When Is New Value Not Really New Value?
by: Michael P. Kruszewski
Quinn, Buseck, Leemhuis, Toohey & Kroto Inc.; Erie, Pa.
One of the most powerful defenses to a preference action is the subsequent new-value defense found in §547(c)(4) of the Bankruptcy Code. This section generally states that a preferential transfer may not be avoided to the extent that, after such transfer, the creditor gave new value to the debtor on account of which the debtor did not make an otherwise avoidable transfer to the creditor. The easiest way to perform an analysis of this defense is to compile all of the invoices and checks dated during the 90-day period prior to the bankruptcy and organize them into a chronological chart illustrating invoice dates against payment dates. Any invoices that remain unpaid likely constitute new value and may be offset on a line-by-line basis against prior preferential transfers made by the debtor, effectively reducing preference liability dollar-for-dollar. When this line-by-line analysis is complete, you often have a mathematical figure of what the defendant’s net preference liability should be. But what happens when new value really is not what it seems at all?
Consider a case where this analysis is performed and it shows a significant amount of goods provided just prior to the last preferential transfer, greater than the sum of all preferential transfers. It would seem that the exposure of the defendant is zero. But this formulaic approach may not always tell the whole truth. Suppose that the only reason that these new goods appear to remain unpaid is actually because they were paid for long ago. Suppose the defendant only released the goods to the debtor upon demanding and receiving the preferential transfers that were made, which were on account of additional, more recent unpaid invoices. Other arguments regarding the defendant’s actions aside, this accounting may not be obvious to the naked eye in light of the state of the debtor’s records, which are often difficult to decipher in many cases.
Of course the defendant will not agree with this assessment because it sees its new-value defense as a sure winner. It will likely argue that the application of payments is a matter of interpretation and an attempt to redirect former payments on the new-value invoices to other outstanding invoices. But if circumstances existed whereby those goods were, in fact, paid for in full some years earlier, the traditional new-value analysis may be distorted. Consider a situation where goods were paid for some years prior to the filing date, but the shipment of such goods was placed on hold in light of circumstances specific to the project site for which they were intended, perhaps because work on the project was suspended. These goods were then stored away by the debtor in the hopes of having some future use for them, perhaps on another similar project. The analysis may be further complicated if the debtor’s general terms and conditions state, for example, that title to such goods passes to the debtor upon identification by the seller of the goods to fulfill the debtor’s order. This begs the question as to whether the goods shipped during the preference periods can be considered “new value” if, by the debtor’s terms and conditions, the debtor already held title to such goods.
This is why a detailed and accurate history of the debtor’s accounting methods is important in the event that such circumstances arise. What at first looks like an easy defense for the defendant turns out to be a severe blow to its case, leaving it only with the other defenses found under §547 that may or may not be as powerful. For these reasons, neither party to the preference action should be so quick to assess the strength of its case upon blindly creating a timeline of invoices and payments. Although this analysis is absolutely necessary, a thorough review based on particular circumstances is also necessary to account for any anomalies, such as payments that may have been previously applied to a potential new value invoice, even if only partially. While a formulaic approach to the new value defense is indispensable in arriving at hard dollar figures, a thorough analytical approach is also terribly important to be sure that those numbers do not tell a false story.