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by Robin Bicket White
Doing business with a financially distressed company can be risky. If financial distress results in bankruptcy, a creditor's concern over non-payment can quickly turn into fear that it received preferential payments in the months prior to the bankruptcy filing. Section 547 of the Bankruptcy Code authorizes the trustee (or Chapter 11 debtor-in-possession) to sue a creditor for payments received in the ninety days (or one year for insiders) before the bankruptcy filing if, among other things, such payments resulted in the creditor receiving more than it would have in a liquidation.
The Code contains several exceptions to the preference rule. The "subsequent new value" exception in Section 547(c)(4) of the Code is one of the most important. Over the last decade, a trend has emerged in the way some courts apply the new value exception, which has led to greater relief for defendant-creditors.
A handful of bankruptcy courts in the Sixth Circuit have followed the trend, but the Sixth Circuit Court of Appeals has yet to explicitly adopt the new method. For this reason, creditors across the country are interested in garnering a favorable ruling from the Sixth Circuit adopting the new method for calculating subsequent new value.
WHAT IS SUBSEQUENT NEW VALUE?
Section 547(c)(4)(B) states that a transfer may not be avoided if it was "to or for the benefit of a creditor, to the extent that, after such a transfer, such creditor gave new value to or for the benefit of the debtor…on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor." This means that if a payment on an antecedent debt is made by the debtor to the creditor during the preference period and the creditor then extends "new value" to the debtor as a result of that payment, then the amount of the new value should offset the preference payment.
For example, if a debtor pays $1,000 to a creditor on day 80 (prior to a bankruptcy) and the creditor then ships $500 of goods to the debtor on day 75, the creditor would argue that it has a 547(c)(4) defense as to $500 of the alleged $1,000 preferential payment. This analysis becomes much more complicated when the debtor and creditor have made numerous exchanges during the preference period. It is this situation, where numerous exchanges have occurred, that has caused the split among the Circuits.
THE DEBATE
The source of the split among the courts is the question "must subsequent new value remain unpaid?" The debate can be traced to a few key cases. Bishop v. Pettigrew was decided in 1982 by the Bankruptcy Court for the Northern District of Georgia. The Bishop court explained that the subsequent new value analysis should be contingent on three requirements: 1) the creditor must extend new value, 2) the new value must come after a preferential transfer, and 3) the new value must remain unpaid. The Bishop analysis was adopted as the "majority rule" across the country regarding calculation of subsequent new value. The Third, Seventh and Eleventh Circuits all favor the Bishop method of calculating new value. Meanwhile, the Eighth Circuit appears to be split regarding whether new value must remain unpaid.
In contrast, the Ninth and Fifth Circuits have held that Bishop is incorrect and that new value need not "remain unpaid." Courts rejecting the Bishop approach point out that there is nothing in the plain language of the statute that requires new value to remain unpaid. It should be noted that even under the new rule, a creditor may not apply a credit for new value given during the preference period but before the first preferential payment. The new value must be subsequent to the first preferential payment.
THE LAW IN THE SIXTH CIRCUIT
Bankruptcy courts in the Sixth Circuit have ruled on the application of the subsequent new value exception with varying results. In the 1980's, bankruptcy courts in the Sixth Circuit followed Bishop with little analysis. Then, in 1992, the Bankruptcy Court for the Western District of Michigan held in In re Check Reporting Services that it declined to follow the Bishop approach. That case was followed by Brown v. Shell Can from the Bankruptcy Court for the Eastern District of Tennessee, and Hunter v. Amerisource from the Bankruptcy Court for the Northern District of Ohio in 1997. Both cases rejected Bishop and held that subsequent new value need not remain unpaid. Hunter was affirmed by the Sixth Circuit, but the Court did not add to the lower court's subsequent new value analysis.
At this point, it appears that the majority of the bankruptcy courts in the Sixth Circuit have sided with the Fifth and Ninth Circuits in holding that subsequent new value need not remain unpaid. Hopefully, the Sixth Circuit Court of Appeals will soon take up the issue squarely and provide clarity to the debate.
CONCLUSION
In summary, the law regarding subsequent new value is evolving across the country. Recent cases from bankruptcy courts in the Sixth Circuit appear to side with the emerging view that new value need not remain unpaid. It is likely that the Sixth Circuit will take the next possible opportunity to clearly state its policy on this issue. Until then, creditors in the Sixth Circuit will remain cautiously optimistic about the future application of §547(c)(4) to offset preference liability.
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