contemporaneous exchange

On August 4, 2016, the Delaware Bankruptcy Court considered cross-motions for summary judgment in a preference action case styled as Pirinate Consulting Group, LLC v. Maryland Department of the Environment (In re NewPage Corp.), Adv. Pro. No. 13-52206 (KG).  This gem of an opinion is noteworthy in that it analyzes various defenses raised by a state agency to a preference complaint.

Background

Pirimate Consulting Group, LLC, as litigation trustee of the NP Creditor Litigation Trust (“Plaintiff” or “Litigation Trustee”) sought to avoid three separate payments as preferences under section 547(b) of the U.S. Bankruptcy Code (the “Code”) against Maryland Department of the Environment (“Defendant” or “MDE”).

The Debtors’ subsidiary, Luke Paper Company operates a mill (the “Luke Mill”) in Maryland that is regulated by various divisions of MDE.  Defendant asserted that “the State’s operating permit program has been in place for decades” and that the Debtors have “been paying the emissions based fee of the type at issue in this case . . . at least since 1997.”  Here, the Trustee seeks to avoid three separate fees paid to MDE.

Under Maryland law, all entities that operate “fuel-burning equipment, statutory combustion turbines, or . . . wood digesters” must obtain a permit.  Accordingly, the Debtors would remit an annual permit-to-operate fee (the “Permit Fee”) in order to maintain their license. The applicable Maryland statute provides that the fee is calculated based upon a “base fee of $200.00 plus an emission-based fee for each ton of regulated emissions from all installations at the plant or facility.”

On July 6, 2011, the Debtor paid the Permit Fee in the amount of $1,597,584 to MDE.  The Debtors have been paying the Permit Fee since at least 2007, and the amount of the fee has ranged from $328,047 to $1,597,584 in 2011.  In addition to the Permit Fee, the Debtors sought to avoid an asbestos license renewal fee in the amount of $750, and a reporting fee of $1,000 under the Federal Emergency Planning and Community Right to Know Act.

In defense, MDE cross-moved for summary judgment, arguing that the Asbestos Fee was not paid on account of an antecedent debt and that the transfers did not enable it to receive more than it would have in a hypothetical liquidation. Additionally, MDE asserts three affirmative defenses under section 547(c) of the Code – the contemporaneous exchange defense, the ordinary course of business defense, and the de minimis exception. Additionally, MDE argues that 28 U.S.C. § 959(b) prohibits a trustee from recovering environmental compliance fees.  Finally, MDE argues that the doctrine of sovereign immunity insulates it from liability in these proceedings.

Analysis

Asbestos Fee Not Recoverable

To start, Judge Gross found that the Asbestos was not made “on account of an antecedent debt.”  The Court explained that a transfer is deemed “on account of an antecedent debt” if the debtor incurs the liability prior to the alleged preferential transfer.” 11 U.S.C. § 547(b)(2); Stanziale v. S. Steel & Supply, L.L.C. (In re Conex Holdings, LLC), 518 B.R. 269, 277 (Bankr. D. Del. 2014). More specifically, courts have held that a debt “is deemed to have been incurred on the date upon which the debtor first becomes legally bound to pay.” Conex, 518 B.R. at 277.

The Court determined that the Debtors did not became legally bound to remit the Asbestos Fee before the Debtors’ payment of such fee.  In this regard, the Court observed that the Debtors had no obligation to renew the license before the expiration date.  The Court also found that MDE’s letter to the Debtors informing of the Debtors about the Asbestos Fee did not trigger an obligation for Debtors to make payment of that amount.  Notably, no services had been provided by MDE prior to submission of the letter.  Thus, the Court found that the Debtors’ payment was not on account of an antecedent debt, and thus not recoverable.

Transfers Protected by Ordinary Course of Business Defense

In analyzing the ordinary course of business defense under Section 547(c)(2), Judge Gross examined the following five factors: “(1) the length of time the parties engaged in the type of dealing at issue; (2) whether the subject transfers were in an amount more than usually paid; (3) whether the payments at issue were tendered in a manner different from previous payments; (4) whether there appears to have been an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as additional security) in light of the debtor’s deteriorating financial condition.” Stanziale v. Indus. Specialists Inc. (In re Conex Holdings, LLC), 522 B.R. 480, 487 (Bankr. D. Del. 2014).

