Preference Actions: Latest Trend in Calculating the “New Value” Defense

01.30.2014

The “new value” defense used by creditors in preference actions requires a creditor to determine the pre-petition amounts of unpaid “new value” it gave to a debtor after the debtor paid the creditor for goods/services provided. Debtors often argue that creditors can’t use this defense for pre-petition new value that has been repaid on a post-petition basis. Such repayments include critical vendor payments and payments for goods/services provided to the debtor within the 20 days prior to a bankruptcy filing.

The Third Circuit Court of Appeals became the first Circuit Court to recently rule on this issue in Friedman’s Liquidating Trust v. Roth Staffing Companies LP, No. 13-1712, 2013 WL 6797958 (3d Cir. Dec. 24, 2013). The Court held that post-petition payments made by a debtor to a creditor will not reduce the creditor’s pre-petition, new value defense.

Roth Staffing in a Nutshell

Friedman’s, Inc. (the “Debtor”) filed for Chapter 7 bankruptcy on January 22, 2008. Within the 90 days before the bankruptcy filing—the preference period—the Debtor paid $81,997.57 (the “Transfers”) to Roth Staffing Companies LP for pre-petition services provided by Roth Staffing. Roth Staffing later provided $100,660.88 in pre-petition services (the “New Value”) to the Debtor, which went unpaid.

With the Bankruptcy Court’s approval, the Debtor paid $72,412.71 (the “Post-Petition Payment”) to Roth Staffing on account of the New Value. The Debtor’s successor in interest—Friedman’s Liquidating Trust (the “Trust”)—later sued Roth Staffing to recover the Transfers as preferential transfers under the Bankruptcy Code. In defense, Roth Staffing asserted that the Trust couldn’t avoid and recover the Transfers because the New Value exceeded the Transfer amounts. The Trust argued that the New Value must be reduced by the amount of the Post-Petition Payment, resulting in remaining preference liability. 

The Bankruptcy Court held that the Petition Date operated as the cutoff date for computing “new value,” and the Trust couldn’t use the Post-Petition Payment to reduce Roth Staffing’s new value. On appeal, the Third Circuit affirmed the lower courts’ rulings for policy and statutory reasons, including: 

• The tests used to analyze preferences suggest that the petition date is the baseline for determining the extent of a creditor’s new value defense.
• The deadline for filing preference actions is calculated using the petition date, indicating that calculating preference liability should remain constant, even post-petition.
• The new value defense was designed to: (1) encourage creditors to continue to deal with troubled businesses; and (2) treat fairly creditors who replenished the estate after receiving a preference.

The Takeaways from Roth Staffing

The Court’s decision in Roth Staffing:

• Provides creditors with a stronger basis for accepting and retaining post-petition payments received from a debtor for pre-petition goods/services provided; and
• Strengthens creditors’ new value defense by advancing the argument that a debtor’s bankruptcy petition date serves as the cutoff in computing new value; in other words, timing matters!