As an initial matter, the Creditor was able to reduce its preference liability by changing how it applied a payment from Roberds. Roberds had sent the Creditor a check for invoices reflecting goods previously shipped; however, the Creditor did not accept the check as payment. Instead, the parties agreed that the Creditor would void the check, and Roberds would wire transfer to the Creditor an amount equal to the check. This amount, however, was used as a prepayment of future shipments from the Creditor to Roberds. The invoices that were to be paid with the initial check remained unpaid and were part of the Creditor’s unpaid prepetition claim. The final result was that the Court found the wire transfer not to be a preference within the definition of §547(b)(2) because the transfer was not “for or on account of an antecedent debt owed by the debtor before such transfer was made.” The Creditor, by being creative, shifted from receiving preferential payments to receiving advance payments. 

For the $2.8 million in payments that were preferential, the Court found that $2 million were within the “ordinary course of business” under Section 547(c)(2) of the Bankruptcy Code. Ordinary course credit was granted for payments made by Roberds to the Creditor up until December 1, 1999. However, for payments received subsequent to that date, the Court found that the Creditor was NOT entitled to the ordinary course of business defense for the remaining $800,000.00 in payments because:

1. The Creditor began to vigorously enforce its credit limits for Roberds;

2. The Creditor used credit holds against Roberds;

3. While “net 30” terms were in effect, Roberds was actually paid earlier than the terms required;

4. Payment terms were changed from “net 30” to “2% net 15”;

5. Payments to other creditors were delayed or denied while Creditor received accelerated payments; and

6. The post-December 1 events described above had not been part of the parties’ prior course of dealing.

The Court then applied the “subsequent new value defense” of Section 547(c)(4) of the Bankruptcy Code. This defense has been the subject of controversy in recent years over the issue of whether “new value” for which the creditor has been “paid” can be used as part of the subsequent new value defense. The Third Circuit Court of Appeals in New York City Shoes, Inc. v. Bentley International, Inc. (In re New York City Shoes, Inc.), 880 F.2d 679 (3rd Cir. 1989), had ruled that paid new value cannot be used as part of a subsequent new value defense. This is the law in the Third Circuit (and therefore applicable in Delaware cases), the Seventh Circuit (including Illinois) and the Eleventh Circuit (including Georgia and Florida). 

In the Roberds case, the Court rejected this position and decided to allow paid new value to count toward the defense. In doing so, the Court adopted the position of the Fifth, Eighth, and Ninth Circuits that the plain text of §547(c)(4) does not require that the “new value” remain unpaid. Instead, the Court found that “paid” subsequent new value may be an affirmative defense to a preferential transfer if the subsequent new value is itself “otherwise avoidable” by the debtor. If the subsequent new value, however, is paid by a transfer that is not avoidable, i.e., the payment was in the ordinary course of business, then the “paid” subsequent new value does not qualify for the affirmative defense. After credit for the paid new value, a judgment was entered against the creditor for $372,000 on the original $2,800,000 preferential payment claim.

The case is currently being appealed on several issues. Roberds has appealed the Bankruptcy Court’s holding with regarding to “paid” versus “unpaid” new value, and both sides have appealed the Court’s holding with regard to the Court’s determination as to which payments were or were not within the “ordinary course of business.”

The case is instructive because it clearly shows that certain actions which creditors routinely take once a debtor is experiencing financial difficulty, can erode the ordinary course of business defense. It also reinforces the strategy that requiring prepayment is one way of capping a vendor’s preference liability because prepayments cannot be preferences. More importantly, if the Sixth Circuit upholds the “Paid New Value” approach, we will then have an even clearer split between the Circuits, and the Supreme Court may take up the issue. Hopefully, the issue would then be resolved in favor of the creditor community by allowing paid new value to be asserted. Even until that happens, there is tremendous value of having another well-reasoned Circuit opinion allowing paid new value to counter the existing New York Shoes decision.

Poyner & Spruill defends preference actions for its clients in bankruptcy courts throughout the country and frequently represents multiple defendants in a single case. This brings additional value to all of Poyner & Spruill’s defendant/ clients in that there is generally a cost savings to all of the defendants. 

If you have questions regarding this publication, please contact Judy Thompson at (704) 342-5255 or  jdthompson@poynerspruill.com or Andy Jurs at (704) 342-5301 or sajurs@poynerspruill.com.

This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.