Friedman’s, Inc. v. Roth Staffing Companies, L.P. (In re Friedman’s, Inc.), Adv. Case No. 09-50364 (CSS) (Bankr. D. Del. Nov. 30, 2011), read opinion here.

Tara Lattomus of Eckert Seamans prepared this summary.

Issue Addressed
Whether the debtor’s post-petition payment of a previously unpaid pre-petition claim reduced a creditor’s new value defense and increased its preference liability?

Short Answer
Based upon Third Circuit case law, the Bankruptcy Court held that preference liability is fixed as of the petition date. Accordingly, any post-petition payments to a preference defendant do not reduce the defendant’s new value defense in the amount of such payments.

On January 22, 2008, an involuntary chapter 7 was commenced against Friedman’s Inc. The chapter 7 case was subsequently converted to a voluntary case under chapter 11 of the Bankruptcy Code. Prior to the bankruptcy, Roth Staffing Company’s L.P. (“Roth”) provided staffing services to the debtor. During the preference period, the debtor paid Roth approximately $82,000. After such payments but prior to the bankruptcy, Roth provided approximately $100,000 of services to the debtor for which Roth was not paid. One of the first day motions filed by the debtor requested authorization to pay, among other things, Roth’s pre-petition claim. The motion stated that unless Roth was paid, the debtor would suffer from significant employee departures and a deterioration in employee morale. The Bankruptcy Court approved the motion and in accordance therewith, Roth was paid approximately $72,400.

In February 2009, the debtor filed a preference complaint against Roth seeking to recover the approximately $82,000 paid to Roth during the preference period. The debtor sought partial summary judgment asserting that Roth’s new value defense was reduced by the post-petition payment resulting in a new value defense in the amount of approximately $28,000 and preference exposure of approximately $54,000.

Section 547(b) of the Bankruptcy Code states that in order to recover a transfer as an avoidable preference, a debtor has to establish six elements: 1) a transfer of the debtor’s property; 2) the transfer was made on account of an antecedent debt; 3) the transfer was made to or for the benefit of a creditor; 4) the transfer was made while the debtor was insolvent; 5) the transfer was made within 90 days of the bankruptcy petition; and 6) that the transfer left the creditor in a better position than had the case been administered under chapter 7 of the Bankruptcy Code. One common defense to a preference action is subsequent new value. Generally, the new value defense allows a creditor to take a credit for the value of any goods and services provided to the debtor after a preferential transfer.

It was undisputed that Roth received preferential payments totaling approximately $82,000 and that it had provided subsequent new value to the debtor in the amount of $100,000. Under typical circumstances, Roth would have a complete defense. However, due to the Bankruptcy Court’s approval of the motion allowing the debtor to pay Roth’s pre-petition claim, Roth’s outstanding unpaid pre-petition claim was reduced to about $28,000. The debtor argued that the post-petition payment of the pre-petition claim reduced Roth’s new value defense leaving Roth with $54,000 of preference exposure. Roth, on the other hand, argued that its preference exposure was fixed as of the petition date. Accordingly, the post-petition payment did not reduce its new value defense and therefore, it had no preference exposure. The Bankruptcy Court held that the issue had previously been decided by the Third Circuit in New York Shoes. In New York Shoes, the Third Circuit stated that in order to assert a new value defense, the debtor must not have compensated the creditor for the new value as of the date it filed its bankruptcy petition. The Bankruptcy Court stated that the clear implication of this language is that the payment of new value after the petition date does not affect the preference analysis even if the debtor completely compensates the creditor for its pre-petition claim.