New Value Explained

The "new value" defense also appears available here. The new value defense most often arises when a defendant receives payments on account of goods or services provided well after the goods or services are provided. The fact that the debtor is paying the defendant late indicates that the defendant probably received transfers that are avoidable as preferences. However, there is also a significant likelihood that some of the invoices remain unpaid when the debtor commenced its bankruptcy proceeding. The unpaid invoices may provide the defendant with a partial or complete defense as to the payments that were received preferentially. This is the case because preferential payments are seen as damaging the estate for the benefit of a particular creditor. However, if the creditor has provided goods or services back to the estate without being compensated, the estate has been enhanced and the creditor’s position diminished. This defense also requires a detailed analysis of the parties’ transactions, which is contained in Table B and discussed below.

The client suggests you begin that analysis immediately, which you will upon receipt of the information requested. While you are waiting for that information, you decide to try to get more information.

Requesting Information from the Debtor or Trustee

Your next task is to prepare a letter to the plaintiff (hereafter, for sake of simplicity, the "bankruptcy trustee") requesting it to furnish you with any information it has supporting its demand. Your goal is to get the bankruptcy trustee to disclose whether it can satisfy its prima facie case before you raise/formulate your defenses. See 11 U.S.C. §547(g) (that subsection provides that the plaintiff has the burden of proving that it has satisfied the primary elements of an avoidance set forth in §547(b) while the creditor against whom an action is brought has the burden of demonstrating the nonavoidability of a transfer for a defense set forth in §547(c)).

Your request to the bankruptcy trustee may not be addressed quickly, or at all. Due to the debtor’s messy records (not at all an unlikely occurrence; they are in bankruptcy for a reason), it is highly probable that the initial preference demand letter was generated from check registers, with no analysis of defenses by the bankruptcy trustee. Realizing you have no way to verify whether they have a valid preference before preparing an answer and affirmative defenses, you focus on the affirmative defenses.

Accountant Analysis of the Transactions for New Value & Ordinary Course Defenses

All the information has come in from your client, so you must move to the next step. As the attorney on the file (who, as legend has it, attended law school because there would be no math), you pick up the phone and call the financial advisor/accountant you are working with in another matter and ask for some advice on how to analyze the information you have received.

After discussing the situation and sharing the information, your accountant is now ready to schedule the information received to determine whether you have any subsequent new value or ordinary course defenses. All transactions prior to and during the preference period should be listed in chronological order: dates when goods were shipped or services provided, invoice dates and payments by the check clearance date. In many jurisdictions, subsequent new value may be applied to reduce the preference exposure on all payments received before the new value was provided. In other jurisdictions, new value may only be applied to the immediately preceding preferential payment but not any prior preferential transfers. After researching the approach used in the relevant jurisdiction and discussing it with the accountant, your accountant puts together a chart.

Table A is an illustration of a transaction chart showing the debtor’s payment history prior to the preference period (for ordinary course purposes), when the alleged preferences were received and when new value was provided. In your case the debtor commenced its bankruptcy proceedings on June 6, 1999.

The transactions that took place in 1998 establish the parties’ pre-preference period transaction history for the ordinary course analysis. The relevant calculation in this part of the analysis is how many days on average the debtor paid the invoices generated by your client both during and before the preference period. The invoice date and payment terms are not listed but are used together with the payment date to calculate the number of days the payment was made after the due date. For example, the invoice payment terms are 30 days. So when indicating that the July 28, 1998, payment was received 60 days after the due date, it means the invoice was issued April 29, 1998 and was due May 29, 1998, but not paid until July 28, 1998. Therefore, to complete the chart you will need to know the invoice date and payment terms, but for ease of review throughout negotiations and the litigation, it is best to only record the payment amount and the resulting “days after due date” figure. After compiling that information you calculate the simple average of the “days after due date” column by adding up the figures in that column and dividing by the total number of entries (607/11=55.181818—if you are proficient in using spreadsheets you can also set up a formula to calculate that figure for you after entering the data). The next step is to create the same chart for the transactions during the preference time period (March 8 through June 5, 1999) and calculate the simple average of days. In this case, the average number of days during the preference period is 73.

