Getting the biggest bang for your new value preference defense buck.
The Facts Of The Globe Case
The preference defendant, Seneca Petroleum Co., had agreed to sell petroleum products to the debtor, Globe. It was Seneca's practice to issue an invoice to Globe after Seneca's shipment of product to Globe.
Globe had made two payments to Seneca within 90 days of its bankruptcy filing. The first payment was by Globe's check, dated October 24, 2000, in the amount of $187,776.60. Seneca deposited that check into its bank account on October 27, 2000, and the check was subsequently honored on October 30, 2000. The second payment was by Globe's check, dated October 27, 2000, in the amount of $169,047.13. Seneca deposited that check on November 1, 2000, and the check was honored on November 2, 2000.
In October and November 2000, Seneca had shipped product to Globe, seen in the table at right.
Globe's Chapter 7 Trustee sued Seneca to recover Globe's payments totaling $356,823.73 to Seneca during the 90-day period prior to Globe's bankruptcy filing. Seneca asserted, among other preference defenses, the new value defense under Section 547(c)(4) of the Bankruptcy Code. Now the fun begins!
The Preference Statute And New Value Defense
A trustee can recover a preference by satisfying all of the following requirements:
* The debtor transferred its property to or for the benefit of a creditor. The most frequent type of transfer is the debtor's payment to a creditor. It is settled law, based on the 1992 United States Supreme Court decision in Barnhill v. Johnson, that for purposes of determining whether a transfer satisfies the requirements for a preference, a debtor's transfer by check occurs on the clearance date of the check;
* The transfer was made on account of antecedent or existing indebtedness that the debtor owed the creditor;
* The transfer was made within 90 days of the debtor's bankruptcy filing, in the case of transfer to non-insider creditors such as Seneca, and within one year of the bankruptcy filing for transfers to insiders of the debtor, such as the debtor's officers, directors, controlling shareholders and affiliated companies;
* The transfer was made when the debtor was insolvent. The debtor's insolvency is based on a balance sheet definition; the debtor's liabilities exceed its assets. The debtor's insolvency is also presumed within the 90-day preference period, which makes it easier for the trustee to prove; and
* The transfer enabled the creditor to receive more than the creditor would have received in a Chapter 7 liquidation of the debtor. This requirement is always satisfied unless the debtor's unsecured creditors receive full payment of their claims.
There are several defenses that reduce or eliminate recovery on a preference claim. The new value defense, arising under Section 547(c)(4) of the Bankruptcy Code, is one of the more frequently asserted preference defenses. The defense applies where the creditor had provided new value to the debtor subsequent to the preference. The new value cannot be secured by a security interest in the debtor's assets that is otherwise unavoidable and cannot be paid by an otherwise unavoidable transfer to or for the creditor's benefit. A creditor's shipment of goods, and/or provision of services, to the debtor on credit following a preference is a frequently invoked example of new value that can reduce preference exposure. The new value defense is designed to protect a creditor from preference exposure to the extent the creditor had replenished the debtor by extending new credit subsequent to the preference.
The Section 547(c)(4) new value defense is not a net result rule. The defense does not allow a netting of all payments and shipments of goods and/or provision of services during the 90-day preference period that would limit preference risk to the extent the payments exceeded the shipments of goods/provision of services. Too bad it could not be that simple! A creditor determines new value under Section 547(c)(4) by offsetting extensions of credit from only previous, and not subsequent, preference payments.
The extent of deductible new value can vary depending on the timing of the transfer. A payment by check could be deemed to have occurred on the date of issuance of the check, the date of the mailing of the check, the date of the creditor's receipt of the check, the date of the creditor's deposit of the check, or the date of clearance of the check. The earlier the payment is deemed to have occurred, the greater the amount of deductible new value, and the less a creditor's preference exposure, might be.
The amount of new value that reduces preference exposure can also vary where there are multiple preferences and extensions of credit. Deductible new value might be drastically curtailed if it is available to reduce exposure on only the immediately preceding preference and not all prior preference payments.
The court in Globe addressed both these issues.
