This article was originally published in the January 2014 issue of Pratt's Journal of Bankruptcy Law.
Preference actions are common in bankruptcy cases. These actions seek to claw back payments made by a debtor to a creditor during the 90 days before the commencement of a bankruptcy case.
A common defense to a preference action is the “new value” defense found in Section 547(c)(4) of the Bankruptcy Code. A creditor has a defense to the extent it provides value to the debtor after the creditor receives a preferential payment. To illustrate, imagine that on Day 1 of the preference period the debtor makes a payment of $100 to the creditor for goods the debtor previously received. On Day 2, the creditor delivers to the debtor $50 more in goods. The creditor has a $50 new value defense and $50 in preference exposure.
But what happens to the new value defense when, on Day 3, the debtor makes another payment of $50 for the goods the creditor delivered on Day 2? In most jurisdictions, the creditor’s $50 new value defense remains unchanged, and its preference exposure increases to $100. But in three federal circuits that have held that new value must remain unpaid, the creditor may enjoy no new value defense and its preference exposure may increase to $150.
Why do we say that the creditor “may” enjoy no new value defense? In two of these jurisdictions, courts have been treating dicta as binding law, but now appear to be moving in the direction of the majority view. In the third jurisdiction, however, the minority view is the law and courts must follow it.
In these three circuits, a creditor facing a preference claim, and considering a proposed settlement, should carefully assess the merits of its new value defense in light of the statutory text and case law.