Is There a Subsequent New Value Preference Defense With Postpetition Sales?(Brief Article)

A sophisticated credit professional who received a preference demand always looks for defenses to defeat the preference demand. If the vendor sold to the debtor post-bankruptcy, can the vendor use this postpetition value, whether the vendor provided goods or services, as a defense to the preference action? A recent bankruptcy court decision [1] considers how far a vendor may use the subsequent new value defense.

The Bankruptcy Preference Law

The Bankruptcy Code vests the trustee with far-reaching powers to avoid transfers and transactions prior to a bankruptcy filing. The power to avoid preferential transfers is one of the trustee's most potent weapons. The Bankruptcy Code defines a preferential transfer expansively to include nearly every transfer by an insolvent debtor during the preference period. Vendors are discouraged from racing to the courthouse to dismember a debtor, thereby hastening its slide into bankruptcy. A debtor is deterred from preferring a vendor by the requirement that any vendor who receives a greater payment than similarly situated vendors disgorge the preference so that like vendors receive an equal distribution of the debtor's assets.

Not all transfers made within the preference period may be recaptured. One of the most effective and commonly used preference defenses used by a vendor is the subsequent new value or subsequent advance rule, which excludes from recapture those payments to a vendor who subsequently extends goods or services (or credit for those goods or services) to the debtor.

Beating the Preference Lawsuit: The Subsequent New Value Defense

The subsequent new value operates as follows. Say on January 1, the debtor gives an unsecured vendor a check for $10,000 for goods supplied. On January 5, the vendor provides the debtor an additional $10,000 in goods on open account (no purchase money security interest is taken in the goods). On February 1, the debtor files bankruptcy. The January 1 payment, made within 90 days before the bankruptcy filing, may be recaptured as a preference, assuming that the criteria for the preference law were met. However, because the subsequent advance of goods by the vendor replenished the bankruptcy estate, the subsequent new value rule permits the vendor to reduce its January 5 advance against the preference, and does not have to disgorge the payment.

The subsequent advance rule has its most frequent application where a vendor provides goods or services on open account, and the debtor pays the vendor at various points during the preference period. Congress intended to protect the open account vendor with the subsequent new value rule. Under this analysis, a single transfer during the preference period is not analyzed in isolation from the overall course of business between the vendor and debtor, as the basis for maintaining the open account is the debtor's entire financial picture and not the debtor's most recent payment.