The Bankruptcy Code confers "administrative expense" priority status on the claims of vendors for the value of goods that are shipped in the ordinary course of business and received by a debtor within 20 days of filing for bankruptcy. It also provides vendors and other creditors with various defenses to the avoidance of preferential payments received from the debtor during anywhere from 90 days to one year before filing for bankruptcy, depending upon whether the creditor is an "insider" of the debtor.
One of those defenses shields from avoidance as a preferential transfer any payment made to a creditor to the extent that the creditor subsequently gave "new value" to the debtor, as long as that new value is provided on an unsecured basis and the debtor does not thereafter make an "otherwise unavoidable" transfer to the creditor.
Because such prepetition unsecured "20-day claims" are granted administrative expense priority—a designation almost exclusively limited to claims against a debtor that arise after the bankruptcy petition date—courts sometimes disagree over whether a preference defendant can use the same value to assert a 20-day claim that it can use to offset its preference liability under the "subsequent new value" defense. The U.S. Court of Appeals for the Eleventh Circuit recently addressed this question as a matter of first impression in Auriga Polymers Inc. v. PMCM2, LLC, 40 F.4th 1273 (11th Cir. 2022). It held that a preference defendant may use the same value to assert a 20-day claim that it can use to offset its preference liability under the subsequent new value defense. In so ruling, the court determined that only prepetition transfers affect a creditor's subsequent new value defense.
Administrative Expense Priority for 20-Day Claims
Section 503(b)(9) of the Bankruptcy Code provides that a creditor shall have an administrative expense claim for "the value of any goods received by the debtor within 20 days before the date of commencement of a [bankruptcy] case … in which the goods have been sold to the debtor in the ordinary course of such debtor's business." Unless the creditor agrees otherwise, a debtor cannot confirm a chapter 11 plan without paying administrative expense claims in full. See 11 U.S.C. § 1129(a)(9)(A). By contrast, vendor claims that do not meet the requirements of section 503(b)(9) typically are treated as general unsecured claims, entitling the holders to no more than their pro rata share of the estate's unencumbered assets.
Section 503(b)(9) was adopted to incentivize trade creditors to continue doing business with distressed companies. The provision "is a significant statutory departure from virtually all other parts of section 503(b), because it expressly affords administrative expense status to certain prepetition debts." Collier on Bankruptcy ("Collier") ¶ 503.16 (16th ed. 2022).
Section 503(b)(9) complements a seller's "reclamation" rights under applicable non-bankruptcy law. Section 546(c) of the Bankruptcy Code provides that, with certain exceptions, the avoidance powers of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") are subject to the right of a vendor who sold goods to a debtor in the ordinary course of the vendor's business to "reclaim" those goods from the debtor, including by stopping shipment of or retrieving the goods, "if the debtor has received such goods while insolvent" and within 45 days before filing for bankruptcy, provided that the vendor timely gives notice of the reclamation. Section 546(c)(2) explicitly provides that a seller failing to timely give such notice may nonetheless "assert the rights contained in section 503(b)(9)." Section 503(b)(9) "'provides a supplemental remedy for those sellers who would be preferred reclamation sellers, but for a minor disqualification under section 546(a).'" In re World Imports, 516 B.R. 296, 297 (Bankr. E.D. Pa. 2014) (quoting In re Momenta, Inc., 2012 WL 3765171, *4 (D.N.H. Aug. 29, 2012)); accord In re O.W. Bunker Holding N. Am. Inc., 607 B.R. 32, 40 (Bankr. D. Conn. 2019).
The Subsequent New Value Defense to Preferential Transfer Avoidance
Section 547(b) of the Bankruptcy Code provides that a trustee or DIP, "based on reasonable due diligence in the circumstances of the case and taking into account a party's known or reasonably knowable affirmative defenses under subsection (c)," may avoid "any transfer" 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 a creditor, if the creditor, by reason of the transfer, receives more than it would have received in a chapter 7 liquidation and the transfer had not been made. 11 U.S.C. § 547(b).
Section 547(c) sets forth nine defenses or exceptions to preference avoidance. One of those is the "subsequent new value" defense in section 547(c)(4), which provides as follows:
The trustee may not avoid under this section 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—
(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[.]