Now what does the data mean? The payments made during the preference period, taken together, were made approximately 73 days late as opposed to 55.18 days late before the preference period. However, removing the one payment made during the preference period that was 238 days late brings the average of the remaining payments down to 54.67 days. You hope that your analysis means that only the one $2,000.00 payment made 238 days late is outside the ordinary course. But you’re sure that the bankruptcy trustee will assert that all payments made during the preference period that are made after the 57–day mark are outside the ordinary course, totaling $666,000. The good news is that you have successfully narrowed the preference exposure to a figure somewhere between $0 and $666,000, instead of $1,220,000. Unfortunately, reasonable minds will disagree about exactly what the preference exposure should be (or what a court would conclude it is), so it is time to put on your negotiators hat… right after completing the new value analysis.

The ultimate net preference exposure is the cumulative exposure of each of the individual checks after the deduction of new value. Therefore, you identify unpaid invoices and insert the dates the goods were delivered and the value of the goods into the chart. Depending on the law of the relevant jurisdiction, the amount of the goods shipped is deducted from any alleged preferential payment received prior to the date the goods were shipped or the amount of the goods shipped is deducted only from the alleged preferential payment received immediately prior to the shipment. The potential preference amount is adjusted by applying new value to the running total in the “potential preference amount.” In this case, your client is entitled to $40,000 in new value, thereby reducing its preference exposure to $1,180,000.

After reviewing both new value and ordinary course you conclude that your client’s maximum exposure is $626,000, assuming that $666,000 in payments were not made in the ordinary course and after deducting $40,000 in new value. You have made some progress, but know your work is not complete.

In an attempt to formalize your findings, you prepare a proposed detailed letter to the bankruptcy trustee setting forth your defenses, which aggressively concludes that your client does not have any preference liability. You send the proposed letter to your client to discuss. Your client is thrilled with the results … so far.

Negotiating a Settlement

Although it would be a wonderful opportunity for you to go solo in front of the judge on behalf of your client, due to cost issues, you know you must make a good faith effort to settle. Your client is the one with the money so you have a strong negotiating position. However, your client is also the one that has to prove that the payments were made in the ordinary course of business, which involves not only proving your initial analysis holds true, but that it holds true in the industry as well.

The first negotiation is the one with your client. Sure your analysis shows that your client may have no preference exposure, but you know that after the preference demand is complete, there isn’t much involved in filing a suit. The discussion with your client should focus on problem issues, such as the location of the potential suit, the costs involved and the prospects of lengthy discovery requests. Understanding that you don’t have an extremely strong case, hopefully you’ll be able to include an offer of settlement in your proposed letter to the bankruptcy trustee.

Finally, the negotiations with the bankruptcy trustee can begin. Beyond renewing your request for all information the bankruptcy trustee used to complete the preference demand, you should also be sure to ask about a possible dividend range to general unsecured creditors, knowing that it is just a range. That information could assist you and your client in determining at what point a settlement makes sense. Other key strategies in structuring a deal:

Remember:
• Never start with your best offer.
• Early settlement may set precedents; therefore, an early offer may show less flexibility at the beginning than after the resolution of several additional claims.
• The bigger the claim the more attention. The amount of attention your preference demand receives may be influenced by its size, not the validity of such.
• Preserve your client’s ability to file a proof of claim.

If all else fails, litigate.

Diagrams:

Allen is the director of the Corporate Recovery Services Group at Amper, Politziner & Mattia P.C. He is located in both the firm's Edison, New Jersey and New York City offices. He can be reached by phone at 732-287-1000.

Rick is an associate in the Insolvency and Reorganization Group of Jaffe, Raitt, Heuer and Weiss, P.C. JaffeRaitt's main office is located at One Woodward Avenue, Suite 2400, Detroit, Michigan 48226. Rick can be reached by phone at 313.961.8380 or by e-mail at rkruger@jafferaitt.com . JaffeRaitt also maintains offices in Birmingham, Ann Arbor and Port Huron, Michigan.

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Bankruptcy Fundamentals Program