Bankruptcy-Preferences & The New Value Defense.

Business owners can breathe a sigh of relief based upon a recent decision by the 11th Circuit Court of Appeals that clarified one of the several defenses to suits by debtors or trustees to recover “preferences”. Preference suits are typically designed to recover payments made by a debtor to creditors within 90 days of a bankruptcy filing or 1 year where the creditor is an insider. These suits often produce harsh results to creditors whose only sin is getting paid for good services they provide to the bankrupt debtor.

Preferences are unique to the Bankruptcy Code and are based upon the public policy that all similarly situated creditors should be treated equally in a bankruptcy case. Even under the English common law, business transactions of insolvent entities were subject to scrutiny to prevent either improvidence by the debtor or favoritism towards certain creditors. The defenses are based upon the policy of trying to promote the extension of credit to financially strapped debtors to avoid bankruptcy.

The two most common defenses are the “ordinary course of business” and the “new value” defenses. Under the new value defense, if the creditor receives avoidable preference payments from the debtor, the creditor can offset the liability by the among of new value that the creditor provided to the debtor during the preference period. Until recently, at least in the 11th Circuit, it was thought that the “new value” needed to remain unpaid. In re BFW Liquidation, Inc., 899 F.3d 1178 (11th Cir. 2018) changed that.

In BFW, the 11th Circuit determined that its one of prior decisions, In re Jet Florida System, Inc., 841 F.2d 1082 (11th Cir. 1988), did not intend to set forth a rule whereby the new value defense is measured by the amount of new value that remained unpaid. In BFW, the debtor, a grocery store chain, made payments of $563,869.37 during the preference period to its ice cream supplier. However, the ice cream supplier provided $438,705.65 in new value (ice cream) during the same period. The bankruptcy court determined that the defendant was only entitled to deduct $438,496.47, the amount of the unpaid new value. The 11th Circuit reversed and remanded the case to the bankruptcy court to calculate the total amount of new value, concluding that it’s statement in Jet Florida System was dictum and that the defense is designed to promote the extension of credit to struggling debtors.

Whereas under the old view, the defendant would have been liable for $438,496.47, the potential liability is now reduced to approximately $128,163.72: a substantial difference and a victory to businesses that supply goods and services on credit in an effort to keep their clients afloat.