With respect to the first factor, the length of time the parties engaged in the type of dealing at issue, the record shows that MDE invoiced the Debtors for at least five (5) years prior to the Petition Date.  Thus the first factor weighed in favor of MDE.

Factor two, whether the subject transfers were in an amount more than usually paid, also weighs in favor MDE. The Asbestos Fee and the Report Fee were constant throughout the historical period – $750 and $1,000 respectively.  The Permit Fee varied considerably, but “[t]he record indicates that the formula for calculating the Permit Fee remained constant throughout the years,” which the Court concluded was the most relevant consideration with respect to this factor.

Factor three, whether the payments at issue were tendered in a different manner than the historical payments, weighed in favor of MDE as neither side has proffered any evidence to suggest payment had been made in a different manner.

Factor four, unusual actions by the debtor or creditor, also weighed in favor of MDE. There was no such evidence.  As to the fifth factor, there was no evidence that MDE attempted to exploit the Debtors’ distressed financial condition or rushed to collect its debt.  Thus, the Court found that the factors weighed in favor of MDE, and each of the transfers were shielded from recovery under the ordinary course of business defense.

Other Defenses

In addition, the Court found that the Asbestos Fee and Permit Fee were shielded by the contemporaneous exchange defense under Section 547(c)(1). Separately, the Court rejected MDE’s defense under 28 U.S.C. Section 959(b), along with MDE’s de minimis exception defense that each transfer should not be aggregated but determined separately whether they exceed the statutory floor of $5,000 under Section 547(c)(9).  Judge Gross noted the majority view that transfers should be aggregated, and there was no reason to depart from this rule especially because the Court separately found that each of the transfers were shielded from recovery under other defenses. Finally, the Court rejected MDE’s sovereign immunity defense, because the U.S. Supreme Court found that such defense is not a bar to preference actions against state agencies.  Cent. Va. Cmty. College v. Katz, 546 U.S. 356, 359 (2006).

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In this prior post, a discussion was provided in connection with requiring a company to prepay for its goods or services in order to limit potential preferential exposure.  If a company heading into bankruptcy cannot prepay for its goods or services, however, another measure which can be taken by vendors to minimize their preferential exposure is to require that payment be made “substantially contemporaneous” with the goods or services provided to the company.

Under Section 547(c)(1) of the Bankruptcy Code, a debtor or trustee may not avoid and recover transfers that are (a) intended by the debtor and defendant to be a contemporaneous exchange for new value given to the debtor, and (b) are in fact a substantially contemporaneous exchange.  What this means is that even if a payment made by a debtor during the 90 day Preference Period is not a prepayment, a creditor can defend itself from liability for such transfer if the parties intended for the debtor’s payment, and the goods or services provided, to be contemporaneous exchanges, and the exchanges were in fact made close to the same time.

Therefore, if your company is providing goods or services to a company in financial distress, it is prudent to require the company to prepay for its goods or services, or at a minimum, to require that payment be made as close as possible to the time that goods or services are provided.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

It’s your worst nightmare: you provided goods and services to a financially struggling company, only to find out that it filed for bankruptcy, leaving your company with a large unpaid balance.  Worst yet, after the debtor filed for bankruptcy, you receive a demand letter in the mail threatening a lawsuit if you do not return payments that you received from the debtor, even though you earned that money by providing goods or services to that entity.  What sense does that make?

Unfortunately, this is the reality that many companies face when transacting business with an entity in the months prior to its bankruptcy filing.  Section 547 of the Bankruptcy Code allows a debtor to avoid and recover transfers that it made in the 90 days prior to its bankruptcy filing, regardless of whether it received anything in return. This section was enacted to preclude a debtor from paying off its favorite creditor(s), while leaving nothing for the rest of the debtor’s creditors.  Hence the term preference payment.

Where does this leave your company after receiving a demand letter or complaint in the mail for the return of such alleged preferential transfers?  Rest assured, the Bankruptcy Code also provides numerous defenses that you can raise in response to such a demand.  This post provides a brief summary of the elements of, and common defenses to, preference claims.

Elements of a Preference Claim

To establish that a defendant received a preferential transfer under Section 547 of the Bankruptcy Code, plaintiff must prove the elements of 11 U.S.C. §547(b).  These elements include that payments were received by a creditor on account of an “antecedent debt”, and that the preferential payments must be made (i) while the debtor was “insolvent”, (ii) made within 90 days before the debtor filed for bankruptcy, and (iii) the payments provide the creditor with more payments than it would receive if the debtor had liquidated under a chapter 7 liquidation.  11 U.S.C. § 547(b).

