Eleventh Circuit: § 547(c)(4) New Value Should Not Be Reduced by Post-Petition § 503(b)(9) Claims

The Bankruptcy Code includes nine defenses to a trustee’s ability to avoid a pre-petition transfer as a preference. One of those defenses — codified at 11 U.S.C. § 547(c)(4) — allows a creditor “who provides new value after receiving a preferential transfer [to] use that new value [1] to offset its preference liability.”[2] The defense — sometimes called the “subsequent new value” defense — is fairly easy to apply. Consider the following example:

Creditor receives a $50,000 payment from Debtor as to goods Creditor previously supplied to Debtor on credit. The $50,000 payment is made by Debtor within 90 days of Debtor’s petition date, and the payment otherwise meets the requirements detailed in § 547(b). Two weeks after Debtor’s payment, but before Debtor’s petition date, Debtor orders an additional $25,000 in goods from Creditor (again on credit) and Creditor abides, delivering the goods the next day. Assuming no other transfers or payments are made between Debtor and Creditor prior to Debtor’s bankruptcy filing, a trustee or debtor-in-possession can seek to unwind the $50,000 payment as a preference. But because of the subsequent new value defense, Creditor will be entitled to offset the $50,000 payment by the $25,000 in goods supplied to the Debtor after the payment was made.

Thus, the subsequent new value defense is straightforward in most instances. Even so, aspects of the defense’s statutory text have created some confusion.

“There are three elements to [the subsequent new value defense]: (1) the creditor must have given new value; (2) the new value was not secured by an otherwise unavoidable security interest; and (3) the debtor did not make an otherwise unavoidable transfer to or for the benefit of the creditor on account of the new value.” [3] Confusion has arisen (mostly) because of the third element and the unfortunate phrase “otherwise unavoidable transfer.” A recent Eleventh Circuit opinion, Auriga Polymers Inc. v. PMCM2 LLC, [4] addressed that issue directly and answered a previously open question in the circuit: whether a creditor facing a preference demand may use funds that are otherwise earmarked to be paid as § 503(b)(9) administrative expenses as a preference offsetting § 547(c)(4) new value.

The debtor in Auriga Polymers, Beaulieu Group, LLC, was a large carpeting manufacturing and distributing company based out of Dalton, Ga. Several market factors, including a change in consumer preference to hardwood floors along with increased competition, pushed Beaulieu into bankruptcy and, ultimately, liquidation. Prior to its bankruptcy filing, Beaulieu purchased “polyester resins and specialty polymers” from Auriga Polymers Inc. on credit. When Beaulieu’s bankruptcy case was filed, Auriga was owed over $4 million related to goods it provided to Beaulieu. Significantly, some of those goods were supplied during the 90-day period leading up to Beaulieu’s bankruptcy filing. Perhaps more importantly, at least $694,502 of the goods provided by Auriga were delivered within 20 days of Beaulieu’s petition date. Auriga filed a large proof of claim in Beaulieu’s case and sought a § 503(b)(9) administrative claim as to the goods it supplied within that final 20-day period.

Thereafter, the bankruptcy court confirmed a liquidating plan proposed by the debtor, and the debtor’s assets were transferred to a liquidating trust, which was managed and administered by a liquidating trustee. Causes of action, including preference claims, were among the assets transferred to the liquidating trust. After the trust was created, the trustee exercised his right to sue Auriga as to payments it received during the 90-day period leading up to the debtor’s bankruptcy filing. In his complaint, the trustee argued that Auriga could not use the value of the goods it supplied to the debtor during the 20 days preceding the petition date to offset its preference liability while also receiving post-petition payment of those amounts under § 503(b)(9). The bankruptcy court agreed with the trustee and held that Auriga could not offset its preference liability with new value that would otherwise be paid as a § 503(b)(9) claim. [5] Auriga appealed, and the issue reached the Eleventh Circuit directly, bypassing the district court.

“Section 503(b)(9) of the Bankruptcy Code grants certain creditors administrative expense priority for ‘the value of any goods received by the debtor within 20 days before the date of commencement of a case under [Title 11] in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.” [6] The parties in Auriga didn’t ultimately dispute Auriga’s entitlement to a § 503(b)(9) claim. Rather, the ultimate issue was whether Auriga could use amounts set aside to pay Auriga’s admin claim as new value for § 547(c)(4) purposes.

On appeal, the trustee argued that the funds he set aside post-petition to satisfy Auriga’s § 503(b)(9) claim constituted an “otherwise unavoidable transfer” that could not be used as subsequent new value. In support, the trustee pointed to the statutory language of § 547(c)(4)(B), which states that a preference defendant cannot rely upon new value “on account of which” the debtor made an “otherwise unavoidable transfer to or for the benefit of such creditor.” Per the trustee, it did not matter that the “otherwise unavoidable transfer” was made post-petition because the statute did not make such a distinction.

In analyzing the question, the Eleventh Circuit noted that only three courts had addressed the precise issue before the court, but that more courts had considered “the broader issue of whether any post-petition payments affect a creditor’s subsequent new value defense.” [7] In one of those cases (In re Friedman’s Inc. [8]), the Third Circuit held that only pre-petition “otherwise unavoidable transfers can offset a creditor’s subsequent new value. [9]

Because the question in Auriga required interpretation of a statutory provision, the Eleventh Circuit’s analysis focused on the plain meaning of § 547(c)(4)(B). Its analysis looked not only to the language of the statute itself, but also to the broader context of the statute as a whole. The court’s ultimate holding in Auriga is simple: The phrase “‘otherwise unavoidable transfers’ means pre-petition transfers.” [10] Thus, Auriga could rely upon its post-petition § 503(b)(9) amounts as new value to offset its preference liability. But to get to that conclusion, the court had to work through several issues.

First, the court determined that the word “transfer,” which is used three times in § 547(c)(4), has the same meaning throughout the entire Code section. Also, when looking at all three uses, the court indicated that it was clear that the word “transfer” in § 547(c)(4) means “transfers that qualify as preferences.” [11] Second, the court reasoned that since the two-year statute of limitations as to a trustee’s ability to assert preference claims runs from the petition date, then it wouldn’t make sense to look to post-petition transfers as part of the analysis. In the court’s estimation, if post-petition payments could defeat a new value defense, then “the calculation of preference liability could change depending on when the preference avoidance action was filed.” [12] Finally, the court determined that policy considerations supported its interpretation. In particular, the court noted that its decision did not sanction “double payment” of Auriga’s invoices. Instead, per the court, “asserting a new value defense does not result in any payment to the creditor; it merely prevents disgorgement of monies previously paid.” [13]

The Auriga Polymers decision is important because the subsequent new value defense is one of the most often utilized preference defenses. A typical first topic in preference negotiations is how much new value the creditor can rely upon and whether a demand reduction is warranted. In addition, many preference demand letters these days include a preliminary new value analysis.

Needless to say, it’s an important defense. Thus, the Eleventh Circuit’s opinion in Auriga Polymers provides immense value to practitioners in the circuit in terms of predictability. From a negotiation standpoint, it is good to know — rather than guess — that post-petition transfers do not impact the § 547(c)(4) analysis.