11 U.S.C. § 547(c)(4) (emphasis added).
Under this section 547(c)(4) exception, even if a creditor receives a preferential transfer, any subsequent unsecured credit provided to the debtor by the creditor may be offset against the creditor's preference liability. The "subsequent new value defense," in turn, is reduced to the extent a debtor makes an "otherwise unavoidable transfer" to the creditor on account of the new value received.
The subsequent new value exception encourages trade creditors—who may fear nonpayment or payment clawback by distressed companies—to continue providing goods and services to such companies by narrowing the circumstances under which a trustee can avoid payment for those goods and services. See Jones Truck Lines, Inc. v. Full Serv. Leasing Corp., 83 F.3d 253, 257 n.3 (8th Cir. 1996). "A subsequent advance is excepted because a creditor who contributes new value in return for payments from the incipient bankruptcy … should not later be deemed to have depleted the bankruptcy estate to the disadvantage of other creditors." In re Jet Florida Sys., Inc., 841 F.2d 1082, 1083 (11th Cir. 1988) (per curiam); accord In re Phoenix Rest. Grp., Inc., 317 B.R. 491, 495 (Bankr. M.D. Tenn. 2004).
New value is defined as "money or money's worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation." 11 U.S.C. § 547(a)(2).
A few areas of disagreement regarding the scope and application of section 547(c)(4) have emerged in the courts. First, some courts have concluded that any new value provided by a creditor must remain unpaid by the debtor for the creditor to benefit from the defense, whereas others have reasoned that the statutory language "otherwise unavoidable transfer" suggests that as long as the payment to a creditor that supplies the new value is avoidable, the "subsequent new value" defense is available. Compare In re N.Y.C. Shoes Inc., 880 F.2d 679, 680 (3d Cir. 1989) (new value must remain unpaid); In re Prescott, 805 F.2d 719, 731 (7th Cir. 1986) (same), with In re BFW Liquidation, LLC, 899 F.3d 1178 (11th Cir. 2018) (joining the Fourth, Fifth, Eighth, and Ninth Circuits in ruling that section 547(c)(4) applies to all new value supplied by the creditor during the preference period and not merely to new value that remains unpaid on the bankruptcy petition date); see generally Collier at ¶¶ 547.04[c] and [e] (citing cases).
Second, courts sometimes disagree over the meaning of the phrase "otherwise unavoidable transfer." Most, however, have concluded that it means a transfer that is not avoidable pursuant to one of the other eight preference defenses or exceptions codified in section 547(c). See, e.g., BFW Liquidation, 899 F.3d at 1198-99 ("We read the phrase 'otherwise unavoidable transfer' in § 547(c)(4)(B) as referring to transfers that are unavoidable for reasons other than § 547(c)(4)'s subsequent-new-value defense… . Our interpretation is bolstered by the fact that § 547(c)(4) is only one exception to avoidability contained within a list of such exceptions… . Thus, a transfer that is rendered unavoidable by one of those other exceptions, such as § 547(c)(2)'s ordinary-course-of-business defense, can naturally be said to be 'otherwise unavoidable' for purposes of § 547(c)(4)(B)."); accord Phoenix Rest. Grp., 317 B.R. at 499–500; In re Check Reporting Servs., Inc., 140 B.R. 425, 431–32, 435–36 (Bankr. W.D. Mich. 1992).
