Southern California Bankruptcy Law Blog

Preferential Transfers IV: Defenses to Preference Avoidance Actions (Part I)

Posted in Chapter 11, Chapter 13, Chapter 7

In my last post I looked at avoidance of preferences.  I now turn to defenses against such actions.  This will be a multi-part series because some of the defenses are a bit complicated and hard to understand.

Defenses To Preference Avoidance Actions:  Part I

The recipient of a prepetition transfer is not without defense against a preference avoidance action.  The defenses are given in § 547(c) and (h).  Once the trustee has met the burden of proving avoidability, “the creditor or party in interest against whom recovery or avoidance is sought has the burden of proving the nonavoidability of a transfer under subsection (c) of this section.”  11 U.S.C. § 547(g).

Keep in mind however, if any of the five requirements of the definition is not satisfied, then the transfer is not avoidable because it is not a preference.  Therefore, if you are asked to defend against a preference avoidance action, first determine whether the transfer really fits within the definition.  If it does not, then you have a defense by proving that the transfer wasn’t a preference in the first place.  Of course, you should also appeal to any applicable § 547(c) defenses as well, since you won’t know, a priori, whether your defense based on the definition will succeed.

This and the next several posts will deal with the § 547(c) defenses.  After that another post will be devoted to the § 547(h) defense.

Section 547(c) has nine defenses against a preference avoidance action.  I consider them in seriatim (with the first being the focus of today’s post).

The Contemporaneous Exchange For New Value Defense

Suppose that:  (a) the debtor owed Creditor ABC $20,000; (b) during the 90-day prepetition period the debtor paid $10,000 to Creditor ABC for some materials to be used in fabricating the goods the debtor sells to its customers; and the debtor paid with a check at the same time the materials were delivered.  Then even though the bank didn’t honor the check at that moment, the transfer was made as part of a contemporaneous exchange for new value.

Indeed, this is the scenario Congress had in its collective mind (if we can anthropomorphize that schizophrenic body as having a single mind) when drafting § 547(c)(1):

The first exception is for a transfer that was intended by all parties to be a contemporaneous exchange for new value, and was in fact substantially contemporaneous.  Normally, a check is a credit transaction.  However, for the purposes of this paragraph, a transfer involving a check is considered to be “intended to be contemporaneous,” and if the check is presented for payment in the normal course of affairs, which the Uniform Commercial Code specifies as 30 days, U.C.C. § 3-503(2)(a), that will amount to a transfer that is “in fact substantially contemporaneous.”

H.R.Rep. No. 95-595, 95th Cong., 1st Sess., reprinted in 1978 U.S. Code Cong. & Ad. News 5963, 6329.  See, e.g., Matter of Vance, 721 F. 2d 259261 (9th Cir. 1983).

This is the sort of transaction envisioned by § 547(c)(1):

The trustee may not avoid under this section a transfer —

(1) to the extent that such transfer was —

(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and

(B) in fact a substantially contemporaneous exchange.

New value is defined in § 547(a)(2) as:

“[N]ew value” means money or money’s worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation.

In sum, new value adds something to the debtor rather than merely changing the terms of an already existing obligation.  According to the Ninth Circuit, “The ‘new value’ defense is grounded in the principle that the transfer of new value to the debtor will offset the payments, and the debtor’s estate will not be depleted to the detriment of the other creditors.”  In re Futoran, 76 F. 3d 265, 267 (9th Cir. 1996) (quoting In re Laguna Beach Motors, Inc., 148 B.R. 322, 324 (9th Cir. BAP 1992)).

As you might imagine, most of the battle is over “new value” and “substantially contemporaneous,” and is very fact specific.

The following cases illustrate some of the “new value” holdings:

i.          Holdings With New Value Transfers

ii.         Holdings With No New Value

The following cases illustrate some of the “substantially contemporaneous” holdings:

i.          Holdings With Substantially Contemporaneous Transfers

Interestingly, the Ninth Circuit held that “section 547(c)(1) does not apply to a purchase money security transaction” because § 547(c)(3) addresses such transactions (I will cover § 547(c)(3) in another post).  See  Matter of Vance, 721 F. 2d 259, 260 (9th Cir. 1983).  The Court’s reasoning was that §§ 547(c)(1) and (c)(3) are mutually exclusive.  However, this does not mean that all of the § 547(c) defenses are mutually exclusive.  The Court based its holding on the fact that § 547(c)(3) explicitly deals with secured interest transactions, and allowing a § 547(c)(1) defense on such transactions would render § 547(c)(3) pure surplusage.

If you’re facing a preference avoidance action, and need an analysis of your case and the possible application of the contemporaneous exchange for new value defense to your case, contact a highly skilled bankruptcy attorney to help you.