April 16, 2014
The Third Circuit Draws a Line in the Sand on New Value in <i>Friedman’s</i>
By Evan T. Miller
Seemingly straightforward on its face, certain aspects of the Bankruptcy Code’s “new value” defense1 have proven frustratingly unclear for practitioners around the country. Illustrative of this frustration is the elusive answer to perhaps the simplest question: When does it apply? More specifically, if a creditor is paid post-petition for new value that remained unpaid as of the petition date, can that creditor continue to use that same unpaid new value as a defense under § 547(c)(4) of the Bankruptcy Code? The picture remains muddled nationwide, but in the Third Circuit, at least, the answer is now clear.
Courts at both the bankruptcy and district court levels across the country have parted ways on how to answer the foregoing question. In one camp, courts have ruled against cutting the preference analysis off at the petition date, thereby allowing post-petition payments (including, notably, payments on administrative expenses under § 503(b)(9) and payments pursuant to critical-vendor orders) to reduce a defendant’s new value defense.2 In the other camp, the prevailing view is that the petition date does become the “cutoff” date for assessing new value, such that post-petition payments on pre-petition new value have no bearing on whether a creditor can use that same new value to reduce its liability in a preference action.3
In November 2011, Judge Christopher Sontchi of the U.S. Bankruptcy Court for the District of Delaware issued an opinion that placed Delaware in the latter of the two camps.4 The facts in Friedman’s were simple and uncontested: The debtor made payments to the creditor-defendant during the preference period in the amount of $81,997.57 (the “transfer”), after which the creditor provided staffing services to the debtor valued at $100,660.88 (the “new value”). The money owed for these services remained unpaid as of the petition date.
Post-petition, the debtor filed a motion in bankruptcy court seeking authority to pay pre-petition wages, compensation and related benefits. The court granted the motion, pursuant to which the debtor paid $72,412.71 (the “wage order payment”) to the creditor. More than a year later, the creditor raised the new value as a defense when the debtor’s liquidating trustee sought to avoid the transfer as a preference. The trustee argued that the new value was reduced by the amount of the wage order payment.
Judge Sontchi ruled for the creditor, finding that the Third Circuit Court of Appeals’ holding in In re New York City Shoes Inc.5 supported a reading that the petition date should act as the “cut-off” date for calculating new value.6 That decision was later affirmed on appeal by the U.S. District Court for the District of Delaware, whose ruling the trustee also appealed. As a matter of first impression, on Dec. 24, 2013, the Third Circuit Court of Appeals affirmed the lower courts for several reasons.
The Third Circuit Court of Appeals first held that its prior references on this issue, including In re New York City Shoes, were non-binding dicta because those cases did not turn on transactions that occurred post-petition.7 The court next concluded that the plain language of § 547(c)(4)(B) is silent as to when a payment must be made by a debtor to defeat a creditor’s new value defense, but the “fact that courts are divided in their interpretations of § 547(c)(4)(B) does not mean … that the provision is necessarily ambiguous.”8 The court looked at the provision in the context of the Bankruptcy Code as a whole, finding numerous indicators that pointed to the petition date as a cutoff for analysis of new value, such as:
Seemingly straightforward on its face, certain aspects of the Bankruptcy Code’s “new value” defense1 have proven frustratingly unclear for practitioners around the country. Illustrative of this frustration is the elusive answer to perhaps the simplest question: When does it apply? More specifically, if a creditor is paid post-petition for new value that remained unpaid as of the petition date, can that creditor continue to use that same unpaid new value as a defense under § 547(c)(4) of the Bankruptcy Code? The picture remains muddled nationwide, but in the Third Circuit, at least, the answer is now clear.
The Lower Court Split
Courts at both the bankruptcy and district court levels across the country have parted ways on how to answer the foregoing question. In one camp, courts have ruled against cutting the preference analysis off at the petition date, thereby allowing post-petition payments (including, notably, payments on administrative expenses under § 503(b)(9) and payments pursuant to critical-vendor orders) to reduce a defendant’s new value defense.2 In the other camp, the prevailing view is that the petition date does become the “cutoff” date for assessing new value, such that post-petition payments on pre-petition new value have no bearing on whether a creditor can use that same new value to reduce its liability in a preference action.3
The Friedman’s Cases
In November 2011, Judge Christopher Sontchi of the U.S. Bankruptcy Court for the District of Delaware issued an opinion that placed Delaware in the latter of the two camps.4 The facts in Friedman’s were simple and uncontested: The debtor made payments to the creditor-defendant during the preference period in the amount of $81,997.57 (the “transfer”), after which the creditor provided staffing services to the debtor valued at $100,660.88 (the “new value”). The money owed for these services remained unpaid as of the petition date.
Post-petition, the debtor filed a motion in bankruptcy court seeking authority to pay pre-petition wages, compensation and related benefits. The court granted the motion, pursuant to which the debtor paid $72,412.71 (the “wage order payment”) to the creditor. More than a year later, the creditor raised the new value as a defense when the debtor’s liquidating trustee sought to avoid the transfer as a preference. The trustee argued that the new value was reduced by the amount of the wage order payment.
Judge Sontchi ruled for the creditor, finding that the Third Circuit Court of Appeals’ holding in In re New York City Shoes Inc.5 supported a reading that the petition date should act as the “cut-off” date for calculating new value.6 That decision was later affirmed on appeal by the U.S. District Court for the District of Delaware, whose ruling the trustee also appealed. As a matter of first impression, on Dec. 24, 2013, the Third Circuit Court of Appeals affirmed the lower courts for several reasons.
The Third Circuit Court of Appeals first held that its prior references on this issue, including In re New York City Shoes, were non-binding dicta because those cases did not turn on transactions that occurred post-petition.7 The court next concluded that the plain language of § 547(c)(4)(B) is silent as to when a payment must be made by a debtor to defeat a creditor’s new value defense, but the “fact that courts are divided in their interpretations of § 547(c)(4)(B) does not mean … that the provision is necessarily ambiguous.”8 The court looked at the provision in the context of the Bankruptcy Code as a whole, finding numerous indicators that pointed to the petition date as a cutoff for analysis of new value, such as: