Narrowing a split among the circuits, the Eleventh Circuit no longer requires that new value remain unpaid on filing to qualify as a defense to a preference.
As it now stands, the Fourth, Fifth, Eighth, Ninth and Eleventh Circuits do not limit the new value defense to subsequent advances of credit that remain unpaid on the filing date. According to the August 14 opinion by Eleventh Circuit Judge Julie E. Carnes, “the Seventh Circuit held, without much discussion, that Section 547(c)(4) does require new value to remain unpaid.”
Similarly, she said that the Third Circuit “also stated in a conclusory fashion [in dicta] that Section 547(c)(4) requires new value to remain unpaid.”
In reality, the Eleventh Circuit was not reversing a prior holding. Judge Julie Carnes, not to be confused with Chief Judge Ed Carnes, said that her court’s prior statement in Charisma Investment Company N.V. v. Airport Systems Inc. (In re Jet Florida System Inc.), 841 F.2d 1082 (11th Cir. 1988), was dicta and therefore was not binding.
Commenting on Judge Carnes’ opinion, Charles Tatelbaum of Miami told ABI, “It’s about time.”
The Facts in the Eleventh Circuit
The appeal to the Eleventh Circuit involved a typical preference, albeit for big bucks. The supplier to a chain of grocery stores was paid more than $550,000 in the 90-day preference period before bankruptcy. Also during the preference period, the supplier provided new value by delivering goods worth some $435,000.
The supplier conceded that the payments satisfied all of the elements of a preference under Section 547(b).
However, the supplier raised the so-called ordinary course defense under Section 547(c)(2) and the new value defense under Section 547(c)(4). The bankruptcy court rejected the ordinary course defense.
Relying on Jet Florida, the bankruptcy court did not allow the supplier to offset new value that the debtor had paid before filing. As a result, the bankruptcy court held the supplier liable for a net of about $440,000 in preferences. Had the defense been allowed, it is possible that the supplier may have had no preference liability at all.
The bankruptcy court certified a direct appeal, which the Eleventh Circuit accepted. The supplier only raised the new value defense on appeal.
Jet Florida’s Dicta
In Jet Florida, the creditor had raised the new value defense under Section 547(c)(4), which allows a creditor to offset “new value” given after a preferential transfer that was “(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 in Jet Florida concluded that the creditor had not given new value as a matter of fact. Agreeing that the creditor had not given new value, the circuit court in Jet Florida upheld the finding of a preference.
In the course of the decision, however, the Eleventh Circuit said that the new value defense has “generally been read to require . . . that the new value must remain unpaid.” Id. at 1083.
Because the statement about remaining unpaid was not necessary to the decision in Jet Florida, Judge Carnes said it was dicta and was therefore not binding on the court.
Plain Language Saves the Supplier
Analyzing the issue anew, Judge Carnes said that the “plain language” of Section 546(c)(4) “does not require new value to remain unpaid.” She also said that “policy considerations strongly disfavor the trustee’s position” that new value must remain unpaid to provide an offset to a preference.
Judge Carnes found nothing in the language of Section 546(c)(4) allowing an offset “only for new value that remains unpaid.” Instead, she said, the “plain language” in subsections (A) and (B) allow the defense “so long as the transfer that pays for the new value is itself avoidable.”
Judge Carnes buttressed her conclusion by analyzing the history of preferences. Under the predecessor to the current preference statute, Section 60c of Bankruptcy Act of 1898 said there was an offset for “such new credit remaining unpaid.” The “remaining unpaid” language, she said, was omitted from the Bankruptcy Code, to be replaced by “something substantively different” in the confusing double negatives now found in subsections (A) and (B).
Judge Carnes cited the Commission on the Bankruptcy Laws of the U.S. for recommending before adoption of the Code that the “remaining unpaid” provision be eliminated.
Even if Congress had not intended to make a change from prior law, Judge Carnes said she would reach the same conclusion from “the unambiguous statutory language.”
Policy Considerations Point in the Same Direction
Requiring new value to remain unpaid “would hinder the policy objective of encouraging vendors to continue extending credit to financially troubled debtors,” Judge Carnes said. Otherwise, a supplier who senses financial trouble would have a “strong disincentive” to continue delivering goods, for fear that preference liability would increase.
Judge Carnes described a hypothetical where a supplier received $5,000 in payments and made $5,000 in advances during the preference period. If “remaining unpaid” were a requirement, the supplier would be liable for the entire $5,000. If it did not matter, the supplier’s maximum liability would be $1,000, she said.
Giving suppliers incentives to cut off customers in financial trouble would hasten bankruptcy, while harming both the debtor and other creditors, Judge Carnes said.
The trustee made a virtually unintelligible argument based on the word “otherwise” in subsection (B). Judge Carnes said that no court had accepted the argument and some have rejected it.
Judge Carnes remanded the case to recalculate the amount of the preference, if any, for which the supplier would be liable.