The Bottom Line:
In Friedman's Inc. v. Roth Staffing Cos., L.P. (In re Friedman's Inc.), Adversary Case No. 09-50364, 2011 Bankr. LEXIS 4500 at *3 n.2 (Bankr. D. Del. Nov. 30, 2011), the bankruptcy court recently held that payment of a claim after the petition date did not invalidate the creditor’s “new value” defense for other payments received during the preference period. The creditor asserted the “subsequent new value” defense under 11 U.S.C. § 547(c)(4), even though it had also received an administrative expense payment for this new value contribution shortly after the petition date pursuant to court order. While the debtor argued that this postpetition payment for the “new value” services reduced the creditor’s new value defense, the bankruptcy court concluded that the filing of a bankruptcy petition “fixes” any analysis of preferential payments as of the petition date. As such, the debtor’s postpetition payment to the creditor for new value provided prepetition did not affect that creditor’s ability to assert a “subsequent new value” defense to the debtor’s preference action.
What Happened:
On January 22, 2008, certain creditors of Friedman’s – a purveyor of middle-market jewelry – commenced an involuntary chapter 7 case against the company. The case was subsequently converted to a voluntary Chapter 11. During the three months leading up to bankruptcy, Friedman’s had made roughly $80,000 in payments to Roth Staffing Companies, an employment firm. Subsequent to these payments, but shortly before Friedman’s filing, Roth provided the debtor with approximately $100,000 of services for which it was not compensated prior to the petition date. Id. at *3. As part of its first-day motions, Friedman’s sought the court’s permission to make payment on these services; the court approved partial payment of around $70,000.
A year later, the debtor-in-possession brought a preference action against Roth seeking to recover the $80,000 that the debtor had paid Roth in the months prior to the petition date. In support of its action, the debtor argued that the $70,000 postpetition payment for services rendered immediately prior to the petition date undercut the availability of a “subsequent new value” defense under Code section 547(c)(4), which provides that the “trustee may not avoid under this section 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 . . . .” Id.; 11 U.S.C. § 547(c)(4). The debtor reasoned, where Roth’s new value defense otherwise would have encompassed the $100,000 in unpaid “new value” services provided prepetition – effectively wiping out the debtor’s $80,000 preference claim – the immediate postpetition payment of $70,000 on those services reduced Roth’s new value defense to $30,000, leaving Roth vulnerable on $50,000 of the $80,000 in preference payments originally made. Id. at *3-4.
The bankruptcy court was faced with the question as to whether a debtor’s postpetition payment on account of a prepetition “new value” contribution should reduce commensurately the value of a creditor’s defense to a preference action. Ultimately, the court ruled that the creditor’s defense should not be reduced by postpetition payments, as the preference analysis should be viewed in terms of the parties’ positions as of the petition date and not affected by subsequent events.
In so holding, the court rejected both parties’ “plain meaning” statutory arguments, id. at *8-12, relying instead on the Third Circuit’s 1989 holding in New York City Shoes, which defined the “subsequent new value” defense in an otherwise dissimilar context. As the Third Circuit explained in that case:
The three requirements of section 547(c)(4) are well established. First, the creditor must have received a transfer that is otherwise voidable as a preference under § 547(b). Second, after receiving the preferential transfer, the preferred creditor must advance “new value” to the debtor on an unsecured basis. Third, the debtor must not have fully compensated the creditor for the “new value” as of the date that it filed its bankruptcy petition. If a creditor satisfies these elements, it is entitled to set off the amount of the “new value” which remains unpaid on the date of the petition against the amount which the creditor is required to return to the trustee on account of the preferential transfer it received.
In re New York City Shoes, 880 F.2d 679, 680 (3d Cir. 1989) (internal citations omitted) (emphasis added).
By the bankruptcy court’s reasoning, the Third Circuit’s holding reflected clearly “that subsequent provision or payment of new value does not affect the preference analysis even if the debtor completely compensates the creditor for its pre-petition claim.” Friedman’s at *14. As the bankruptcy court expounded:
This is consistent with the purpose of the preference law-to reduce damaging, pre-petition opt out behavior and to level the pre-bankruptcy playing field for all creditors. Once the bankruptcy is filed the preference law becomes unnecessary. The automatic stay steps in to stop the race to the assets and the supervision of the case by the court, among other things, ensures that similar claims receive similar treatment.
[. . .]
In a pre-petition, preference context the different treatment arises from the parties’ behavior with some claimants receiving better treatment by winning the race to the debtor's assets. But, in a post-petition scenario such as that before the Court, pre-petition claims cannot be paid unless approved by the Court.
Id. at *14-15, *15 n.24.
Thus, the court ruled, “[n]either the post-petition provision of new value by the creditor nor the post-petition payment of unpaid, pre-petition new value affects the preference calculation.” Id. at 15.
Why the Case is Interesting:
This case has drawn attention for its holding that a creditor facing a preference action may assert as a defense the full amount of any prepetition new value provided to the debtor, even where that creditor is compensated in full for this contribution immediately postpetition. For purposes of analyzing a preference action, parties’ rights are frozen as of the petition date; a creditor could therefore be paid fully for new value it provided after receiving preferential payments and still use that new value to offset its preference liability.