Defending Preference Actions: Transfers For Subsequent New Value

Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.
Creditworthy News

Another statutory defense available to creditors subject to a bankruptcy trustee’s preference action relates to transfers for subsequent new value. Bankruptcy Code Section 547(c)(4) provides:

(c) The trustee may not avoid under this section a transfer —

(4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor —

(A) not secured by an otherwise unavoidable security interest; and

(B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor.

The defense usually applies to instances where the debtor and the creditor have an open or running account relationship. In order for the defense to apply the following must occur: (i) the creditor receives a transfer which is avoidable as a preference under Section 547(b); (ii) after receipt of the preference transfer, the creditor advances additional credit to the debtor on an unsecured basis; and (iii) the additional unsecured credit advanced to the debtor remains unpaid in whole or in part as of the date that the debtor files bankruptcy.

The public policy underlying the defense is that it encourages the extension of credit to financially troubled companies and limits the ability of the trustee to avoid all transfers made by the debtor to a creditor during the preference period without giving the creditor any credit for new value extended. Thus, even though the creditor receives a preference, the creditor may still offset against a preference claim any subsequent unsecured credit that was extended to the debtor.

It is important to keep in mind that the defense as enacted under the Code applies only to new value payments carried forward. For example, a creditor is owed $4,000.00 90 days before bankruptcy. The creditor extends $2,000.00 of additional credit on two dates, 60 days and 30 days before bankruptcy. The creditor also receives a $4,000.00 payment 40 days before the bankruptcy. This payment is a preference not protected by other sections of 547. Under the subsequent new value advance rule set forth in Section 547(c)(4), only the second advance qualifies as such, and the $4,000.00 payment received is only protected from a preference action to the extent of $2,000.00. Thus, only subsequent advances of credit can be used to offset the preference payment.

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