In my bankruptcy practice, I assist creditors in collecting what they are entitled to receive in bankruptcy proceedings (through a distribution or otherwise) and protecting their business interests. Protecting creditors’ interests often includes defending them against lawsuits seeking to pull back – or claw back – certain transfers they received from a business partner within 90 days of the partner filing for bankruptcy (also known as “preferences”). The 11th Circuit Court of Appeals recently issued a decision favorable to creditors which exemplifies both aspects of this work and of which creditors will want to take note.

The Case

The case is Auriga Polymers Inc. v. PMCM2, LLC, 40 F.4th 1273 (11th Cir. 2022). There, the 11th Circuit decided a legal issue involving creditors’ “new value defense” to preference lawsuits. Because this court is in a federal circuit that includes Florida, the ruling affects – and indeed benefits – trade creditors in Florida in the form of more certainty in their business dealings with a debtor surrounding the filing of the bankruptcy and infuses additional value into the above defense. The decision also benefits creditors in other circuits where the law on this issue remains unsettled. They can look to the decision to develop their defenses to preference lawsuits (though the decision will be persuasive rather than binding there).

A Brief Bankruptcy Background

The language of the opinion is quite technical because it involved a detailed analysis of several sections of the Bankruptcy Code. Therefore, some background is helpful.

Leading up to a bankruptcy filing, creditors continue providing goods and services to a business partner who becomes the debtor. Likewise, the debtor continues to make payments to these creditors. The Bankruptcy Code governs this “pre-petition” period of business activity and sets forth specific rights/powers the trustee and creditors have with respect to services, goods, and payments that are exchanged.

Section 547(b) empowers a trustee to “avoid” or undo preferences—again, certain transfers made by the debtor to a creditor within 90 days of the filing of a bankruptcy petition—and force the creditor to return the payment or property it received. Therefore, to the extent the creditor received transfers during this period, the creditor faces potential exposure to a preference lawsuit seeking to claw back the transfers. Among the creditor’s potential defenses is the “new value defense” set forth in section 547(c)(4). This defense allows the creditor to offset its liability in the amount of the goods, services, or money the creditor provides to the debtor after the creditor receives a preference (i.e., subsequent new value). Not so fast. The new value must either remain unpaid or if the debtor repays it, then the transfer cannot be “otherwise unavoidable.” Put simply, the creditor cannot rely on the new value to reduce its liability on a preferential transfer and keep the payment creating the new value under another defense—no double counting. Otherwise, this will offset or reduce the creditor’s defense.

Defenses aside, creditors who provide goods to a debtor in the ordinary course of the debtor’s business within the 20-day period just before the bankruptcy filing have a separate path for recovering the value of the goods. Creditors can file an “administrative expense claim” pursuant to section 503(b)(9) of the Bankruptcy Code. This is a claim for the value of the goods provided, which is afforded priority – or the right to be paid before – other unsecured claims.

Now Back to Auriga

Auriga Polymers Inc., the creditor in this case, provided goods to the debtor, Beaulieu Group, LLC, and received payments from the debtor (both involving millions of dollars) within the 90-day period before Beaulieu filed for Chapter 11 bankruptcy. Auriga raised a “new value defense” based on new value it provided to Beaulieu after receiving the transfers. The last payment Auriga received after providing goods was in the amount of $421,119, for which Auriga faced preference liability (the parties agreed the other transfers at issue were protected by the defense). Auriga separately filed an administrative expense claim seeking payment of $694,502 – the value of the goods it transferred within the 20-day period before the bankruptcy.

The question before the 11th Circuit was whether a creditor can rely on the same value to seek payment of an administrative expense claim and as “new value” for a new value defense to reduce the amount the creditor must pay on account of a preference claim. For Auriga, this meant deciding whether it could seek payment for the $694,502 worth of goods provided to the debtor and also use this amount as “new value” to cancel out its $421,119 in preference liability.

The 11th Circuit answered this question in the affirmative, ruling in Auriga’s favor. In doing so, the Court confirmed a debtor’s payment to a creditor made post-bankruptcy filing—here, any amounts paid to Auriga to satisfy its administrative expense claim—was not an “otherwise unavoidable transfer” and does not reduce a creditor’s new value defense to a preference claim. The Court further clarified that only “otherwise unavoidable transfers” occurring pre-petition will reduce a creditor’s new value defense. After all, the new value must be given by the creditor pre-petition to establish the defense, thus, it makes sense it should only be reduced by pre-petition transfers.

Significance Beyond Auriga

The impact of this decision can be significant in preference liability cases. Indeed, in Auriga, it precluded the trustee from clawing back an allegedly preferential payment from the creditor approaching half of a million dollars.

The opinion has broader impact as well. It provides more certainty for creditors that elect to continue doing business with a business partner leading up to a bankruptcy filing. In fact, the policy underlying the creation of the preference defenses in the Bankruptcy Code was intended to encourage creditors to continue to do business with the debtor under usual business practices. Creditors will now have more certainty as to the treatment of payments for goods and services by the debtor leading up to and after a bankruptcy filing. This, in turn, should promote early resolution of more preference claims.

The above information does not constitute legal advice or opinion which depends upon specific factual circumstances.