A simple statement of the April 28, 2010 holding in TI Acquisition, LLC, v. Southern Polymer, Inc. 2010 WL 1993848 (Bankr.N.D.Ga.), may paint the decision as adverse to creditor interests.  Certainly, Judge Mary Grace Diehl held that “new value” paid as a 503(b)(9) administrative expense is unavailable in a “subsequent new value” defense to a bankruptcy preference claim. However, this holding is overshadowed by the sound reasoning and observations of the Court on three fronts:

1. the decision provides a solid analytical foundation for protection of bankruptcy preference defendants seeking allowance and payment a Section 503(b)(9) administrative expense;

2. it recognizes that critical vendor payments may be treated differently than 503(b)(9) administrative expense payments for purposes of the subsequent new value defense; and

3. it dispels the generally held belief that the Eleventh Circuit Court of Appeals has adopted the “remains unpaid” approach to the application of the subsequent new value defense.

The Controversy – $300,000 of “New Value” Received by Debtor within 20 Days before Bankruptcy

TI Acquisition (the “Debtor”) filed bankruptcy on July 27, 2008. On the 16th and 5th days prior to the filing, the Debtor received two shipments invoiced at $154,840.00 and $147,672.00, respectively, from Southern Polymer, Inc. (“SPI”). Following the bankruptcy, SPI filed a § 503(b)(9) claim in the amount of $302,512.06.

On January 30, 2009, the Debtor filed an adversary complaint against SPI to avoid alleged preferential transfers. The preference recovery was sought by the Debtor “in the net amount of $193,152.75 reflecting a “new value” credit to SPI for the shipments that were the subject of SPI’s pending § 503(b)(9) claim.” Debtor’s Complaint stated that, if SPI’s § 503(b)(9) claim was allowed, that Debtor would not grant SPI new value credit and that the amount of preference sought would be $495,664.75.

On May 6, 2009, the Court entered an Order in the bankruptcy case allowing the full amount of SPI’s § 503(b)(9) claim. In re TI Acquisition, LLC, 410 B.R. 742, 751 (Bankr.N.D.Ga.2009). That Order further provided that the payment of the claim was deferred pending the outcome of this adversary proceeding. Id. (See article “Can Pre-Petition Deliveries Provide a Bankruptcy Preference ‘New Value’ Defense and Section 503(b)(9) Administrative Expense?” (February 2nd, 2010) discussing this first decision.)

A Matter of First Impression Framed by “Payment” of Defendant’s 503(b)(9) Claim

In Commissary Operations, the Bankruptcy Court for the Middle District of Tennessee held that claims entitled to § 503(b)(9) status may constitute new value for purposes of 11 U.S.C. § 547(c)(4). In re Commissary Operations, 421 B.R. 873, 879 (Bankr.M.D.Tenn.2010). However, in Commissary Operations the 503(b)(9) claim had neither been paid nor had any reservation for payment been made.

In TI Acquisition, the Debtor’s secured creditor agreed to reserve funds from the liquidation of Debtor’s assets to cover SPI’s allowed § 503(b)(9) administrative expense. This reservation of funds for payment of SPI’s allowed § 503(b)(9) administrative expense presented the TI Acquisition Court with a “ripe” controversy. Was SPI “entitled both to receive payment on its allowed § 503(b)(9) claim and to use the value of the same pre-petition shipments as a defense pursuant to § 547(c)(4)”?

When are § 503(b)(9) Claims like Reclamation Claims? – When Payment is Assured.

The court in Commissary Operations devoted substantial attention to distinguishing another decision out of the Middle District of Tennessee, In re Phoenix Rest. Group, Inc., 373 B.R. 541, 547-548 (M.D.Tenn.2007), where the District Court held that goods subject to a reclamation claim could not qualify as “new value”.

