Wahoski v. American & Efrid, Inc. (In re PillowtexCorp., et al.), 416 B.R. 123 (Bankr. D. Del. 2009)

 Commissary Operations, Inc. v. Dot Foods, Inc., et al.  (In re Commissary Operations, Inc.), No. 08-06279, 2010 WL 99036 (Bankr. M. D. Tenn. Jan. 7, 2010)

 The Bankruptcy Courts for the District of Delaware and Middle District of Tennessee have issued recent decisions that clarify their interpretations of the “new value” defense to preference actions. The Bankruptcy Court for the District of Delaware held that the new value defense provided under section547(c)(4) of the Bankruptcy Code is available even to a creditor that gets paid for the new value, so long as such payment is not otherwise unavoidable. The Bankruptcy Court for the Middle District of Tennessee held that goods delivered to the Debtor for which the creditor receives an administrative expense claim under section 503(b)(9) may still be used as new value under section 547(c)(4).

 Pillowtex

 In 2005, the Pillowtex creditors’ committee filed preference actions against two companies that conducted business with the Debtors prior to their bankruptcy filings. Both Defendants moved for partial summary judgment, asserting that some of the payments they received from the Debtors were protected by the new value defense pursuant to section 547(c)(4) of the Bankruptcy Code. In their opposition, the Debtors claimed that the Defendants could not use this defense because the Defendants were paid for the new value they provided.

 The new value defense is set forth in section 547(c)(4) of the Bankruptcy Code, which provides that a debtor 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— (A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor.

 The Bankruptcy Court stated that there are two schools of thought among Circuit Courts on whether new value must remain unpaid in order for it to be a valid defense to a preference action. The Bankruptcy Court noted that the Third, Seventh and Eleventh Circuits have held that new value must remain unpaid. This approach is known as the “remains unpaid” approach. On the other hand, the Fourth, Fifth and Ninth Circuits have held that the plain language of the Bankruptcy Code contains no such restriction. This approach is known as the “subsequent advance” approach, because its focus is on the subsequent new value that the defendant provided. The Eighth Circuit has issued conflicting opinions on the issue.

 In ruling in favor of the Defendants, the Bankruptcy Court noted that most of the courts that are considered to be part of the remains unpaid school have only stated that requirement in dicta. This was the case in a leading Third Circuit decision, New York City Shoes, Inc. v. Bentley Int’l., where the Bankruptcy Court set forth a three-part test for new value, including that it remain unpaid. The Bankruptcy Court noted that in the New York City Shoes decision, the Third Circuit was primarily concerned with a different part of the test – whether the defendant provided new value on an unsecured basis. New York City Shoes, Inc. v. Bentley Intl., Inc. (In re New York City Shoes, Inc.), 880 F.2d 679, 680 (3rd Cir. 1989). The Bankruptcy Court also pointed to the subsequent decision in Hechinger that held the new value must not necessarily remain unpaid. Hechinger Investment Co. of Delaware, Inc. v. Universal Forest Products, Inc. (In re Hechinger Investment Co. of Delaware, Inc.), No. 99-2261, 2004 WL 3113718 (Bankr. D. Del. Dec. 14, 2004).

 The Bankruptcy Court found that the “plain meaning” of section 547(c)(4) of the Bankruptcy Code required the Defendants to show that the new value: (i) was extended after the preferential payment, (ii) is not secured with an otherwise unavoidable security interest and (iii) has not been repaid with an otherwise unavoidable transfer. Payments for new value would be otherwise unavoidable if, for instance, they were not made on account of an “antecedent debt,” which is one of the criteria for avoiding a payment as preferential.

 In its analysis, the Bankruptcy Court found the subsequent advance approach to be consistent with two policies that underlie the new value defense: encouraging trade creditors to continue dealing with troubled businesses and treating a creditor who replenishes the estate after receiving a preference  payment fairly. The Bankruptcy Court partially granted the Defendants’ motions for summary judgment by holding that their new value could be used as a defense as long as it was not part of an otherwise unavoidable transfer. The Bankruptcy Court’s decision required one of the Defendants to submit evidence that the payments it received were not otherwise unavoidable.

 Commissary Operations

 In Commissary Operations, the Debtor brought avoidance actions against creditors that held administrative expense claims for goods shipped within 20 days prior to the Debtor’s bankruptcy filing. The Debtor moved for declaratory judgment that such shipments could not be used for a new value defense, because it would permit the Defendants to receive “double value” for their shipments (payment on the administrative expense claim and a defense to the preference action). The Defendants moved for summary judgment. 

 The Bankruptcy Court ruled in favor of the Defendants. In its analysis, the Bankruptcy Court found that there is nothing in the “plain language” of section 503(b)(9) of the Bankruptcy Code (which states that a claim arising from goods received by a debtor within 20 days prior to filing for bankruptcy is entitled to administrative expense priority status) or section 547(c)(4) to indicate that the two sections are mutually exclusive. Furthermore, it stated that the “preference window” closed on the date the Debtor filed its bankruptcy petition and “postpetition payments [on 503(b)(9) claims] could not be used to deplete prepetition ‘new value.’” It also reasoned that requiring suppliers to choose between an administrative expensive claim and new value defense would negate the benefits that Congress intended to confer upon businesses that ship goods to troubled companies when it enacted the new value defense in the Bankruptcy Code. Finally, the Bankruptcy Court noted that, unlike shipments that form the basis of a reclamation claim, which may not be used as new  value, shipments of goods that form the basis of a 503(b)(9) claim do benefit a debtor’s estate, because a debtor retains them and uses them in its business.

 Accordingly, the Bankruptcy Court denied the Debtor’s motion for declaratory judgment and granted the Defendants’ motions for partial summary judgment.

Commentary

 The decisions of the Bankruptcy Court for the District of Delaware and the Bankruptcy Court for the Middle District of Tennessee help define previously unclear boundaries of the new value defense to preference actions, and, in doing so, have strengthened the new value defense. Even so, the Pillowtex decision contains a significant restriction – that the new value cannot be paid with an otherwise unavoidable transfer. Both decisions show a strong inclination by the respective Bankruptcy Courts to implement Congressional policies designed to incentivize entities to deal with troubled companies.