An antecedent debt arises when a party receives a right to payment from the debtor for goods or services provided to the debtor.  This means that transfers which were “prepayments” do not qualify as preferential transfers under Section 547. To determine whether a payment falls within the 90 day preference period,  count back ninety days from the date the debtor filed for bankruptcy (the petition date).  For preference claims against “insiders” of the debtor, the preference period extends back one year prior to the petition date.

Finally, the plaintiff must show that the creditor received more than it would have received had it not received the payment, but instead received a distribution in a chapter 7 liquidation. This means that in order to show that a creditor received “preferential” treatment by the debtor,  the plaintiff must prove that the creditor’s payment was greater than what the creditor would have received had the debtor liquidated its assets under chapter 7 of the Bankruptcy Code.

Affirmative Defenses to Preference Litigation: Ordinary Course of Business, New Value and Contemporaneous Exchange

Even if the plaintiff can establish that the debtor made a preferential transfer as defined under the Bankruptcy Code, there are several affirmative defenses available to creditors under Section 547(c).  The more common defenses include the subsequent new value defense, ordinary course of business defense, and the contemporaneous exchange of new value defense, which are discussed below.

  • Ordinary Course of Business Defense – Section 547(c)(2)

The party receiving the payment may still avoid returning the money by proving the payment was made in the “ordinary course of business.” The ordinary course of business defense is the most widely used defense to a preference claim. Congress created the ordinary course defense in order to protect recurring, customary credit transactions that are incurred and paid in the ordinary course of business of the debtor and the debtor’s customers.

Under the 2005 amendments to the Bankruptcy Code, it is now easier for creditors to prove payments were made in the ordinary course of business. Under the amended provisions of the Code, a creditor that receives preferential payments must prove that payment was received in the ordinary of business of the debtor and creditor (the “subjective test”). Alternatively, if the creditor cannot prove that the payments were made according to ordinary business terms between the parties, it can still prevail by showing that the payments were made according to ordinary business terms (the “objective test”). Prior to the 2005 amendments, the creditor had to satisfy both the subjective and objective tests in order to satisfy the ordinary course of business defense.

  • Subsequent New Value Defense – Section 547(c)(4)

Exposure to a preference action can be reduced by the amount of “new value” provided by the defendant to the debtor subsequent to receipt of the preferential payment. To establish a new value defense, the creditor must show that it received a preference payment, the creditor then provided the debtor with new value in the form of subsequent goods or services.

  • Contemporaneous Exchange of New Value Defense – Section 547(c)(1)

Creditors can also defend against a preference claim by showing that the payment(s) received from the debtor were contemporaneous exchanges for subsequent new value.  The contemporaneous exchange defense requires the creditor who received the payments from the debtor provide the debtor with “new value” after receiving payment, which can include the value of goods or services.  Additionally, the creditor and debtor must intend for the payments to be a contemporaneous exchange.  Finally, the payments received by the creditor and the exchange of new value must actually be substantially contemporaneous.

Conclusion

The above is a brief introduction to the elements and core defenses of Section 547 preference actions.  Subsequent posts will explore in greater detail the various components of preference claims.  Besides looking at substantive legal issues, however, it is also important to understand the Local Rules and General Orders that govern the procedural flow of these cases from beginning to end.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Introduction

In January, Mortgage Lenders Network commenced over 65 adversary actions against various defendants, seeking the avoidance and recovery of preferential transfers (read one of the preference complaints here).  As reflected in its complaints,  Mortgage Lenders filed a chapter 11 bankruptcy petition in the Delaware Bankruptcy Court on February 5, 2007. During the ten years prior to its bankruptcy, Mortgage Lenders grew from a small mortgage company with seven employees, to a residential mortgage provider serving 47 states with over 1,700 employees. 

Given the commencement of Mortgage Lenders’ preference program, this post provides a brief summary of the elements and common defenses to preference claims.

Elements to a Preference Claim

In order to establish that a party received a preferential transfer, the plaintiff must prove that payments were received by a creditor on account of an “antecedent debt.” Further, the preferential payments must be made (i.) while the debtor was “insolvent”, (ii.) made within 90 days before the debtor filed for bankruptcy, and (iii.) the payments provide the creditor with more payments than it would receive if the debtor had liquidated under a chapter 7 liquidation.

 

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