The Court in TI Acquistion went directly to the Phoenix Rest. Group holding and analysis and disagreed with the Commissary Operations Court’s rationale for distinguishing a reclamation claim from a 503(b)(9)administrative expense. Judge Diehl identified a critical distinction between a reclamation claim and a 503(b)(9)  expense: “While a reclamation claim can be satisfied by the return of the goods, an administrative expense is vulnerable to non-payment by an insolvent estate.” The Court went on to pound home the point:

If goods subject to a reclamation claim are returned to the creditor, the estate is not enhanced by those goods. Similarly, once a creditor has been given an allowed § 503(b)(9) administrative claim and the claim has been paid (or, as here, reserved for), it is clear that the estate was not enhanced by the “new value.” While the Commissary Operations court ultimately concluded that § 503(b)(9) claims generally should be distinguished from reclamation claims, this Court finds that § 503(b)(9) claims that have been or will be paid in full are similar to reclamation claims.

This observation formed the key underpinning of the TI Acquisition Court’s ultimate holding. “A creditor that delivered goods to the debtor pre-petition is not entitled to the new value defense under § 547(c)(4) when that creditor has been paid in full by a § 503(b)(9) claim. This is the same treatment provided to reclamation claimants.”

Good News for Unsecured Creditors with 503(b)(9) Claims

The TI Acquisition reasoning supports the proposition that, unless the 503(b)(9) claim has been paid or funds have been set aside for its payment, a creditor’s assertion of a 503(b)(9) claim does not bar its assertion of a 547(c)(4) subsequent new value preference defense.

The decision’s focus on the risk of administrative insolvency also supports a broader proposition that the determination of a creditor’s entitlement to 503(b)(9) status should not be placed on hold pending resolution of a preference claim.  Such a delay could permanently deprive the creditor of its standing and rights to participate in the case as holder of an administrative expense, including its right to object to any plan of reorganization that does not include its claim in the total and provide for its payment in full.

More Good News – Critical Vendor Payments Still Should not Reduce Subsequent New Value

Those bankruptcy courts that previously had considered the argument that 547(c)(4) “subsequent new value” should be reduced by “critical vendor” payments  had rejected the argument.   Judge Diehl leaves this prior authority unblemished by observing:

Payment pursuant to a critical vendor order differs markedly from the statutory priority accorded to § 503(b)(9) claims. An order designating an unsecured creditor as a “critical vendor” accords the debtor-in-possession a great deal of latitude in negotiating the terms and conditions of “critical vendor” status while conditioning the designation as a “critical vendor” on the creditor’s agreement to provide post-petition credit to the debtor-in-possession. See, e.g., In re Phoenix Rest. Group, 373 B.R. at 544-545 (describing how parties negotiated for critical vendor terms).

And the Really Good News – The “Subsequent Advance” Approach to “Subsequent New Value” May Still have Life in the Eleventh Circuit

A widely cited 2004 law review survey article had characterized the Eleventh Circuit “as holding that the new value must remain unpaid in order for it to be effectively used by the creditor to offset an otherwise avoidable transfer.” Noah Falk, Section 547(c): The Subsequent New Value Exception Defense to Preferences, 2004 ANN. SURV. OF BANKR.LAW PART I (Norton October 2004) This approach (the “remains unpaid” approach) is contrasted with the “subsequent advance” approach that allows for the continued recognition of “subsequent new value” even after the resulting obligation is satisfied pre-petition.

The 2004 law review survey pronouncement was based on language in the Eleventh Circuit decision in In re Jet Fla. Sys. Inc., 841 F.2d 1082, 1083 (11th Cir.1988). Judge Diehl carefully examined that decision and concluded:

Despite the Eleventh Circuit’s categorization by other courts as an adopter of the remains unpaid approach, it is unclear whether the Eleventh Circuit officially has adopted that approach. A careful look at the Eleventh Circuit authority on the new value defense shows that its holding is not at odds with the subsequent advance approach.

This observation opens the door for those defending preference actions in the Northern District of Georgia, and possibly within other districts in the Eleventh Circuit to present the subsequent new value defense based on the “subsequent advance” approach.

On a Net Basis TI Acquisition is a Win for Suppliers

For defendants of adversary proceedings for the recovery of preferential transfers, the TI Acquisition decision is a “must read.”  The narrow adverse holding is more than outweighed by the value to unsecured creditors of the reasoning and ancillary observations that will advance the protection of Section 503(b)(9) expenses and dissuade those who consider launching punitive preference actions against suppliers asserting these administrative expenses. Finally, the decision brings the possibility of the resurrection in the Eleventh Circuit of the “subsequent advance” approach to the subsequent new value defense.