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July 22, 2022

Trimming Back the Claws: Eleventh Circuit Strengthens Creditor “New Value” Defense Against Avoidable Preference Lawsuits

The U.S. Court of Appeals for the Eleventh Circuit reversed a bankruptcy court’s decision which held that a “subsequent new value” defense to avoidable preference liability must be reduced by payments the creditor-defendant receives during the bankruptcy case. In doing so, the Eleventh Circuit joined the Third Circuit in ruling that payments received by a creditor after a bankruptcy filing for pre-bankruptcy shipments of goods do not diminish the creditor’s defense. This decision better insulates creditors from avoidable preference liability after a bankruptcy case is filed.

Background and Bankruptcy Court Decision

The case, styled Auriga Polymers, Inc. v. PMCM2, LLC as Trustee, arose from the bankruptcy of Beaulieu Group, LLC, one of North America’s largest carpet manufacturers. Before the bankruptcy filing, one of Beaulieu’s creditors, Auriga Polymers, sold polymer resins and specialty polymers to the debtor for use in making textile products.

As slackening consumer demand pushed down carpet prices, Beaulieu faced a liquidity crisis, and it filed a chapter 11 petition in bankruptcy court in Georgia on July 16, 2017. The bankruptcy court approved a plan of liquidation that transferred Beaulieu’s assets, including “clawback” claims for avoidable preferential payments, to a liquidating trust. The trustee of the trust then filed a lawsuit against Auriga, seeking to recover $2.2 million in payments made to Auriga during the 90 days before the bankruptcy filing.

The Bankruptcy Code permits a bankrupt debtor (or in this case, a liquidating trustee), to sue a creditor, under certain conditions, to avoid and recover payments made by the debtor in the 90 days before a bankruptcy filing. But it also gives creditors a defense for new value (goods, services, or money) extended to a debtor after receiving payments during that 90-day period. There is, however, a catch: The new value that reduces a creditor’s liability must either remain unpaid, or if paid, was not paid with an otherwise unavoidable payment. This is commonly referred to as the “subsequent new value” defense.

Auriga and the trustee agreed the subsequent new value defense protected all but the debtor’s last payment, totaling just over $421,000. The creditor, Auriga, argued that its liability for the $421,000 payment should be reduced by the nearly $695,000 value of its polymer shipment made after receiving the $421,000 payment, leaving Auriga with zero liability.

The trustee argued the new value defense did not apply. It noted that shortly after the bankruptcy filing, Auriga had asked to be paid for the $695,000 shipment as a priority claim under Bankruptcy Code section 503(b)(9), which gives priority payment to shipments of goods made to a debtor in the last 20 days before a bankruptcy filing. Since Auriga was entitled to full priority payment of that $695,000 under section 503(b)(9), the trustee argued, it should not be entitled to “double-dip” and use that same new value to shield it from preference liability. After all, it argued, Bankruptcy Code section 547(c)(4) requires the new value to remain unpaid, or if paid, be paid only with an “otherwise avoidable transfer.” Arguably, the 503(b)(9) claim payment is not an “otherwise avoidable transfer,” so the $695,000 should not reduce the trustee’s clawback of the $421,000 pre-bankruptcy payment.

The bankruptcy court agreed with the trustee. Auriga appealed to the district court, which certified the case for direct appeal to the Eleventh Circuit.   

Finding Meaning in a Silent Statute

The Eleventh Circuit sided with Auriga and held that a creditor’s receipt of payment after a bankruptcy filing under section 503(b)(9) does not reduce new value it provided before the filing. Writing for the court, Judge Barbara Lagoa noted that the Bankruptcy Code is silent on what to do about post-bankruptcy payments for purposes of the subsequent new value defense. The Eleventh Circuit disagreed with the bankruptcy court on the significance of that silence. Reviewing the statute in context, the court held the Bankruptcy Code was designed to limit defenses relating to pre-bankruptcy payments; post-bankruptcy payments do not affect a creditor’s defenses. The court reached this decision after concluding that (a) the transfers described in Bankruptcy Code section 547 only clawback transfers made before a bankruptcy filing, and the use of the word “transfers” in the subsequent new value defense should be interpreted similarly; (b) the title of the statute, “preferences,” implies that its focus is the 90-day “preference period” before bankruptcy (and there is another section, 549, that addresses post-bankruptcy transfers); (c) if new value extended after a bankruptcy filing does not help a creditor, as a number of courts have concluded, then payments after a bankruptcy filing should not hurt a creditor; and (d) the statute of limitations, which begins to run on the bankruptcy filing date, implies a creditor’s liability should be fixed on that date—not affected by post-bankruptcy events. Moreover, Congress intentionally favored creditors who ship goods within 20 days before a bankruptcy filing (as set forth in section 503(b)(9)), and the Eleventh Circuit did not wish to disturb this policy.

In reaching its decision, the Eleventh Circuit, opining the case to be one of first impression in the circuit, adopted the rule—though not all the reasoning—of the Third Circuit in its 2013 opinion In re Friedmans, Inc., which held that only pre-petition payments reduce a creditor’s subsequent new value defense. (The Eleventh Circuit noted, in a footnote, that dicta in a 2005 Fourth Circuit case, In re JKJ Chevrolet, Inc., implies a contrary result.)

Better Protection for Trade Creditors

Trade creditors who supply companies in financial distress will welcome Auriga Polymers as a reinforcement to the protections Congress enacted in the Bankruptcy Code’s avoidable preference statute. With the right facts and venue, creditors that continue to supply companies up to the moment of a bankruptcy filing may find themselves better insulated against preference liability down the road.