VA Bankruptcy Court Rules on New Value Defense and ' 503(B)(9) Claim

Circuit City argued that, although Mitsubishi Digital Electronics had advanced new value after receiving the alleged preferential transfers, it was not entitled to both a new value defense and a valid administrative claim under ' 503(b)(9) because a valid administrative claim resulted in payment on account of the new value provided by Mitsubushi Digital Electronics. Mitsubishi Digital Electronics countered that Circuit City had not yet paid Mitsubishi Digital Electronics on account of the new value, because the bankruptcy court had temporarily disallowed Mitsubishi Digital Electronics' claim. Additionally, Mitsubishi Digital Electronics argued that only transfers made by Circuit City prior to its bankruptcy filing could negate Mitsubishi Digital Electronics' new value defense.

Analysis

Under ” 547 and 550 of the Bankruptcy Code, a debtor-in-possession generally may recover any amounts it paid within 90 days prior to filing for bankruptcy in satisfaction of preexisting indebtedness, subject to certain defenses. One of these defenses is the subsequent new value defense, codified in ' 547(c)(4). That section provides that if, after an otherwise avoidable transfer to a creditor, the creditor advances new value to the debtor on an unsecured basis, then the creditor has a defense to preference liability to the extent of the amount of new value advanced. However, this defense is subject to an important exception ' the new value cannot have paid by an otherwise unavoidable transfer. See 11 U.S.C. ' 547(c)(4).

The bankruptcy court held that the new value defense was not available to Mitsubishi Digital Electronics, because the establishment of a reserve for its administrative claim constituted payment for the new value. The court first held that the establishment of the reserve for the company's claim constituted a “transfer” to Mitsubishi Digital Electronics, because Circuit City had “parted with [its] interest” in the reserve funds, and the funds on reserve would go to Mitsubishi Digital Electronics after it had satisfied any preference liability. The court then held that because the creation of the reserve was specifically authorized by the bankruptcy court and otherwise compliant with the Bankruptcy Code, the creation of the reserve was an “otherwise unavoidable” transfer. Since the debtor had made this otherwise unavoidable transfer to Mitsubishi Digital Electronics on account of the new value, Mitsubishi Digital Electronics could not use that new value as part of a new value defense pursuant to ' 547(c)(4). The court also summarily dismissed Mitsubishi Digital Electronics' argument that only prepetition transfers on account of new value should negate the new value defense, remarking in a footnote that the Fourth Circuit had stated that postpetition transfers could also be considered in this analysis.

The court noted that its analysis was similar to that contained in a recent case from the United States Bankruptcy Court for the Northern District of Georgia, TI Acquisition, LLC v. Southern Polymer, Inc. (In re TI Acquisition, LLC), 429 B.R. 377 (Bankr. N.D. Ga. 2010). In TI Acquisition, the bankruptcy court had compared claims under ' 503(b)(9) to both reclamation claims and “critical vendor” claims. Reclamation claims on account of new value advanced had been held by another court to preclude the claimant from using that same new value for a new value defense to preference liability. See Phoenix Restaurant Grp., Inc. v. Proficient Food Co. (In re Phoenix Restaurant Grp., Inc.), 373 B.R. 541 (M.D. Tenn. 2007). However, claims for new value advanced that were paid in full under so-called “critical vendor orders” did not interfere with a creditor's right to use that same new value as a predicate for a new value defense, according to another court. See Phoenix Restaurant Grp., Inc. v. Ajilon Prof'l Staffing LLC (In re Phoenix Restaurant Grp., Inc.), 317 B.R. 491 (Bankr. M.D. Tenn. 2004). The TI Acquisition court held that ' 503(b)(9) claims were more like reclamation claims, in that the new value advanced did not actually enhance the debtor's bankruptcy estate, because the debtor was forced to pay full price for the new value.

