Seventh Circuit Decision Endorses Useful Tool for Applying “New Value” Defense Under 11 U.S.C. § 547(c)(4)

In Levin v. Verizon Bus. Global LLC (In re OneStar Long Distance Inc.),[1] the U.S. Court of Appeals for the Seventh Circuit recently issued an important opinion on the “new value” defense for preference actions, affirming the bankruptcy court’s “per diem” method of determining the precise amount of “subsequent new value” extended by a trade creditor on a given day during the preference period. The per diem method allocates a specific amount of new value to each day of a given month by dividing the total amount billed at the end of the month by the number of days in the month, then presuming that the resulting average daily value was provided on each day during the month. The Seventh Circuit is the first appellate court to endorse the use of this method of calculating the amount of new value provided by a preference defendant.

The facts of Onestar Long Distance demonstrate the difficulty a trade creditor may have in persuading a debtor during settlement discussions, or the bankruptcy court at trial, of the precise point in time at which new value was provided to the debtor. MCI Inc.[2] was a wholesaler of telecommunications services. MCI billed the debtor, OneStar Long Distance Inc., at the end of each month at a variable rate for its “switched” services, and at a fixed monthly charge for “unswitched” services. For the preference period, MCI billed OneStar approximately $1.3 million in October 2003, $1.3 million in November 2003 and $1.1 million in December 2003. During that time, OneStar paid MCI $1,900,012.81.

After OneStar filed for bankruptcy, the chapter 7 trustee sought to recover the $1.9 million from MCI, alleging that the payments were preferential transfers. At trial, the bankruptcy court was faced with the issue of determining how much new value had been advanced by MCI to OneStar and, importantly, when exactly the new value had been provided. The matter was complicated by the fact that only the aggregate monthly totals of MCI’s services were known. The applicable invoices did not allocate MCI’s services on a daily basis, and neither MCI’s nor the debtor’s records contained sufficient information to allow the parties to determine exactly how much new value had been provided on any given day during the preference period.

While the parties did not dispute that MCI had advanced enough new value to cover the October and November 2003 payments totaling approximately $1.6 million, the trustee argued that the two December 2003 payments — a $100,000 payment on Dec. 9, 2003, and a $200,000 payment on Dec. 17, 2003 (collectively, the “December payments”) — were avoidable because MCI was unable to prove that it had provided its December services subsequent to those dates. MCI could prove only that in December 2003 it had provided OneStar with services worth a total of $1.1 million. It was unable to prove the specific amount provided on any given day, so it was unable to prove the specific amount provided to the debtor subsequent to MCI’s receipt of the December payments.

The bankruptcy court came to MCI’s assistance and applied the per diem method, dividing the total amount of the December invoice by the number of days in the month, and presuming for purposes of the new value defense that the resulting daily average was the amount of new value that had been provided on each day. Under this method, enough of the new value was deemed to have been provided subsequent to the December payments to completely cancel out any liability that MCI would otherwise have had. Accordingly, the bankruptcy court held that the December 2003 payments were unavoidable.

The Seventh Circuit affirmed the bankruptcy court’s ruling. The Seventh Circuit noted that while it was “theoretically possible” that MCI had front-loaded the new value before the December payments, the court stated that it was “highly improbable” for two reasons. First, a portion of MCI’s services carried fixed charges, making large fluctuations in total charges less likely. Second, OneStar’s revenue only slightly declined between December 2003 and January 2004, suggesting that OneStar’s use of switched services did not drastically plummet in the middle of December. Ultimately, the Seventh Circuit held that the bankruptcy court’s per diem method for allocating new value was reasonable, and that OneStar’s December 2003 payments to MCI were fully protected by the new value defense.

The OneStar decision sets out a practical and straightforward method for preparing a new value defense in circumstances where the defendant provided continual, but variable-rate, services to the debtor and billed on a monthly basis, and where calculating the exact daily value is not feasible. This could be a valuable tool to unsecured creditors who would otherwise face a complicated and perhaps impossible task in calculating the exact amount of new value advanced on each given day of the preference period.