92 for every $1 shipped, pursuant to an agreement between the parties intended to cause the debtor to pay down antecedent debt. This arrangement diminished the value of the estate at almost twice the value of the shipments, and the debtor's obligation to Avnet remained essentially unchanged during the preference period. Avnet objected to the trustee's attempt to invoke a "material benefit" requirement, arguing that the language of the statute simply requires a creditor to provide value.

The court agreed with Avnet that the code contains no material benefit test. Rather, under § 547(a)(2), "new value" is examined in isolation to ascertain whether the creditor provides actual value in the form of "money's worth in goods, services or new credit." The court followed the prevailing consensus in favor of the "actual value" test, concluding that shipments by Avnet during the preference period conveyed actual value to the debtor and thus qualified as new value.

Second, the trustee argued that any new value that is paid by the debtor to the creditor cannot then be used to offset previous payments. Avnet responded that the text of § 547(c)(4) contains no requirement that new value remain unpaid; to the contrary, the subsection only excludes new value for which the debtor pays by way of an "otherwise unavoidable" payment.

The court agreed with Avnet on this issue as well. Citing the plain language of the statute, the court held that there is no requirement that new value remain unpaid in order to be asserted as a defense to a preference claim.

This second holding — that new value may be "paid for" and still be applied to offset against prior payments — leads to the third issue of whether such subsequent payment can also be offset by a later advance of new value. Tying together its reasoning on these matters, the court explained that the underlying policy is to ensure replenishment of the estate:

"[S]ubsequent shipments by a creditor, which enlarge the debtor's estate, are defenses to a trustee's preference recovery even if the debtor has later paid for those shipments, which reduces the debtor's estate, if the repayment of the subsequent new value would itself be avoidable and recoverable as a preference by the debtor but for the application of the new value defense."

The following table provides a simplified outline of the facts:

Section 547(c)(4)(B) provides that the trustee may not avoid a payment "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 on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor." (emphasis added). Thus, P2 can pay NV1 only if P2 is an avoidable preference that is not "otherwise unavoidable." The question is whether, as Avnet argued, P2 may be an avoidable preference but for the new value defense provided by NV2; or whether, as the trustee argued, P2 must be an avoidable preference under all circumstances.

The trustee contended that "not otherwise unavoidable" means that "a transfer [P2] that pays for new value [NV1] that is used to offset a prior transfer [P1] cannot later be subject to any subsequent new value [NV2] and requires a defendant to concede its avoidability for all purposes." Avnet disputed this interpretation of "otherwise," arguing that it applies only to preference defenses other than the new value defense. In short, "subsequent new value [NV2] can offset a transfer [P2] that pays a previously advanced new value [NV1]."

The court agreed with Avnet's reading of "otherwise," holding that "subsequent new value [NV2] can offset a transfer [P2] that pays a previously advanced new value [NV1]" as long as the payment in question is not shielded by some preference defense other than the new value defense.

Stakes of the Controversy

In this case, the trustee sought to avoid $4,372,645 as preferences, but the court held that the creditor's preference exposure was only $337,521. This illustrates the stakes of the controversy over the scope of the new value defense. It remains to be seen how the 1st Circuit and the other four undecided courts of appeals will ultimately rule on the issue of whether paid new value may offset against previous payments. If In re Amherst is any indication, the outcome of this circuit split will have major implications for the financing arrangements between creditors and distressed businesses. Attorneys who are consulted about the desirability of their clients' continued extensions of credit to a troubled company should be aware of the current law in the applicable circuit as it applies to new value: Whether through good counsel or good luck, Avnet was able to effect a significant reduction of its accounts receivable with the debtor while significantly limiting its preference exposure.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is chairman of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. He is a member of the American Bankruptcy Institute, the American Bar Association and its business law section, the Commercial Law League of America, the Pennsylvania Bar Association and the business law section of the Philadelphia Bar Association.

Aaron J. Margolis is an associate with the firm's business reorganization and financial restructuring group. He attended Washington University in St. Louis, graduating in 2010 with a J.D./M.B.A.

This article originally appeared in The Legal Intelligencer and is republished here with permission from law.com.

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