Both of these cases expressly disagreed with Commissary Operations, Inc. v. Dot Foods, Inc. (In re Commissary Operations, Inc.), 421 B.R. 873 (Bankr. M.D. Tenn. 2010), another decision from 2010 discussing the interplay of ' 503(b)(9) of the Bankruptcy Code and the new value defense. In Commissary Operations, the court held that new value advanced that is subject to a ' 503(b)(9) claim can nevertheless be used as the predicate for a new value defense. The court reasoned that, unlike reclamation claims, which exist under state law and are merely preserved by the Bankruptcy Code, ' 503(b)(9) operates as a part of the normal claims process in bankruptcy, simply assigning a higher priority to claims for goods delivered within 20 days of a bankruptcy filing. Specifically, the court noted that ' 503(b)(9) claims must only be paid in full if there are enough funds in the estate to pay claims of that priority level.

Conclusion

As can be seen from these three cases, all decided in 2010, the interplay between ' 503(b)(9) administrative claims and the new value defense of ' 547(c)(4) is far from resolved. It is likely to arise relatively frequently, since any habitual vendor of goods to a debtor is likely to be in the position where the debtor paid an outstanding invoice to the vendor and the vendor subsequently sent more goods, with the debtor filing bankruptcy less than 20 days later.

Pedro A. Jimenez is a partner and Nicholas C. Kamphaus is an associate in the Business Restructuring and Reorganization Practice of Jones Day, New York. The views expressed in this article are solely those of the authors and should not be attributed to Jones Day or its clients. The authors can be contacted respectively at [email protected] and [email protected].

A recent decision issued by the Bankruptcy Court for the Eastern District of Virginia further calls into question the availability of a new value defense in a preference action when the amount claimed by the creditor to constitute new value represents an administrative claim under ' 503(b)(9) for goods delivered to the debtor during the 20-day period prior to the debtor's bankruptcy filing.

Background

In Circuit City Stores, Inc. v. Mitsubishi Digital Elecs. (In re Circuit City Stores, Inc.), No. 10-03068 (Bankr. E.D. Va. Dec. 1, 2010), Mitsubishi Digital Electronics, the creditor, had filed a proof of claim for nearly $5 million for goods that it had advanced to Circuit City during the 20-day period prior to Circuit City's bankruptcy filing. Pursuant to ' 503(b)(9) of the Bankruptcy Code, Mitsubishi Digital Electronics asserted an administrative priority claim, meaning that its claim would have priority over general unsecured claims, thus making it more likely that Mitsubishi Digital Electronics would be paid in full for its claim. Thereafter, Circuit City filed a complaint against Mitsubishi Digital Electronics, asserting that it was liable under ' 547 of the Bankruptcy Code for approximately $6.7 million in preferential transfers, representing amounts paid to Mitsubishi Digital Electronics during the 90-day period prior to Circuit City's bankruptcy filing. In response to the preference complaint, Mitsubishi Digital Electronics asserted that it was not liable for the preferential transfers because it was entitled to a new value defense as a result of the goods it provided to Circuit City after the alleged preferential transfers had been made, but prior to Circuit City's bankruptcy filing.

Circuit City argued that, although Mitsubishi Digital Electronics had advanced new value after receiving the alleged preferential transfers, it was not entitled to both a new value defense and a valid administrative claim under ' 503(b)(9) because a valid administrative claim resulted in payment on account of the new value provided by Mitsubushi Digital Electronics. Mitsubishi Digital Electronics countered that Circuit City had not yet paid Mitsubishi Digital Electronics on account of the new value, because the bankruptcy court had temporarily disallowed Mitsubishi Digital Electronics' claim. Additionally, Mitsubishi Digital Electronics argued that only transfers made by Circuit City prior to its bankruptcy filing could negate Mitsubishi Digital Electronics' new value defense.

Analysis

Under ” 547 and 550 of the Bankruptcy Code, a debtor-in-possession generally may recover any amounts it paid within 90 days prior to filing for bankruptcy in satisfaction of preexisting indebtedness, subject to certain defenses. One of these defenses is the subsequent new value defense, codified in ' 547(c)(4). That section provides that if, after an otherwise avoidable transfer to a creditor, the creditor advances new value to the debtor on an unsecured basis, then the creditor has a defense to preference liability to the extent of the amount of new value advanced. However, this defense is subject to an important exception ' the new value cannot have paid by an otherwise unavoidable transfer. See 11 U.S.C. ' 547(c)(4).