Seneca's And The Globe Trustee's Differing Calculations Of New Value
Seneca argued for the most generous calculation of new value, deducting from preference exposure all new value shipments of goods after the issuance date of the first $187,776.60 check on October 24, 2000, and the second $169,047.13 check on October 27, 2000. This method of calculating new value would have allowed Seneca to maximize the amount of deductible new value by counting its shipments on October 25, 26 and 27, totaling $85,175.51.
Globe's trustee argued the other extreme position of calculating new value. The trustee reduced Seneca's preference exposure by counting only extensions of credit after the clearance date of the checks, October 30, 2000, for the first check, and November 2, 2000, for the second check. Based on the trustee's far less generous calculation, Seneca's October 25, 26 and 27 shipments would not have counted as deductible new value. Seneca's new value defense would have been limited to shipments starting on October 31, 2000, for the first check, and November 3, 2000, for the second check.
Seneca and Globe also disagreed on whether Seneca's subsequent extensions of credit can reduce only the immediately preceding preference payment or also all prior payments. Seneca argued that its subsequent extensions of credit should qualify as new value to reduce all prior preference payments, and thereby allow Seneca to increase the amount of deductible new value and reduce its preference exposure. Globe's trustee sought to limit the new value defense to reduce only the immediately preceding preference payment, and thereby increase Seneca's preference exposure.
THE COURT'S DECISION IN THE GLOBE CASE
New Value Calculated After Creditor's Receipt Of Payment
First, the court calculated new value by deducting all shipments (1) after the date of Seneca's receipt of the alleged preference payments, rather the clearance date of the check as Globe's Trustee had argued. The United States Supreme Court's ruling, in Barnhill v. Johnson, that a payment by check is deemed to have been occurred upon clearance, was only for the purpose of determining whether the trustee had proved a preference under Section 547(b) of the Bankruptcy Code. The Supreme Court did not rule on when a payment by check is deemed to have been made for calculating any of the preference defenses, such as the new value defense. (2)
The Globe court noted that determining new value from the date the creditor had received a check encourages creditors to continue dealing with troubled companies. Creditors selling on credit terms usually treat a payment by check as a cash transaction, and ship new orders or provide services after their receipt of the check. It would be unfair to penalize a creditor for extending credit after receiving a check but prior to clearance of the check, particularly since the debtor was replenished by the creditor's credit extension in either event.
Seneca could not prove when it had received the two checks from Globe. Seneca could have received the first check in the amount of $187,776.60 as early as the issuance date of the check, October 24, 2000, or as late as the deposit date of October 27, 2000. Seneca could have received the second check in the amount of $169,047.13, as early as the date of that check, October 27, 2000, or as late as the deposit date of November 1, 2000. The court opted for the latest possible receipt date and calculated new value from the date of Seneca's deposit of the payments, October 27 for the first check, and November I for the second check. That method for calculating new value may allow a creditor to assert a larger new value defense than the trustee's argument for deducting only new value extended after the check clearance date.
New Value Applied To All Prior Preferences
The court also considered the manner of calculating new value where there are multiple preference payments and extensions of credit during the 90-day preference period. The court followed the majority rule that allows a preference defendant to deduct new value from the payment immediately preceding the extension of credit as well as all prior preference payments. This rule increases the amount of deductible new value and has been followed by most courts, including three United States Circuit Courts of Appeal, the Fourth Circuit in In re Meredith Manor, Inc., the Fifth Circuit in In re Micro Innovations Corp., and the Ninth Circuit in In re IRFM, Inc. (3)
Application Of Court's Holding To Seneca's New Value Shipments
The Globe court ruled that with respect to Globe's first check in the amount of $187,770.50, Seneca's shipments totaling $29.446.13 on October 25, 2000, and $29,724.50 on October 26, 2000, were made before Seneca's deposit of that check, on October 27, 2000. Therefore, these shipments, totaling $59,170.63, were not counted as deductible new value. Also, Seneca's shipment of $26,004.88 on the check deposit date of October 27, 2000, the date of Seneca's first payment, did not quality as deductible new value because Seneca could not prove that it had made the shipment after its receipt of the payment.
