Eighth Circuit Expands Subsequent New Value Preference Defense in Cases Involving Three-Party Relationships
A bankruptcy trustee or chapter 11 debtor-in-possession has the power under section 547 of the Bankruptcy Code to avoid a transfer made immediately prior to bankruptcy if the transfer unfairly prefers one or more creditors over the rest of the creditor body. However, not every payment made by a debtor on the eve of bankruptcy can be avoided merely because it appears to be preferential. Indeed, section 547 provides several statutory defenses to preference liability. The Eighth Circuit Court of Appeals recently addressed one such defense to preference avoidance—the "subsequent new value" exception. In Stoebner v. San Diego Gas & Electric Co. (In re LGI Energy Solutions, Inc.), 2014 BL 76796 (8th Cir. Mar. 20, 2014), the court, in a matter of first impression, ruled that "new value" (either contemporaneous or subsequent) for purposes of section 547(c) can be provided by an entity other than the transferee.
Avoidance of Preferential Transfers
A fundamental goal underlying U.S. bankruptcy law is equality of distribution among similarly situated creditors. To that end, the automatic stay generally prevents creditors from acting to collect on their debts after a debtor files for bankruptcy. In addition, section 547(b) of the Bankruptcy Code provides for avoidance of transfers made by an insolvent debtor within 90 days of a bankruptcy petition filing (or up to one year, if the transferee is an insider) to or for the benefit of a creditor on account of an antecedent debt where the creditor, by reason of the transfer, receives more than it would have received if, assuming the transfer had not been made, the debtor were liquidated in chapter 7.
Section 547(c) contains nine exceptions to avoidance of a preference. Of these, the three defenses most commonly invoked by commercial creditors are the "contemporaneous exchange" defense (section 547(c)(1)), the "ordinary course payment" defense (section 547(c)(2)), and the "subsequent new value" defense (section 547(c)(4)).
Section 547(c)(4) provides as follows with respect to the subsequent new value defense:
The trustee may not avoid under this section a transfer . . . (4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor—
(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[.]
Thus, even where a creditor has received a preferential transfer, the transferee may offset against the preference claim any subsequent unsecured credit that was extended to the debtor. The purpose of the exception is to encourage creditors to continue working with troubled businesses. See Jones Truck Lines, Inc. v. Full Serv. Leasing Corp., 83 F.3d 253, 257 n.3 (8th Cir. 1996). "It recognizes that the ‘new value’ effectively repays the earlier preference, and offsets the harm to the debtor’s other creditors. . . . Accordingly, ‘the relevant inquiry under section 547(c)(4) is whether the new value replenishes the estate.’ " Savage & Assoc., P.C. v. Level (3) Communications (In re Teligent, Inc.), 315 B.R. 308, 315 (Bankr. S.D.N.Y. 2004) (internal citations omitted).
"New value" is defined in section 547(a)(2) of the Bankruptcy Code to include, among other things, "money or money’s worth in goods, services, or new credit." In other words, a creditor must establish that it provided the debtor with "something new that is of tangible value." In re Fuel Oil Supply & Terminaling, Inc., 837 F.2d 224, 230 (5th Cir. 1988).
The issue addressed by the Eighth Circuit in LGI Energy is whether the language "such creditor gave new value" in section 547(c)(4) means that, in order to shield a transfer from avoidance, the "new value" provided to the debtor following the transfer must have come from the recipient of the challenged transfer, as distinguished from a third party.
LGI Energy Solutions, Inc., and an affiliate (collectively, "LGI") performed bill payment services for clients that were large utility customers. Pursuant to contracts between LGI and its customers, LGI periodically sent each customer a spreadsheet detailing its payment obligations under invoices that LGI received from the utilities that provided services to the customer. After the customer sent a check payable to LGI for the aggregate amount due, LGI deposited the funds into its own commingled bank accounts and then sent checks drawn on those accounts to the utility companies. Even though the utilities sent bills for LGI’s customers to LGI, the utilities had no contracts with LGI.
Over a three-week period in November 2008, LGI paid two utility providers approximately $258,000 for utility services provided to LGI customers. After those transfers, the utilities continued to provide services to the customers and sent new invoices to LGI. LGI continued to bill the customers, which sent checks totaling $297,000 to LGI for the payment of the invoices. LGI never paid any of those funds to the utilities.
