In a precedential decision impacting critical vendors and, arguably, section 503(b)(9) claimants, the United States Court of Appeals for the Third Circuit upholds the Delaware district court’s affirmation of the bankruptcy court’s initial ruling in In re Friedman’s Inc., 2011 Bankr. LEXIS 4500 (Bankr. D. Del. 2011).  The opinion, filed December 24, 2013, states that “We hold that where ‘an otherwise unavoidable transfer’ is made after the filing of a bankruptcy petition, it does not affect the new value defense.”  In other words, even if a vendor receives payment of its pre-petition invoices after the petition date, the vendor is not precluded from later using those same invoices as part of a “subsequent new value” defense to a preference action.  The filing of the bankruptcy petition “fixes” the preference analysis.

In its analysis, the Court of Appeals considers “contextual indicators” in the Bankruptcy Code, including:

  • The fact that section 547 is titled “Preferences,” suggesting that it concerns those transactions made during the Preference Period (i.e. 90 days before the bankruptcy filing);
  • The hypothetical liquidation test, which must be performed as of the petition date;
  • The statute of limitations, which begins to run on the petition date;
  • The improvement-in-position test, which includes the phrase “as of the date of the filing of the petition”; and
  • The logical conclusion that if post-petition payments can affect the preference analysis, vendors must be entitled to assert new value defenses for post-petition extensions of new value, the latter of which has been rejected by numerous courts.

The Court of Appeals also analyzes the policies behind section 547, including:

  • Encouraging trade creditors to continue dealing with troubled businesses, such as critical vendors; and
  • Equal distribution among similarly situated vendors, such as section 503(b)(9) claimants.

Ultimately, the court holds that, contrary to the appellant’s arguments, a vendor is not “double dipping” when it asserts a subsequent new value defense for pre-petition invoices paid by post-petition transfers.  The vendor still replenished the debtor’s estate during the preference period, and therefore aided the debtor in avoiding bankruptcy.

The Court of Appeals also rejects the Appellant’s argument that policy behind section 547 requires all vendors must be treated equally, and instead states that “the Bankruptcy Code does not give equal treatment to the claims of all creditors, but rather carves out special treatment for creditors or claims of certain kinds.”  As examples, the Court of Appeals cites to critical vendors and section 503(b)(9) claimants, both of which can be given special treatment under the Bankruptcy Code.

The vendor in Friedman’s, represented by Blakeley & Blakeley,received payment of certain pre-petition invoices through a first-day motion by the debtor seeking approval to pay pre-petition wages.  However, the decision should apply with equal force to all vendors (including section 503(b)(9) claimants) who receive payment of pre-petition invoices after a bankruptcy case is filed and later attempt to use those same invoices as part of a new value defense to a preference action.  The decision is binding in the Third Circuit courts (which includes Delaware, New Jersey and Pennsylvania) and persuasive in all other circuit and district courts.