Delaware Preference Update: New Value, Prejudgment Interest and Early Payment Ordinary Course Defenses
In a recent opinion dated March 29, 2016, the Delaware Bankruptcy Court on remand from, and following the direction of, the Delaware District Court, ruled that only prepetition unpaid invoices may be counted for purposes of the new value defense under 11 U.S.C. § 547(c)(4). The Bankruptcy Court also ruled that the plaintiff Chapter 7 trustee was entitled to prejudgment interest from the date of the filing of the preference avoidance complaint. Further, the District Court, in affirming the Bankruptcy Court on this point, addressed the ordinary course defense under 11 U.S.C. § 547(c)(2), adding to the discussion on when payments may be avoidable if they are made during the preference period sooner than when they were made in the pre-preference period.
These rulings are the most recent pronouncements in the Third Circuit on whether postpetition services are a defense against a prepetition avoidance action (they are not); whether a preference defendant is liable for prejudgment interest (it may be); and whether prejudgment interest runs from the date of receipt of the avoided transfer or the date of the complaint commencing the action (here, from the date of the complaint commencing the action). In addition, although the District Court’s opinion provided some guidance that payments received faster during the preference period as compared to the pre-preference period could weigh as a factor against the ordinary course of business defense, it remains an area that will depend on “the unique facts of each case” (a 40% improvement is probably not ordinary course, while a 15% improvement may be ordinary course).
These issues were addressed in the Chapter 7 case of AE Liquidation, Inc., et al., Case No. 08-13031(MFW) and the related adversary proceeding Case No 10-55543(MFW). The Bankruptcy Court’s March 29, 2016 Opinion may be found at the Delaware Bankruptcy Court’s website or 2016 WL 1238848. The District Court’s decision may be found at the Delaware District Court’s website or 2015 WL 5301553 (D. Del. Sept. 10, 2015).
In 2010, the Chapter 7 Trustee commenced an avoidance action seeking recovery of 12 transfers to the defendant within the 90-day preference period, totaling $781,702.61 (the “Transfers”). After mediation failed, a trial was held in March of 2013. In July 2013, the Bankruptcy Court issued an Order with respect to the defendant’s defenses, including the defenses that (a) the Transfers were made in the ordinary course of business under Section 547(c)(2) of the Bankruptcy Code, (b) after the Transfers the defendant gave new value to or for the benefit of the Debtor under Section 547(c)(4), and (c) the defendant was not liable for prejudgment interest even if it was required to disgorge the Transfers.
In its July 2013 opinion, the Bankruptcy Court allowed certain preference period and postpetition advances of alleged new value to be applied to reduce the avoidance demand, found that certain payments made sooner than had been paid on an historical basis as between the debtor and the transferee were not made in the ordinary course, and denied the trustee’s request for prejudgment interest. On appeal, the District Court affirmed in part and remanded in part. More specifically, the District Court affirmed the Bankruptcy Court’s ruling denying the transferee’s ordinary course defense and remanded with respect to the Bankruptcy Court’s calculation of the new value and for the Bankruptcy Court to state its basis for denying prejudgment interest.
Ordinary Course. Although the District Court affirmed the Bankruptcy Court’s ruling denying the transferee’s ordinary course defense, its rationale for doing so provides some guidance on what may be considered ordinary course, at least in Delaware, when an alleged preferential transfer is paid sooner than was paid on an historical basis as between the debtor and the transferee. In this case, the days between the invoice date and the payment clearing date during the preference period was 28 days and the average number of days to clear before the preference period was 45.3 days, being an approximately 17 day difference. In its opinion, the District Court referred to this reduction of the period as being a “roughly 40% improvement”. The District Court noted that the Bankruptcy Court did not hold that the payments were outside the ordinary course of business simply because they were made faster, and not slower, during the preference period. Rather, the Bankruptcy Court rejected the transferee’s ordinary course defense because it found that the change in the payment timing was significant coupled with several other factors. These other factors included that the transferee had insisted on a quicker payment schedule as it became aware of the Debtor’s financial troubles, the payments before the preference period were on a more random and haphazard basis than during the preference period, the subject Transfers were tendered differently during the pre-preference period than during the preference period, with payment of some of the Transfers being made by wire and not by check, as they had been done in the pre‑preference period. Further, certain Transfers were paid from the Debtor’s payroll account rather than its operating account, again being different from during the pre-preference period (although the Bankruptcy Court opined in its first decision that the change in payment method, which lasted only three weeks, would not be considered out of the ordinary course of business for that reason alone).