LGI ceased operating in December 2008. Shortly afterward, involuntary chapter 7 petitions were filed against LGI in Minnesota. After entry of orders for relief in the consolidated cases, the chapter 7 trustee sued the utility providers to avoid as preferential the $258,000 in payments made by LGI. Although the challenged transfers were made to satisfy LGI’s antecedent obligations to its utility customers—the transfers were made "for the benefit" of the customers—
the trustee elected not to sue these primary creditor beneficiaries. The utilities invoked section 547(c)(4)’s subsequent new value defense.
The bankruptcy court concluded that the utilities were "creditors" under third-party and trust beneficiary principles, even though no contractual relationship existed between the providers and LGI. In addition, the court construed the language "such creditor" in section 547(c)(4) to mean that new value for purposes of the exception must have been provided to, or for the benefit of, LGI by the utilities, rather than to LGI’s customers. Accordingly, the bankruptcy court ruled that the $297,000 in services provided by the utilities to LGI’s customers did not qualify as new value furnished to LGI subsequent to the $258,000 in payments LGI made to the utilities within 90 days of the bankruptcy petition date.
A bankruptcy appellate panel reversed the ruling in part on appeal. The appellate panel agreed with the bankruptcy court’s conclusion that the utilities were creditors despite the absence of a contract with LGI. However, relying on Jones Truck Lines, the court disagreed with the bankruptcy court’s reading of "such creditor" to preclude new value provided to a debtor by a third party:
Jones Truck Lines can be harmonized with the [reference to "such creditor" in section 547(c)(4)] by interpreting it as a recognition that in tripartite relationships where the [preferential] transfer to a third party [here, the utility] benefits the primary creditor [here, the utility customer], new value can come from that [primary] creditor, even if the third party is a creditor in its own right.
The trustee appealed to the Eighth Circuit.
The Eighth Circuit’s Ruling
A three-judge panel of the Eighth Circuit affirmed.
At the outset, the court severely criticized the trustee’s approach in suing the utilities instead of LGI’s customers, who could have warded off any liability by means of section 547(c)(4) because they clearly provided post-transfer value to LGI. According to the court, "This approach does fundamental violence to the ‘prime bankruptcy policy of equality of distribution among creditors.’ " If the utilities were required to return the preferential payments to LGI, the Eighth Circuit wrote, "the estate is ‘doubly replenished’ entirely at the expense of only two creditors, [LGI’s customers], who got no benefit for their subsequent new value and will continue to be liable to the utilities for their unpaid invoices."
The Eighth Circuit distanced itself from the lower courts’ determination that the utilities were "creditors" who received a transfer or its benefit within the meaning of section 547(b)(1). Because the utilities did not raise this issue on appeal, however, the Eighth Circuit noted merely that "it seems open to serious question . . . and [the ruling] should not be considered Eighth Circuit precedent."
The court faulted the trustee’s reliance on In re Musicland Holding Corp., 462 B.R. 66 (Bankr. S.D.N.Y. 2011), for the proposition that "such creditor" in section 547(c)(4) must "in all circumstances" be construed as "limiting subsequent new value to that personally provided by the creditor the trustee elects to sue to recover the preferential transfer." In Musicland, the Eighth Circuit explained, the court denied the preference defendant’s claim of an offset for subsequent new value provided by another creditor who, unlike in LGI Energy, "neither received nor benefitted [sic] from the preferential transfer." Here, the Eighth Circuit emphasized, both LGI’s customers and the utilities benefited from LGI’s preferential payments to the utilities.
The Eighth Circuit agreed with the bankruptcy appellate panel that Jones Truck Lines adequately refuted the trustee’s position. In Jones Truck Lines, the Eighth Circuit ruled that payments made by a debtor-employer to benefit plans to satisfy its obligations to pay pension and welfare benefits were excepted from preference liability to the extent that the employees provided the debtor with post-transfer new value in the form of services. The court’s analysis was directed principally toward new value in the context of the contemporaneous exchange defense in section 547(c)(1). Even so, the Jones Truck Lines court went on to address the related subsequent new value defense under section 547(c)(4). The court wrote that "[i]f [the debtor] received no contemporaneous new value for the weekly payments [to the benefit funds], then it necessarily received subsequent new value for each payment (except the last one) because its employees continued working." Jones Truck Lines, 130 F.3d at 327.
