In a recent decision from the Delaware bankruptcy court, Judge Christopher S. Sontchi joined the debate over the interpretation of section 547(c)(4)(B) of the Bankruptcy Code, which sets forth the new value defense to a preference claim. 

In Miller v. JNJ Logistics LLC (In re Proliance Int’l, Inc.), the question was “whether an (alleged) preferential transfer may be reduced by subsequent new value regardless of whether it was ‘paid’ or ‘unpaid’ prior to the petition date, or whether the defense is only to the extent that the subsequent new value remained ‘unpaid.’”  In a victory for the defendant, Judge Sontchi explicitly held that the defendant was entitled to reduce its preference exposure by both unpaid and paid new value, adopting the “subsequent advance approach” in calculating the new value defense.

Absent defenses, a trustee may avoid any transfer of an interest of the debtor in property (i) to or for the benefit of a creditor, (ii) on account of antecedent debt, (iii) while the debtor was insolvent, (iv) made within 90 days of the filing of the petition (or 1 year in the case of insider transfers), and (v) that left the creditor better off than it would have been in a chapter 7 case if the transfer had not been made.

Pursuant to section 547(c)(4), a transfer may not be avoided “to the extent that, after such 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.”

Judge Sontchi recognized a jurisdictional split regarding the interpretation and application of the new value defense.  The 7^th and 11^th Circuits have adopted the “remains unpaid” approach, including Matter of Prescott, 805 F.2d 719, 732 (7th Cir. 1986) and Charisma Inv. Co., N.V. v. Airport Sys., Inc. (In re Jet Florida Sys., Inc.), 841 F.2d 1082, 1083 (11th Cir. 1988), have concluded that new value must remain unpaid at the end of the preference period to be used as a preference defense.  The rationale behind this approach is that “paid new value does not represent the return of a preferential transfer to the estate.”

Under the “subsequent advance” approach, new value does not need to remain unpaid at the end of the preference period.  Courts including the 4^th, 5^th, 8^th and 9^th Circuits have adopted this approach.  Crichton v. Wheeling Nat’l Bank (In re Meredith Manor, Inc.), 902 F.2d 257 (4th Cir. 1990); Laker v. Vallette (Matter of Toyota of Jefferson, Inc.), 14 F.3d 1088, 1091 (5th Cir. 1994); Jones Truck Lines, Inc. v. Central States, Southeast and Southwest Areas Pension Fund (In re Jones Truck Lines, Inc.), 130 F.3d 323, 328 (8th Cir. 1997); Mosier v. Ever-Fresh Food Co. (In re IRFM, Inc.), 52 F.3d 228 (9th Cir. 1995).

Judge Sontchi discussed two prior Delaware bankruptcy court opinions on the subject (Burtch v. Revchem Composites, Inc. (In re Sierra Concrete Design, Inc.), 463 B.R. 302 (Bankr. D. Del. 2012) and Burtch v. Masiz (In re Vaso Active Pharm., Inc.), 500 B.R. 384 (Bankr. D. Del. 2013)), indicating that “the Court believes that its previous rulings have, at least by inference, adopted the subsequent advance approach.”

Accordingly, Judge Sontchi adopted the “subsequent advance” approach to the new value defense, giving the defendant full credit for all subsequent new value it provided to the debtor, whether unpaid or paid.

The decision undoubtedly represents a victory for preference defendants in Delaware cases.  However, given the jurisdictional split, defendants in other jurisdictions, including the 7^th and 11^th, should be aware that the creditor-friendly “subsequent advance” approach has been rejected in favor of the “remains unpaid” approach.