Ruling in Eleventh Circuit Bankruptcy Code case favors creditors

The preference defense received a major boost this week when the Eleventh Circuit ruled that bills paid under 11 USC § 503(b)(9) can count as “new value” in the defense against claims for preference. It is the first circuit court to consider the issue, making its decision in favor of creditors’ rights all the more significant.

A brief reminder of two key points puts the opinion in perspective. First, in 2005, Section 503(b)(9) was added to the Bankruptcy Code. This section provides special treatment for goods delivered to a debtor within 20 days of the debtor filing a bankruptcy petition. Although there are certain conditions and caveats, this section of the Bankruptcy Code often allows creditors to receive full payment in the event of the debtor’s bankruptcy for goods they provided during this short window. Requests for payment for these goods are often referred to as “503(b)(9) claims”.

Second, the Bankruptcy Code allows a bankrupt debtor to file “preferential” lawsuits, which are attempts to recover funds paid to creditors within 90 days before the debtor’s bankruptcy petition is filed. The Bankruptcy Code also provides creditors with defenses against such lawsuits that can reduce or eliminate a creditor’s liability. One such defense is the “new subsequent value” defense. This defense reduces a creditor’s preference risk by the amount of “new value” that the creditor provided to the estate after a preferential transfer (that’s to say, a payment to the creditor) has been made. Usually the new value takes the form of goods and services that the creditor has provided to the debtor and is documented by an invoice issued for those goods and services. The important point is that the new value only counts as a defense in a preferential action if “the debtor has not made an otherwise unavoidable transfer” because of the new value provided.

The question then is: if a creditor is paid for an invoice under section 503(b)(9), is that payment an “otherwise unavoidable transfer” that precludes the creditor from counting the invoice as “new value” in defense of a claim of preference? Debtors claim this is the case, because they cannot “avoid” (that’s to sayretrieve)[1] payments they make under section 503(b)(9). Moreover, allowing creditors both to be paid for an invoice and to use it to defend against preferential action seems like “double counting” to them. Creditors deny this is double counting as they are not trying to get paid twice – they are just hoping to keep the money they have rightfully earned. Further, there is no logical reason to give creditors special treatment under 503(b)(9) only to have that treatment reversed in a preferential action.

So far, no circuit court had ruled on the issue, and lower court rulings were split on the issue. Now, the Eleventh Circuit has ruled that the “otherwise unavoidable transfer” language in the statute applies only to pre-petition transfers; it does not apply to post-petition payment of 503(b)(9) claims. Thus, an invoice that is paid as a 503(b)(9) claim can also be used to help defend a preference lawsuit. While this ruling only binds the Eleventh Circuit bankruptcy courts (Alabama, Florida and Georgia), it will likely have persuasive value nationwide as the courts continue to wrestle with the issue.


FOOTNOTES

[1] Preference shares themselves are called “avoidance” shares because debtors use them to avoid and recover money they previously paid to creditors.

© 2022 Miller, Canfield, Paddock and Stone PLC National Law Review, Volume XII, Number 202

Comments are closed.