In LGI Energy, the Eighth Circuit concluded that, even if not controlling, Jones Truck Lines provides persuasive authority contradicting the trustee’s "inequitable" interpretation of the term "such creditor" in section 547(c)(4):
Our decision is limited to the circumstances presented by this case, for the statute is complex. We hold that, in three-party relationships where the debtor’s preferential transfer to a third party benefits the debtor’s primary creditor, new value (either contemporaneous or subsequent) can come from the primary creditor, even if the third party is a creditor in its own right and is the only defendant against whom the debtor has asserted a claim for preference liability. As § 547(b) makes avoidable a transfer "for the benefit of a creditor," it both serves the purposes of § 547 and honors the statute’s text to construe "such creditor" in the § 547(c)(4) exception as including a creditor who benefitted [sic] from the preferential transfer and subsequently replenished the bankruptcy estate with new value.
LGI Energy is a positive development for those doing business with financially troubled entities because it expands the scope of the subsequent new value defense to encompass payment relationships involving multiple parties. In one sense, the ruling can be viewed as an instance of judicial activism directed at harmonizing the Bankruptcy Code with the realities of complex financial transactions. A handful of other courts have similarly concluded that new value provided by a third party in similar three-party transactions is adequate for the transaction at issue to fall within the exceptions provided by sections 547(c)(1) and 547(c)(4). See, e.g., In re H&S Transp. Co., 939 F.2d 355, 358‒60 (6th Cir. 1991); Fuel Oil Supply, 837 F.2d at 231; Holmes Environmental, Inc. v. Suntrust Banks, Inc. (In re Holmes Environmental, Inc.), 287 B.R. 363, 386 (Bankr. E.D. Va. 2002).
However, it could be argued that the Eighth Circuit’s decision was motivated more by equitable and policy considerations than by a careful examination of the plain meaning of section 547(c)(4). The court stated in no uncertain terms that it viewed the trustee’s preference litigation strategy as "do[ing] fundamental violence" to the policy of equality of distribution. The problem with the court’s approach is that, even though the result may have been seen as fair, it glosses over the specific language of section 547(c)(4) and related provisions in the statute. Section 547(c)(1) and section 547(c)(4) share the concept of "new value" as a defense to preference liability. The former exempts from avoidance a transfer made as "a contemporaneous exchange for new value given to the debtor," whereas the latter shields a transfer to the extent that "after such transfer, such creditor gave new value" (emphasis added). Thus, section 547(c)(1) does not specify by whom new value can be provided, but section 547(c)(4) clearly provides that "such creditor"—i.e., the transferee—must be the source.
When Congress makes a distinction of this nature between two subsections of the same statute, it is presumed to have intended that they be implemented differently. Other courts have reached this conclusion with respect to sections 547(c)(1) and 547(c)(4), ruling that only the former allows new value to be provided by a third party. See, e.g., Manchester v. First Bank & Trust Co. (In re Moses), 256 B.R. 641, 652 (B.A.P. 10th Cir. 2000); Gray v. Chace (In re Boston Publishing Co.), 209 B.R. 157, 174 (Bankr. D. Mass. 1997) (same).
In LGI Energy, the Eighth Circuit did not conclude that the language of section 547(c)(4) is ambiguous and therefore did not offer a rationale for declining to apply it literally. Nor, in its opinion, did the court examine the legislative history of section 547(c) in an effort to discern why lawmakers chose to use different wording in sections 547(c)(1) and 547(c)(4). As such, even though the outcome may have been fair, the ruling does not provide an ideal road map for invoking the subsequent new value defense in other cases involving three-party relationships.
The court in this case could have elected a pathway more consonant with the literal terms of section 547(c)(4) that nevertheless reached the same result. As the Eighth Circuit noted, the ruling below that the utilities were "creditors" of LGI was "open to serious question." A conclusion that the utilities were not in fact creditors of LGI—given that the parties had no contractual relationship—would have resulted in no preference liability, while simplifying the resolution of the case considerably.