Contributed by Danielle Donovan
Does the creditor asserting a “subsequent new value” exception to preference liability have to be the creditor that provided the value directly to the debtor? In In re LGI Energy Solutions, Inc., the Eighth Circuit became the first court of appeals to interpret section 547(c)(4) of the Bankruptcy Code under such facts.
Before its bankruptcy, the debtor provided bill payment services to its clients, large utility customers such as restaurant and fast food chains. During the 90 days prior to bankruptcy, the debtor made transfers totaling approximately $259,000 to two utilities to pay outstanding invoices for services provided to the debtor’s clients. The debtor’s chapter 7 trustee sought to recover the payments from the utilities as avoidable preferences under section 547(b) of the Bankruptcy Code. In response, the utilities asserted the subsequent new value defense under section 547(c)(4).
The utilities continued to provide services to the debtor’s clients after the preferential transfers were made. The debtor also continued to send invoices to its clients, who then sent checks totaling some $297,000 to the debtor for payment of the invoices. Having found itself in financial distress, the debtor never passed any of the new money on to the utilities. Those post-preference customer payments were the “subsequent new value” at issue in this case.
The subsequent new value exception in section 547(c)(4) provides that a trustee may not avoid a transfer “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.”
It’s safe to say the court found the trustee’s attempt to circumvent this exception pretty transparent. The trustee sued the utilities instead of the debtor’s clients because the trustee knew that the clients would assert the section 547(c)(4) exception for their post-preference transfers. None too pleased with this tactic, the court noted that “this approach does fundamental violence to the ‘prime bankruptcy policy of equality of distribution among creditors.’” If the utilities had been required to return the transfers to the bankruptcy estate, the estate would have been doubly replenished — and entirely at the expense of two of its creditor clients. Neither client received any benefit for its subsequent new value, and each client also remained on the hook for its unpaid utilities invoices.
You may be asking yourself, what in the preference statute could mandate such an inequitable result? According to the trustee, two little words.
The crux of the trustee’s argument was that, because section 547(c)(4) limits the subsequent new value exception to new value “such creditor” gave to or for the benefit of the debtor, only subsequent new value given by the utilities, and not by the clients, could offset the utilities’ preference exposure. The bankruptcy court accepted this interpretation, but the Eighth Circuit Bankruptcy Appellate Panel disagreed. Attempting to refute the BAP’s interpretation on appeal, the trustee relied primarily on In re Musicland Holding Corp. to support his argument that “such creditor” must in all circumstances be construed as limiting new value to that personally provided by the creditor that the trustee is suing on account of the preferential transfer. Although not binding precedent, the Eighth Circuit distinguished Musicland, noting that the bankruptcy court denied the defendant’s claim of an offset for subsequent new value provided by another creditor who neither received nor benefitted from the preferential transfer. The court therefore interpreted Musicland to stand only for the proposition that a preferred creditor cannot offset subsequent new value provided by a non-preferred creditor.
But, as you’ve seen, in this case, both the clients and the utilities benefitted from the debtor’s preferential transfers.
Like the BAP, the Eighth Circuit relied on its decision in Jones Truck Lines to reject the trustee’s interpretation of section 547(c)(4). In Jones Truck Lines, the debtor sued to recover as avoidable preferences weekly employee benefit contributions paid to third-party benefit funds. In that case, the defendant funds claimed the protection of two exceptions found in sections 547(c)(1) and (c)(4). The Eighth Circuit held that, in certain circumstances, a transfer of new value by a third party to the debtor may satisfy the new value requirement of the contemporaneous new value exception. The court also addressed the subsequent new value issue and noted that, even if the debtor had not received contemporaneous new value for the weekly payments, it necessarily received subsequent new value for each payment because its employees had continued working. Put differently, Jones Truck Lines concluded that transfers the debtor made to the benefit funds to satisfy obligations to pay employee benefits, if otherwise preferential, were excepted from preference liability to the extent the employees provided the debtor with post-transfer new value by continuing to work.
This case is closely analogous to Jones Truck Lines. The debtor’s preferential transfers to the utilities were based upon the debtor’s contractual obligations to its clients, who benefitted from those transfers by having their invoices paid. Accordingly, the Eighth Circuit held that, in three-party relationships where the debtor’s preferential transfer to a third party benefits the debtor’s primary creditor, new value (either contemporaneous or subsequent) can come from the primary creditor, even if the third party is a creditor in its own right and is the only defendant against whom the debtor has asserted a claim of preference liability. The utilities were therefore permitted to offset all new value the clients transferred to the debtor subsequent to the preferential transfers if those transfers of new value satisfied the conditions in section547(c)(4)(A)-(B).
In this case, it didn’t really matter which creditor provided the new value, because the bankruptcy estate couldn’t have its cake and eat it too.