How Valuable Is 'New Value' In Preference Litigation?

It is not uncommon for a supplier of goods or services to receive a demand letter or adversary complaint alleging that it received avoidable transfers - commonly known as "preferential payments" or "preferences" - during the 90 days preceding a customer's bankruptcy filing. Such claims arise under section 547 of the Bankruptcy Code, and can result in a supplier having to return certain payments made during the 90-day preference period.

One of the most common defenses to an alleged preference is the "new value" defense.1 Simply stated, the "new value" defense provides that, to the extent a creditor gives "new value" (usually in the form of additional goods or services provided on credit) to the debtor after receiving preferential payments, the creditor is entitled to reduce its preference exposure by offsetting the new value against the preferential payments. See 11 U.S.C. §§ 547(a)(2) and (c)(4).

An example of a straightforward application of the new value defense is as follows:

A supplier received a $10,000 payment from a debtor 70 days before the debtor's bankruptcy filing. Five days after receiving the $10,000 payment (on the 65th day before the bankruptcy filing), the supplier shipped $5,000 worth of goods to the debtor on credit, thereby making the supplier a creditor of the debtor in the amount of $5,000. The supplier expected to be paid for the additional $5,000 of shipped goods within 30 days after invoice, per stated invoice terms. Unfortunately, the debtor never paid the $5,000 invoice, and filed bankruptcy before payment was made. The supplier will be entitled to offset this $5,000 "new value" against the $10,000 potential preference payment received by the supplier on the 70th day before bankruptcy, thereby reducing the supplier's preference exposure to $5,000 before the application of other possible defenses. The supplier is also entitled to file a general unsecured claim in the debtor's bankruptcy case for $5,000 -the amount of the unpaid invoice.

Limitations on the "New Value" Defense

In order to be used as part of a "new value" defense, "new value" cannot be "secured by an otherwise unavoidable security interest." 11 U.S.C. § 547(c)(4)(A). Basically, this means that the creditor cannot have a security interest securing its right to payment for the "new value."

Further, "new value" can only be used as a defense if "the debtor did not make an otherwise avoidable transfer to or for the benefit of such creditor" on account of the "new value". 11 U.S.C. § 547(c)(4)(B). This requirement can be interpreted in simple terms to mean that the creditor cannot have received payment for amounts that it...