The District Court rejected the transferee’s argument that the Bankruptcy Court’s determination that the 40% faster payment was not in the ordinary course, was inconsistent with the Bankruptcy Court’s determination in another case where it found a 10% to 15% quicker payment during the Preference Period did not take such payments out of the ordinary course. Here, the District Court stated that it did “not find that this establishes clear error. In fact, there is no inconsistency between finding that a 10% to 15% increase is insignificant, while a 40% increase is significant. This is especially true given the subjective nature of this determination and the unique facts of each case.” 2015 WL 5301553 at *5.
Here, the trustee also had argued that during the preference period the transferee had placed the Debtor on billing review and instituted a payment plan, making the Transfers made under that payment plan necessarily out of the ordinary course. The transferee countered that similar circumstances had arisen before the Preference Period that had resulted in the transferee placing the Debtor on a similar billing review and payment plan. The Bankruptcy Court was dismissive of the argument that just because the parties had done something similar one other time, that such practice was ordinary course. Ultimately, the District Court affirmed the Bankruptcy Court with respect to ordinary course stating “overall, the Bankruptcy Court’s conclusion regarding [the transferee’s] ordinary course of business defense depended on the party’s length of engagement, the change in timing of the Debtor’s payments, [transferee’s] collection efforts, and the advantage [transferee] gained over the Debtor while the Debtor was financially deteriorating . . . supports [the Bankruptcy Court findings]; therefore, the Bankruptcy Court did not commit clear error by denying the [transferee’s ordinary course of business] defense.” Id. at *6. The takeaway here is that in the absence of other factors, an earlier payment alone may not be enough to render a subject transfer as not ordinary, but would be one of the factors to be considered.
New Value. This case also stands for the proposition, as found by the District Court and followed by the Bankruptcy Court, that only services provided before the petition date may be included in the Bankruptcy Code § 547(c)(4) new value defense. The Bankruptcy Court had in its first decision concluded that the transferee had a valid new value defense in the amount of $128,379.40, an amount the trustee had argued improperly included $71,808.03 on account of postpetition services. The trustee had argued that the petition date was the final cut-off for calculating this defense. The District Court agreed and reversed the Bankruptcy Court. The District Court remanded the matter to the Bankruptcy Court to reexamine the facts to determine what new value was provided postpetition, with instructions that those extensions of new value would not reduce the otherwise avoidable prepetition preferences. In its July 2013 opinion, following the District Court’s instructions, the Bankruptcy Court eliminated the postpetition services from its calculation of the new value defense.
Prejudgment Interest. Finally, the District Court considered whether the Bankruptcy Court erred in not awarding prejudgment interest. The District Court noted that, in Hechinger Inv. Co. of Del., Inc. v. Universal Forest Prods., Inc. (In re Hechinger Inv. Co. of Del., Inc.), 489 F.3d 568 (3d Cir. 2007), the Third Circuit ruled that “prejudgment interest should be awarded unless there is a sound reason not to do so.” Prudential Real Estate and Relocation Servs., Inc. v. Burtch (In re AE Liquidation, Inc.), 2015 WL 5301553, at *8 (D. Del. Sept. 10, 2015) (quoting Hechinger, 489 F.3d at 580)). Thus, the District Court remanded the issue of prejudgment interest back to the Bankruptcy Court for an explanation of its reasoning for denying the Trustee’s request for prejudgment interest or, alternatively, to award such interest. In its March 29, 2016 Opinion, the Bankruptcy Court awarded prejudgment interest from and after the date of the filing of the adversary proceeding at the federal judgment rate.
Again, the take away here is: (a) while dependent on the “unique facts of each case”, a 40% improvement in the speed of payments will probably not pass muster as “ordinary course”; (b) post-petition services or goods may not be relied upon as “new value”, and (c) unless the Bankruptcy Court can articulate a sound reason for not awarding prejudgment interest, prejudgment interest should be awarded.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.