Eighth Circuit Applies Subsequent New Value Defense To Payments Received From Third Party Creditor

by Stinson Leonard Street

The Eighth Circuit held that preferential payments are subject to a new value defense of § 547(c)(4) where the new value was provided by a third party that benefitted from the preferential transfers.

John Stoebner, as Chapter 7 Trustee for LGI Energy Solutions Inc. (LGI), brought an avoidance action against San Diego Gas & Electric Company (SDGE) and Southern California Edison Company (SCEC) to recover under § 547 of the Bankruptcy Code payments made by the debtors to SDGE and SCEC during the 90 days prior to the debtors' bankruptcy filings. The debtors were utility management companies that paid utility bills on behalf of large retailers such as Buffets, Inc. and Wendy's International Inc. The utilities would send invoices for Buffets and Wendy's directly to the debtors who would then group the invoices into a single payment request to Buffets and Wendy's. Once the debtors received payment from Buffets and Wendy's, the debtors would then cut checks to each individual utility company.

During the 90 days prior to the debtors' bankruptcy filings, the debtors made payments to SDGE totaling $75,053.85 and SCEC totaling $183,512.74. The debtors subsequently received additional payments from Buffets and Wendy's but did not remit these additional payments to the utility companies.

In the avoidance action, SDGE and SCEC asserted the subsequent new value defense under § 547(c)(4) of the Bankruptcy Code, which states, in pertinent part, that the trustee may not recover a transfer "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." (emphasis added) The utility companies argued that their preference liability should be reduced by the subsequent payments made to the debtors by Buffets and Wendy's. The trustee disagreed, arguing that the plain language of the statute requires that the subsequent new value be given by "such creditor" and that, because the payments were received from Buffets and Wendy's and not the utility companies, the payments did not qualify as subsequent new value under the statute.

The bankruptcy court ruled in favor of the utility companies in part, applying the subsequent new value defense to payments made by Buffets and Wendy's after the payment of the preferential transfers, but excluding those payments for utility charges generated prior to the preferential transfers. The Eighth Circuit Bankruptcy Appellate Panel (BAP) reversed the bankruptcy court in part, applying the subsequent new value defense to all payments made by Buffets and Wendy's after the payment of the preferential transfers, regardless of when the utility charges arose.

The trustee appealed, arguing that the lower courts' holdings did not follow the plain language of the statute, which required the subsequent new value to be provided by "such creditor." The Eighth Circuit rejected this argument, holding as follows:

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 of preference liability.

The Eighth Circuit expanded its prior holding In re Jones Truck Lines, where the debtor sued to recover preferential payments made to an employee benefit funds pursuant to a collective bargaining agreement. The defendants asserted defenses under § 547(c)(1) of the Bankruptcy Code – the "contemporaneous exchange for new value" defense – and § 547(c)(4) of the Bankruptcy Code. In applying the contemporaneous exchange for new value exception to these transfers, the Eighth Circuit held that the "'new value' Jones received for paying current wages and benefit contributions during the 90-day preference period were the services its employees continued to provide." Id. at 327. The court said that even if the exchange was not contemporaneous, the debtor still received the subsequent new value of the employee's continued performance. See id. at 328.

Because the debtors' receipt of the subsequent payments from Buffets and Wendy's would not have occurred but for the debtors' preferential payments to the utility companies, the payments by Buffets and Wendy's constituted subsequent new value within the meaning of the statute. The Eighth Circuit said that to hold otherwise would improperly permit a double recovery to the debtors' bankruptcy estates where the amount of Buffets and Wendy's claims would increase, but they would only share pro rata in the recovery of the transfers.

Also noteworthy is the Eighth Circuit's apparent disagreement with the lower courts' holding that SDGE and SCEC were "creditors" of the debtors within the meaning of § 101(10) of the Bankruptcy Code. In noting that the utility companies did not appeal this issue, the Eighth Circuit said "[t]he issue is not before us, so we do not consider it. But this part of the BAP decision should not be considered Eighth Circuit precedent."

This comment is instructive and may afford a third party transferee an opportunity to escape preference liability under § 547(b)(1), which requires that the transfer be made "to or for the benefit of a creditor."

The Eighth Circuit remanded the case to the BAP to correct a clerical error in the BAP's calculation of SCEC's preference liability, but the decision has otherwise been upheld.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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