The Bottom Line

The Eleventh Circuit, in In re BFW Liquidation, LLC., Case No. 17-13588, 2018 WL 3850101 (11th Cir. Aug. 14, 2018), reversed the Bankruptcy Court’s decision on direct appeal, holding that the new value defense to preferences does not require new value to remain unpaid. The Debtors paid one of its suppliers more than $550,000 during the 90-day preference period. During the same preference period, the supplier delivered $435,000 worth of goods (i.e., new value). In overturning the Bankruptcy Court’s decision that new value had to remain unpaid, the Eleventh Circuit found that the prior Eleventh Circuit decision the lower court relied upon was merely dicta and a statutory analysis of Section 547(c)(4), and public policy objectives supported a finding that new value defense does not require value to remain unpaid.

What Happened? 

The liquidating trustee (the Trustee) administering and liquidating the bankruptcy estate of Bruno’s Supermarkets LLC (the Debtor) initiated an adversary proceeding to recover $438,496.47 in payments the Debtor made to Blue Bell Creameries Inc. (Blue Bell) during the 90-day period prior to the Debtor’s bankruptcy filing. Blue Bell conceded that the payments received from the Debtor constituted preferences, but argued Blue Bell was entitled to the “ordinary course of business” defense under Section 547(c)(2) or “subsequent new value” defense under Section 547(c)(4).

The Bankruptcy Court concluded Blue Bell was not entitled to the ordinary course of business defense, which Blue Bell did not challenge on appeal. However, Blue Bell did appeal the Bankruptcy Court’s ruling that Blue Bell was entitled to offset its preference liability only to the extent any new value during the 90-day preference period remained unpaid. In concluding the Trustee could claw back $438,496.47 of the $563,869.37 transferred to Blue Bell during the preference period, the Bankruptcy Court relied uponits ruling on the Eleventh Circuit’s decision in Charisma Investment Company, N.V. v. Airport Systems, Inc. (In re Jet Florida System, Inc.), 841 F.2d 1082 (11th Cir. 1988), in which the court stated that Section 547(c)(4) had “generally been read to require . . . that the new value must remain unpaid.” Id. at 1083.    

On direct appeal, the Eleventh Circuit first concluded that new value defense was not applicable in Jet Florida System. Because the issue of new value remaining unpaid did not play a role in the court’s decision or reasoning, the court found any language regarding the new value defense was merely dictum and the Eleventh Circuit was “free to give . . . fresh consideration.” BFW Liquidation, Case No. 17-13588, 2018 WL 3850101 at *4.

Next, the Eleventh Circuit conducted a statutory analysis of Section 547(c)(4) and concluded that the plain language of the statute only requires “(1) any new value given by the creditor must not be secured by an otherwise unavoidable security interest and (2) the debtor must not have made an otherwise unavoidable transfer to or for the benefit of the creditor on account of the new value given.” Id. at *6. Section 547(c)(4) only excludes any “‘paid’ new value that is paid for with ‘an otherwise unavoidable transfer.’” Id. Therefore, as long as the transfer that pays for the new value is avoidable, the transfer may be subject to the new value defense. The court also cited cases from the Fourth, Fifth, Eighth and Ninth Circuits that have made similar conclusions.

In reaching its decision, the court also looked to the legislative history of Section 547. Prior to the enactment of Section 547(c)(4), Section 60(c) of the Bankruptcy Act of 1898 (the Bankruptcy Act) provided new value must remain unpaid. However, the Commission on the Bankruptcy Laws of the United States established by Congress specifically recommended rewriting the preference section of the Bankruptcy Act and removing the language that required new value remain unpaid. When Congress subsequently enacted Section 547(c)(4)(B)’s requirement that the debtor “not make any otherwise unavoidable transfer to or for the benefit of the creditor who gave new value,” it explicitly repealed the “remaining unpaid” language. Id. at *7 (internal citations omitted). The court found that Congress’s omission of the “remaining unpaid” language from Section 547(c)(4) was indicative of its decision to substantively change the meaning of the statute and to remove this requirement for the new value defense.

Lastly, the court found that public policy considerations support the conclusion that new value does not need to remain unpaid. If new value is required to remain unpaid, creditors concerned about a debtor’s financial difficulty are incentivized to stop delivering goods and services, because any payments they receive after extension of a short-term period of credit could be avoided post-petition (unless the vendor requires advance payment or cash upon delivery). However, if new value is not required to remain unpaid, “creditors are encouraged to continue extending credit to financially troubled debtors.” Id. at *10. For similar reasons, the court found that not requiring new value to remain unpaid promotes equality among short- and longer-term creditors.

Why This Case Is Interesting

The Eleventh Circuit now joins the Fourth, Fifth, Eighth and Ninth Circuits in holding the new value defense is not limited to subsequent advances of credit that remain unpaid on the filing date. In light of the narrowing circuit split, courts such as the Seventh and Third Circuits that have stated in dicta that Section 547(c)(4) requires new value to remain unpaid, may be asked to revisit this issue. As the circuit split continues to narrow, short-term creditors extending credit and providing goods and services to distressed companies can feel more confident their entire payment will not be clawed back.