The bankruptcy court held that the new value defense was not available to Mitsubishi Digital Electronics, because the establishment of a reserve for its administrative claim constituted payment for the new value. The court first held that the establishment of the reserve for the company's claim constituted a “transfer” to Mitsubishi Digital Electronics, because Circuit City had “parted with [its] interest” in the reserve funds, and the funds on reserve would go to Mitsubishi Digital Electronics after it had satisfied any preference liability. The court then held that because the creation of the reserve was specifically authorized by the bankruptcy court and otherwise compliant with the Bankruptcy Code, the creation of the reserve was an “otherwise unavoidable” transfer. Since the debtor had made this otherwise unavoidable transfer to Mitsubishi Digital Electronics on account of the new value, Mitsubishi Digital Electronics could not use that new value as part of a new value defense pursuant to ' 547(c)(4). The court also summarily dismissed Mitsubishi Digital Electronics' argument that only prepetition transfers on account of new value should negate the new value defense, remarking in a footnote that the Fourth Circuit had stated that postpetition transfers could also be considered in this analysis.

The court noted that its analysis was similar to that contained in a recent case from the United States Bankruptcy Court for the Northern District of Georgia, TI Acquisition, LLC v. Southern Polymer, Inc. (In re TI Acquisition, LLC), 429 B.R. 377 (Bankr. N.D. Ga. 2010). In TI Acquisition, the bankruptcy court had compared claims under ' 503(b)(9) to both reclamation claims and “critical vendor” claims. Reclamation claims on account of new value advanced had been held by another court to preclude the claimant from using that same new value for a new value defense to preference liability. See Phoenix Restaurant Grp., Inc. v. Proficient Food Co. (In re Phoenix Restaurant Grp., Inc.), 373 B.R. 541 (M.D. Tenn. 2007). However, claims for new value advanced that were paid in full under so-called “critical vendor orders” did not interfere with a creditor's right to use that same new value as a predicate for a new value defense, according to another court. See Phoenix Restaurant Grp., Inc. v. Ajilon Prof'l Staffing LLC (In re Phoenix Restaurant Grp., Inc.), 317 B.R. 491 (Bankr. M.D. Tenn. 2004). The TI Acquisition court held that ' 503(b)(9) claims were more like reclamation claims, in that the new value advanced did not actually enhance the debtor's bankruptcy estate, because the debtor was forced to pay full price for the new value.

Both of these cases expressly disagreed with Commissary Operations, Inc. v. Dot Foods, Inc. (In re Commissary Operations, Inc.), 421 B.R. 873 (Bankr. M.D. Tenn. 2010), another decision from 2010 discussing the interplay of ' 503(b)(9) of the Bankruptcy Code and the new value defense. In Commissary Operations, the court held that new value advanced that is subject to a ' 503(b)(9) claim can nevertheless be used as the predicate for a new value defense. The court reasoned that, unlike reclamation claims, which exist under state law and are merely preserved by the Bankruptcy Code, ' 503(b)(9) operates as a part of the normal claims process in bankruptcy, simply assigning a higher priority to claims for goods delivered within 20 days of a bankruptcy filing. Specifically, the court noted that ' 503(b)(9) claims must only be paid in full if there are enough funds in the estate to pay claims of that priority level.

Conclusion

As can be seen from these three cases, all decided in 2010, the interplay between ' 503(b)(9) administrative claims and the new value defense of ' 547(c)(4) is far from resolved. It is likely to arise relatively frequently, since any habitual vendor of goods to a debtor is likely to be in the position where the debtor paid an outstanding invoice to the vendor and the vendor subsequently sent more goods, with the debtor filing bankruptcy less than 20 days later.

Pedro A. Jimenez is a partner and Nicholas C. Kamphaus is an associate in the Business Restructuring and Reorganization Practice of Jones Day, New York. The views expressed in this article are solely those of the authors and should not be attributed to Jones Day or its clients. The authors can be contacted respectively at [email protected] and [email protected].