A maddening bankruptcy concept among people unfamiliar with bankruptcy law, and certainly to creditors that did business with an entity that later files for bankruptcy, is the preference claim. To be sued for recovery of “preferential” payments when the creditor did nothing “wrong” – it simply sold goods or provided services to the debtor prior to bankruptcy and then received the agreed upon payment, especially when the creditor still may be owed for other goods or services provided – can, and usually does, cause a particularly angry or unbelieving reaction. Of course, the bankruptcy lawyer will counsel his creditor client that the preference statute is not based on “right or wrong” or “fault,” but rather is designed to foster equality of treatment among all similarly situated creditors of the debtor and prevent certain creditors, which may have been more aggressive, lucky, or both, from receiving payments when similarly situated creditors have not.
Creditors that have done business with Chapter 11 debtors prior to bankruptcy also often do so after bankruptcy, based on the debtor’s authority under bankruptcy law to pay for post-bankruptcy goods and services provided in the ordinary course of business and the prospect that the debtor, free from its pre-bankruptcy financial burdens, will have the wherewithal to pay. However, not every Chapter 11 debtor is able to reorganize and sometimes post-bankruptcy creditors are unpaid. When reorganization fails, the debtor will be liquidated for the benefit of all creditors. Such often will include prosecution of preference claims against pre-bankruptcy creditors. On July 25, 2016, the Delaware Bankruptcy Court decided a case that provides some additional ammunition to the creditor sued on a preference claim that also is owed for post-petition goods or services provided.
In Quantum Foods, LLC, Case No. 14-10318 (KJC) (Bankr. D. Del.), Tyson Foods, a pre-bankruptcy vendor to the Debtors, continued to sell product to the Debtors post-bankruptcy. When the Debtors failed to pay, Tyson sought, and obtained, an order allowing it an administrative claim for just over $2,600,000. About eight months later, the Creditors Committee sued Tyson for over $13 million in preference claims. Tyson filed a counterclaim (and a third-party claim against the Debtors) asserting its administrative claim as a setoff to its preference liability. The Committee moved for judgment on the pleadings, arguing, inter alia, that the setoff claim was nothing more than a “disguised” new value defense which, because it accrued post-bankruptcy, could not be used as a defense to the preference claim under the Third Circuit’s decision in In re Friedman’s, Inc., 738 F.3d 547 (3d Cir. 2013)(which held that, with certain narrow exceptions, post-bankruptcy events cannot be taken into account in analyzing preference claims and defenses under section 547; and, specifically, that a creditor paid for pre-petition invoices post-petition pursuant to a critical vendor order nevertheless could still use such pre-petition invoices as new value against its preference liability).
Although some courts have considered the question whether an administrative claim can be used as a “new value defense” under section 547(c) to a preference claim (and generally have not sustained that defense),1 the Delaware Bankruptcy Court stated that the issue before it – specifically whether an administrative claim could be used as a setoff (and not necessarily as a new value defense) to preference claim liability – was of first impression in Delaware.
The Court first concluded that Tyson’s counterclaim seeking to use its administrative claim as a setoff to its preference liability was not a disguised new value defense under section 547 because the existence and proposed use of the administrative claim as a setoff did not affect the analysis of Tyson’s preference liability, which is based on the prima facie claim requirements of section 547(b) and the defenses thereto under section 547(c). Rather, the Court determined that the administrative claim was an “independent, pre-existing and wholly unrelated” claim vis a vis the preference claim liability which affected the preference claim only “externally, not internally.” The Court also determined that the counterclaim “fits squarely into the definition of setoff” (defined as “[a] counterclaim demand which defendant holds against plaintiff arising out of a transaction that is extrinsic of plaintiff’s cause of action”). The Court also concluded that the requirements for setoff – mainly that the claims arose and existed in the same time frame (i.e., the post-bankruptcy period) – were satisfied. The administrative claim clearly arose post-bankruptcy and, because such claims do not exist absent bankruptcy and arise only upon a bankruptcy filing, so did the preference claim.
Accordingly, the Delaware Bankruptcy Court denied the Committee’s motion for judgment on the pleadings.2 The decision does not appear to be at odds either with Friedman’s or with prior decisions holding that post-bankruptcy administrative claims could not be used as “new value” under section 547 as Judge Carey did not decide Quantum Foods on a “new value” or “preference liability analysis” basis. Ironically, there are positives for both debtors and creditors in this decision. For a debtor that needs continued vendor support post-petition, that a creditor may use an administrative claim as a setoff against preference liability may be some (perhaps very small) additional inducement for the creditor to continue doing business with the debtor post-bankruptcy. Of course, for creditors, and especially for involuntary post-petition creditors such as utilities or landlords, the ability to use an administrative claim as a setoff against preference liability prevents the creditor from a double dose of outrage – first by having preference exposure for doing no wrong and then later not being paid for post-bankruptcy business and also not being allowed to offset those mutual debts – a very reasonable result under those circumstances.
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1 See e.g., Bergquist v. Anderson-Greenwood Aviation Corp. (In re Bellanca Aircraft Corp.), 850 F.2d 1275, 1284 (8th Cir. 1988) (the phrase “for the benefit of the debtor” implies that only subsequent advances given pre-petition qualify for new value under section 547(c) because post-petition advances are given to the debtor’s estate, not to the debtor); Field v. Md. Motor Truck Assoc. Workers Comp. Self-Ins. Grp. (In re George Transfer Inc.), 259 B.R. 89, 96 (Bankr. D. Md. 2001) (“[u]nfortunately for the defendant, its refund to the debtors does not qualify … as ‘new value’ because it was made postpetition”); Clark v. Frank B. Hall & Co. of Colo. (In re Sharoff Food Serv. Inc.), 179 B.R. 669, 678 (Bankr. D. Colo. 1995) (“[T]he specific language ‘to or for the benefit of the debtor’ [indicates] that the subsequent advances of new value are only those given prepetition, because any postpetition advances are given to the debtor’s estate, not the debtor”). See also TennOhio Trans. Co. v. Felco Comm. Servs. (In re TennOhio Trans. Co.), 255 B.R. 307, 310 (Bankr. S.D. Ohio 2000); Wallach v. Vulcan Steam Forging (In re D.J. Mgmt. Grp.), 161 B.R. 5, 6 (Bankr. W.D.N.Y. 1993); Wolinsky v. Cent. Vt. Teachers Credit Union (In re Ford), 98 B.R. 669, 680 (Bankr. D. Vt. 1989); Warsco v. Ryan (In re Richards), 92 B.R. 369, 372 (Bankr. N.D. Ind. 1988); Cullen v. TDK Elec. Corp. (In re Antinarelli Enter. Inc.), 76 B.R. 247, 251 (Bankr. D. Mass. 1987).
2 The Court also held that section 502(d), which requires disallowance of pre-petition claims pending repayment of preference liability, did not require disallowance of Tyson’s administrative claim because section 502(d) by its terms is inapplicable to administrative claims.