Third, most, but not all, courts have concluded that only prepetition transfers by the debtor and creditor should be considered for purposes of the subsequent new value preference defense. Compare In re Friedman's Inc., 738 F.3d 547, 557 (3d Cir. 2013) (citing and discussing cases and ruling that a DIP's postpetition payment of prepetition wages did not affect the calculation of preference liability under section 547(c)(4)); In re Bellanca Aircraft Corp., 850 F.2d 1275, 1284 (8th Cir. 1988) (postpetition goods or services provided to a DIP do not qualify as "new value" for purposes of § 547(c)(4): "'for the benefit of the debtor' … impl[ies] that subsequent advances of new value are only those given pre-petition, because any post-petition advances are given to the debtor's estate, not to the debtor"); Phoenix Rest. Grp., 317 B.R. at 496 ("The plain language of § 547 closes the preference window at the petition, limiting the § 547(c)(4) defense to new value supplied and payments made before the debtor crosses into bankruptcy."); In re Slamdunk Enterprises, Inc., 2021 WL 389081, *29 (Bankr. E.D. Tex. Jan. 29, 2021) (postpetition payments do not qualify for the subsequent new value defense); In re Dearborn Bancorp, Inc., 583 B.R. 395, 429 (Bankr. E.D. Mich. 2018) ("[A]ny new value from services that Defendants provided during the Post–Petition Period does not count as new value under Defendants' § 547(c)(4) defense."), with In re Furr's Supermarkets, Inc., 485 B.R. 672, 734 (Bankr. D.N.M. 2012) (post-petition payments made under an employee benefits order can be used to limit the creditor's new value defense); In re JKJ Chevrolet, Inc., 412 F.3d 545, 553 n.6 (4th Cir. 2005) ("While post-petition transfers [under a floor plan financing arrangement] may be considered under section 547(c)(4)(B), … neither party has addressed whether the post-petition transfers that occurred in the instant case were unavoidable.").
Only a handful of courts have considered whether section 547(c)(4) provides a defense to preference liability where a creditor received postpetition administrative expense payments under section 503(b)(9) in exchange for the subsequent new value. Some bankruptcy courts have concluded that a vendor/creditor should be restricted to using the value of the goods supplied either as a "new value" defense to preference liability under section 547(c)(4) or as an administrative claim under section 503(b)(9), but not both, whereas others have ruled to the contrary. Compare In re Commissary Operations, Inc., 421 B.R. 873, 878-89 (Bankr. M.D. Tenn. 2010) (holding that payment under section 503(b)(9) does not impact the subsequent new value defense), with PMCM2, LLC v. Fabric Sources, Inc. (In re Beaulieu Grp., LLC), 616 B.R. 857, 878 (Bankr. N.D. Ga. 2020) ("Fabric Sources") ("[T]he Court concludes that there is no temporal requirement in § 547(c)(4) for the debtor's transfer on account of new value. Accordingly, when a creditor has a claim under § 503(b)(9) and a defense under § 547(c)(4) and when the debtor has established reserves to pay administrative claims in full, then that reserve constitutes an 'otherwise unavoidable transfer' by the debtor, and the new value represented by the § 503(b)(9) claim cannot be used to offset the creditor's preference liability."); In re TI Acquisition, LLC, 429 B.R. 377, 385 (Bankr. N.D. Ga. 2010) (ruling that payment under section 503(b)(9) reduces a creditor's new value defense); In re Circuit City Stores, Inc., 515 B.R. 302, 314 (Bankr. E.D. Va. 2014) (same); In re Circuit City Stores, Inc., 2010 WL 4956022, *9 (Bankr. E.D. Va. Dec. 1, 2010) (same); see generally Collier at ¶ 547.04[e] (citing cases).
These rulings hinge in part on whether the payment of a 20-day administrative expense claim under section 503(b)(9) is an "otherwise unavoidable transfer" within the meaning of section 547(c)(4), such that the amount in question cannot be used to offset the recipient's preference liability under the subsequent new value defense.
The Eleventh Circuit considered this question as a matter of first impression in Auriga Polymers.
Beaulieu Group, LLC (the "debtor") was a carpet manufacturer and distributer of residential and commercial flooring products. Following a downturn in the carpet industry, the debtor and its affiliates each filed a voluntary petition under chapter 11 of the Bankruptcy Code on July 16, 2017, in the Northern District of Georgia.
Prior to the bankruptcy filing, Auriga Polymers Inc. ("Auriga") sold materials used in a variety of products to the debtor. Auriga sold goods worth nearly $4.3 million to the debtor on credit for which it had not received payment as of the petition date. During the 90-day preference period (Auriga was not an insider), the debtor paid Auriga over $2.2 million in aggregate.
The debtor made its final $421,119 payment to Auriga during the preference period on June 23, 2017. After receiving that payment and within 20 days of the July 16 bankruptcy petition date, Auriga delivered $694,502 in goods to the debtor. Thus, the subsequent new value provided by Auriga during the 20 days preceding the petition date exceeded the June 23 payment by nearly $274,000.
