Using the Subsequent New Value Defense in a Preference Action

If you, or your company, is facing a claim in a bankruptcy court in Tennessee, or facing a demand letter from a bankruptcy trustee, or other party, for the return of payments made to you by a company or individual now in bankruptcy, you might be able to use what is referred to as the “subsequent new value” defense. This defense, just one defense in the Bankruptcy Code available to a creditor which is the subject of a preferential payment lawsuit, is particularly useful for creditors which maintained open accounts for now bankrupt debtors.

In concept, the defense is fairly easy to understand. In many cases, its successful application will require complex and tedious analysis of the statutory elements in light of the particular facts of the case.  Assuming that the trustee, or other party which has filed the adversary proceeding, meets his or her burden of proof that the payments to the creditor by the debtor were preferential payments under 11 U.S.C.A. §547(b), a creditor which can prove the elements of the subsequent new value defense (11 U.S.C.A § 547(c)(4)) can avoid repaying the preference payments, or some portion thereof.

To succeed under the subsequent new value defense, a creditor must, to paraphrase the statute, prove three elements: (1) That it gave new value to the creditor after a preferential transfer (a transfer with respect to which the trustee has proven all of the elements of §547(b));  (2) that the new value given was not secured by a security interest which the trustee cannot avoid; and (3) that the debtor did not repay the debt for the new value with a transfer that the trustee cannot avoid.

Like all statutes and laws, understanding the reason for it is helpful in the analysis of particular factual scenarios.  First, it is intended to promote creditors’ willingness to continue to do business with financially troubled accounts, which, ideally, will prevent bankruptcies. Second, when a creditor provides new value to a debtor, the same increases the value of the bankruptcy estate of the debtor, which increases the amount of assets available for distribution to other creditors. Thus, the defense recognizes that it is fair to allow that creditor to offset the value of the new value provided against the amount of the preferential transfers to it.

Here are some cases from bankruptcy courts in the Sixth Circuit (the same circuit in which bankruptcy courts in Tennessee are located) and takeaways from them that are helpful in understanding the defense.

In re Transport Associates, Inc. (Bankr. W.D. Ky. 1994):  In this case, the court adopted what is known as the “Garland Rule.”  Under this rule, each advance of new value by the creditor can be used to offset all prior preference payments.  Under this rule, a creditor is not limited to offsetting each advance of new value against only the immediately preceding preference.  For example, assume the following:

  • Debtor pays Creditor $10,000 on July 5
  • Debtor pays Creditor $15,000 on July 7
  • Creditor provides $12,500 worth of goods or services to Debtor on July 10
  • Debtor pays $15,000 to Creditor on July 15
  • Creditor provides $75,000 worth of goods and services to Debtor on July 21
  • Debtor pays Creditor $75,000 on July 31
  • Debtor files bankruptcy on August 1

In the above example, Creditor has received preference payments of $115,000 and may offset $40,000 of preference payments — thus being required to repay $75,000.  Creditor may use the $75,000 in new value transferred on July 21 to offset all prior preference payments ($40,000).  It is not limited to using the $75,000 of that new value only to offset the $15,000 preference payment on July 15.  (Creditor cannot use the $75,000 in new value provided on July 21 to offset the $75,000 payment on July 31 as new value can only be used to offset preferences that occurred before the new value was given.)

In re Smith Mining and Material, LLC (Bankr. W.D. Ky. 2009): The issue in this case was when was the new value provided by the creditor.  Any new value provided by a creditor after the debtor has filed a petition for bankruptcy (“post-petition”) cannot be used under the subsequent new value defense of §547(c)(4). The creditor shipped about $4,000 worth of product to the debtor before it filed bankruptcy, but did not invoice the creditor for over three weeks and invoiced it on the same day the debtor filed its petition. The court held that the new value was considered given on the date of delivery. Thus, the creditor was able to use the $4,000 to offset the preference payments it had received.

In re Phoenix Restaurant Group, Inc. (Bankr. M.D. Tenn. 2004): This case explains, as well as any, the requirement of §547(c)(4)(B) that the new value must not have been paid for by the debtor with a transfer that cannot itself be avoided.

In re Dearborn Bancorp, Inc. (Bankr. E.D. Mich. 2018): If you want to understand how the subsequent new value defense might work when the new value given by the creditor is in the form of services, this case, though long, is well worth reading.

For Tennessee commercial attorneys who handle preference cases, the new value defense may well be one that can help their clients, particularly clients which have kept open accounts for their customers.

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