Now for the good news--the court deducted Seneca's shipment on October 31, 2000, in the amount of $29,662.13 as new value because it was made after Seneca's receipt of the first payment. That reduced Seneca's exposure on account of the first payment to $158,154.47. The court also deducted Seneca's November 1 shipment in the amount of $25,992.00, further reducing its exposure on the first payment to $132,232.47. The court also deducted all of Seneca's shipments, totaling $292,253.03 on and after November 2, 2000, from the balance of the first payment, $132,232.47, and from $160,020.56 of the second payment. Seneca was left with a remaining preference exposure of just $9,020.57.
Seneca's preference exposure would have been far greater if the court had utilized Globe's trustee's method of calculating new value. That would have resulted in the loss of approximately $123,000.00 of deductible new value because Seneca would have been permitted to apply all shipments on or after November 2, 2000, in reduction of only the second preference payment, and not from the first payment. That would have saddled Seneca with far greater preference exposure than would have been the case based upon the court's methodology for calculating new value.
So--guess what--Globe's trustee asserted a preference claim of $356,823.73, but after applying the new value defense, the court reduced Seneca's preference exposure to just $9,026.57. And Seneca could still take advantage of the Section 547(c)(2) ordinary course defense to possibly eliminate all remaining preference exposure!
So the Globe court's methodology for determining the new value defense allowed Seneca to reduce its preference liability by far more than if the court had adopted the Globe trustee's less generous calculation. Trade creditors should be aware that a trustee may calculate new value in a very stingy manner that most courts reject. As the court in Globe made clear, a trustee's calculation of new value that minimizes the amount of the new value defense and, therefore, maximizes preference risk, might be incorrect and shortchange the amount of new value available to reduce preference exposure. Creditors should be aware of the correct approach to calculating new value that might substantially reduce preference exposure. A little knowledge goes a long way!
Related Sessions at Credit Congress:
Bankruptcy Update One Year Later 14040
Bankruptcy/Creditors' Rights Forum: You Ask the Speaker! 14054
(1.) The court found that Seneca had extended new value when it had shipped goods to Globe, rather than based upon invoice date which was later in some instances. The court relied upon Seneca's agreements with Globe under which Globe had acquired an interest in the goods purchased from Seneca on the date of shipment.
(2.) The Supreme Court recognized that most United States Circuit Courts of Appeal, and other courts, had ruled that the payment date of a check for determining preference defenses, such as the new value defense, is not the clearance date of the check.
(3.) The court in Globe rejected the minority view, asserted by Globe's trustee and followed by the United States District Court of Maine, in Leathers v. Prime Leather Finishes Co., that limits the new value defense to reduce only the immediately preceding preference payment, and precludes carrying back the new value to prior preference payments.
Bruce S. Nathan, Esq. is a Partner in the law firm of Lowenstein Sandler PC in New York, NY. He is also a member of NACM and is a Co-Chair of the American Bankruptcy Institute Unsecured Trade Creditors Committee. He can be reached via e-mail at email@example.com.
Shipment Date Invoice Date ($) Value of Shipment 10-25-00 10-31-00 $29,446.13 10-26-00 10-31-00 $29,724.50 10-27-00 10-31-00 $26,004.88 10-31-00 10-31-00 $29,622.13 11-02-00 11-02-00 $37,027.25 11-01-00 11-06-00 $25,922.00 11-02-00 11-06-00 $29,740.75 11-07-00 11-07-00 $22,173.13 11-09-00 11-09-00 $25,805.00 11-06-00 11-09-00 $26,004.88 11-07-00 11-09-00 $29,610.75 11-09-00 11-10-00 $25,783.88 11-10-00 11-13-00 $22,381.13 11-13-00 11-14-00 $18,544.50 11-14-00 11-15-00 $22,065.88 11-17-00 11-17-00 $29,376.75 11-15-00 11-20-00 $3,739.13
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|Title Annotation:||CREDIT COLUMN; Seneca Petroleum Co.; Globe|
|Author:||Nathan, Bruce S.|
|Date:||Mar 1, 2006|
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