11 U.S.C. § 547 gives a bankruptcy trustee or debtor in possession strong powers in avoiding transfers made by the bankrupt debtor within the 90-day period prior to the debtor's bankruptcy filing. I am sure there are many creditors who have had the unpleasant experience of receiving a letter from a bankruptcy trustee demanding repayment of all payments the creditor rightfully received on account of debts that the debtor actually owed to the creditor within the 90 days prior to the debtor's bankruptcy filing. Usually these same creditors are owed substantial amounts by the debtor prior to paying the money back, and this only adds insult to injury.
Theoretically, preference law was intended to make it so that one creditor was not preferred over other creditors by receiving more payments than other creditors might just because a particular creditor was more aggressive in seeking collection. Also, bankruptcy preference law was meant to discourage a "rush" by creditors on a debtor who might be on the verge of a bankruptcy filing in hopes that the bankruptcy could be avoided altogether. Perhaps more simply put, it was meant to help maintain the status quo. In fact, one of the defenses to a bankruptcy preference claim is that the payment was a payment within the ordinary course of business between the debtor and the creditor based on their past historical dealings, or that it was within the ordinary course of business for the particular industry that the creditor and debtor are a part of. While the ordinary course of business defense can often prove helpful in reducing or eliminating a creditor's exposure to a preference claim, there is no clear standard of what constitutes the ordinary course of business. And, many different factors can be taken into account, which can leave a judge a lot of wiggle room to rule one way or the other.
A more favored defense, because it is not so nuanced as an ordinary course of business defense, is the "subsequent new value" defense provided for by 11 U.S.C. § 547(c)(4). The subsequent new value defense essentially allows a creditor to deduct the value of new goods or services provided to the debtor subsequent to the receipt of payments with the 90-day preference period. This is a nice and easy math problem that can sometimes make whole preference claims go away. For example, if a trustee is seeking to avoid $100 of payments you received within the 90-day preference period, but you can show that you shipped the debtor $200 of goods following the payments within the same 90-day period, then you could have a complete defense to the trustee's preference claim. There is one catch to the new value defense: the new value had to remain unpaid. So, taking the example above, if I received a later payment of $150 on the goods I shipped, then I could only use the remaining $50 as part of my new value defense. That may now be changing as more and more courts are holding that subsequent new value does not need to remain unpaid in order to be used as a defense to a preference claim.
Most recently, in In re Proliance International, Inc., 514 B.R. 426 (Bkrtcy.D.Del.2014), Judge Sontchi of the United States Bankruptcy Court for the District of Delaware held that a preference defendant’s preference exposure can be reduced upon application of both paid and unpaid subsequent new value. This is not a new idea as there are decisions from other courts going back more than 10 years that have also held the same way. However, such decisions were decidedly in the minority of preference legal jurisprudence.
Judge Sontchi seemed particularly impressed with the analysis performed by the Bankruptcy Court for the Western District of Michigan in In re Check Reporting Services, Inc., 140 B.R. 425 (Bkrtcy.W.D.Mich.,1992). The Court in In re Checking noted that the language of 11 U.S.C. § 547(c)(4)(B) created a "subsequent advance" approach to the subsequent value defense, thereby making any new value advanced following a preference payment a defense to the avoidance of that payment. The Court in In re Checking also noted, and Judge Sontchi agreed, that this achieved the goal of encouraging continued business with the debtor because, "the only sure defense to a preference was to continue dealing with the debtor by supplying additional new value after receiving each preference." Id. at 437.
It will be interesting to see if more courts will adopt the holdings In re Proliance International, Inc., and In re Check Reporting Services, Inc. by allowing for paid new value to be included in the subsequent new value defense. If so, this could make a very big difference in encouraging creditors to continue to do business with debtors, as could take some assurance in knowing that doing so may be the best way to avoid having to pay back money to a bankruptcy estate on account of a preference claim.