During the bankruptcy case, Auriga filed: (i) a general unsecured claim in the amount of $3.596 million, representing the difference between the nearly $4.3 million total owed to Auriga and the $694,502 for which Auriga asserted a 20-day claim under section 503(b)(9); and (ii) a motion for payment of $694,502 as an administrative expense under section 503(b)(9).
The bankruptcy court subsequently confirmed a liquidating chapter 11 plan for the debtor pursuant to which all of its assets, including avoidance causes of action, were transferred to a liquidating trust. The liquidating trustee (the "Trustee") commenced an adversary proceeding to avoid the $2.2 million in transfers to Auriga as a preference under section 547(b) and to recover that amount from Auriga under section 550.
Auriga moved for summary judgment, claiming that its preference liability was eliminated pursuant to the subsequent new value defense under section 547(c)(4). It also argued that the value it provided during the 20 days prior to bankruptcy, for which it asserted a section 503(b)(9) claim, could also be used for its section 547(c)(4) defense. Pursuant to a stipulation between the parties, the trust distributed the undisputed amount of Auriga's section 503(b)(9) claim (approximately $274,000), and the Trustee set aside a $421,119 reserve to cover the balance pending resolution of the Trustee's adversary proceeding.
The Trustee and Auriga agreed that Auriga provided new value to the debtor in the entire $694,502 amount, but disagreed over whether the placement of funds in reserve to satisfy Auriga's section 503(b)(9) claim constituted an "otherwise unavoidable transfer" on account of the new value provided by Auriga, such that the value of the funds reserved could not offset Auriga's preference liability.
Noting that the issue had already been decided in another adversary proceeding filed by the Trustee against a different preference defendant in the debtor's chapter 11 case (see Fabric Sources, 616 B.R. at 878), the bankruptcy court held that Auriga could not use the same value to seek payment under section 503(b)(9) and to offset its preference liability under section 547(c)(4). Thus, the court held, Auriga was entitled to the full $694,502 under section 503(b)(9), but that amount could not be used to reduce its $2.2 million preference liability.
Relying on BFW Liquidation and the plain language of section 547(c)(4), the bankruptcy court summarized its ruling as follows:
[P]ayment, or reserves for full payment, of a creditor's § 503(b)(9) administrative expense will offset that creditor's new value defense to a preference. Or, conversely, if the creditor successfully asserts a new value defense, it cannot receive payment of a § 503(b)(9) claim to the extent it is based on the same new value… . Under the plain language of the statute, payment of a § 503(b)(9) claim is an otherwise unavoidable transfer. It is a post-petition transfer that is authorized by the Bankruptcy Code; therefore, it is not avoidable under § 549. In addition, the plain language of the statute includes no requirement that the otherwise unavoidable transfer occur pre-petition. This interpretation is supported by the statutory history in that the predecessor to § 547(c)(4) included a temporal limitation on the payment of new value that was omitted from § 547(c)(4). The bankruptcy policies of encouraging creditors to continue doing business with financially distressed creditors and of equality of distribution also support this interpretation.
In re Beaulieu Grp., LLC, 2020 WL 7330537, *4 (Bankr. N.D. Ga. Mar. 20, 2020), rev'd and remanded, 40 F.4th 1273 (11th Cir. 2022).
Auriga appealed the ruling to the district court, which stayed the appeal pending the outcome of a direct appeal to the Eleventh Circuit.
The Eleventh Circuit's Ruling
A three-judge panel of the Eleventh Circuit reversed and remanded the case below.
Initially, the Eleventh Circuit rejected the Trustee's argument that its precedent in BFW Liquidation controlled the issue of whether funds held in reserve to pay Auriga's 20-day claim constituted an "otherwise unavoidable transfer" that would preclude its preference defense with respect to those funds.
In BFW Liquidation, the Eleventh Circuit held that new value need not remain unpaid in order to offset preference liability. Based on the plain language of section 547(c)(4), the court concluded that "otherwise unavoidable transfer" in section 547(c)(4)(B) means a transfer that is unavoidable for reasons other than those stated in section 547(c)(4).
The Trustee had argued that, in accordance with BFW Liquidation, section 547 does not on its face limit which unavoidable transfers affect a creditor's new value defense. The Eleventh Circuit disagreed, clarifying that BFW Liquidation did not address the timing of transfers with respect to a defendant's new value defense. The Eleventh Circuit accordingly found that BFW Liquidation was distinguishable because it did not address whether a defendant may assert both a section 503(b)(9) claim and reduce its preference liability under section 547(c)(4) based on the same underlying value.
Writing for the panel, U.S. Circuit Judge Barbara Lagoa noted that section 547(c)(4) does not specify whether an "otherwise unavoidable transfer" is a prepetition transfer or a postpetition transfer. However, based upon principles of statutory construction, the handful of decisions addressing the question in the context of section 503(b)(9), and other cases examining whether postpetition transfers can offset a transferee's preference liability under section 547(c)(4), the Eleventh Circuit ruled that an "otherwise unavoidable transfer" in the context of section 547(c)(4) refers to a prepetition transfer.
Examining the language and context of section 547, Judge Lagoa reasoned that the use of the word "transfer" in section 547(b) is instructive in ascertaining the meaning of the term in section 547(c)(4). According to Judge Lagoa, the phrase "otherwise avoidable transfer" in section 547(c)(4) must be interpreted in the context of the prepetition preference periods specified in section 547(b) because the meaning of words throughout a statute should be consistent. Moreover, she reasoned, section 547's title—"Preferences"—coupled with the fact that a separate provision (section 549) governs the avoidance of postpetition transfers, supports the conclusion that only prepetition transfers may be offset against a new value defense. Next, Judge Lagoa noted, most courts have concluded that value extended by a creditor after the petition date does not increase a creditor's new value defense, suggesting that postpetition payments do not affect preference liability.
In addition, the Eleventh Circuit explained that the statute of limitations for preference actions—which begins to run on the petition date or the appointment or election of a trustee (see 11 U.S.C. § 546(a)(1))—further supports the conclusion that "transfer" under section 547(c) means a prepetition transfer. Based on its statutory interpretation analysis, the Eleventh Circuit ruled that only prepetition amounts paid by a debtor reduce a preference defendant's new value defense.
This Eleventh Circuit downplayed the bankruptcy court's concerns that permitting a transferee to reduce its preference liability based on the same value supporting its section 503(b)(9) claim would amount to "double payment" or violate the bankruptcy principle of equality of distribution. It explained that there is no risk of double payment:
[A]sserting a new value defense does not result in any payment to the creditor; it merely prevents disgorgement of monies previously paid. Before the Petition Date, Auriga delivered a substantial amount of goods to Beaulieu. Both Auriga's general unsecured claim and its § 503(b)(9) request only seek payment for unpaid invoices.
Auriga Polymers, 40 F.4th at 1288. "More importantly," Judge Lagoa explained, "equity of distribution does not mean equal distribution, as the bankruptcy code treats many kinds of creditors differently." Id. (citing 11 U.S.C. §§ 503, 503(b)(9), and 507). According to the Eleventh Circuit panel, "[a]ll of these code provisions are themselves the result of independent policy choices made by Congress, all of which are entitled to judicial respect," and it is not a court's role to second guess how lawmakers have chosen to balance "the Bankruptcy Code's sometimes competing policies in different provisions." Id. (citations and internal quotation marks omitted).
Both the statutory priority afforded to 20-day claims under section 503(b)(9) and the subsequent new value preference defense under section 547(c)(4) protect creditors who do business with financially distressed companies that later file for bankruptcy protection. In Auriga Polymers, the Eleventh Circuit embraced what would previously have been characterized as the minority view on this issue, predicated largely on the court's reading of the plain meaning of section 547(c)(4), its statutory context, and lawmakers' perceived policy considerations in electing to give priority status to 20-day claims.
The Eleventh Circuit's rationale for dismissing the bankruptcy court's "double payment" concerns is not entirely satisfactory. In the case before it, the transferee creditor would receive full payment of its 20-day claim as a priority administrative expense, yet still could use the same value to offset its preference liability. This means that the bankruptcy estate will have less value to distribute to other unsecured creditors. That may result from the plain language adopted by Congress in enacting sections 503(b)(9) and 547(c)(4), but lawmakers' intent on this point is far from clear.
Finally, Auriga Polymers underscores that, in interpreting the text of provisions of the Bankruptcy Code, courts examine both: (i) the statutory context of the relevant provisions rather than considering them in isolation and (ii) the bankruptcy policies involved.