In a recent decision, LGI Energy Solutions, Inc. v. Stoebner, 2014 US App LEXIS 5227 (8th Cir Mar 20, 2014), the United States Court of Appeals for the Eighth Circuit held that, in a three-party relationship in which a debtor’s otherwise preferential transfers to a third-party benefit the debtor’s primary creditor, new value coming from the primary creditor can provide a defense to the third-party that received the transfers.
The debtor, LGI, performed utility bill payment services for its clients (large restaurant chains) (the “Restaurants”). As provided in contracts between LGI and the Restaurants, utilities providing service to the Restaurants (the “Utilities”) would send invoices directly to LGI, rather than to the Restaurants. LGI would periodically send spreadsheets to the Restaurants summarizing their payment obligations under the invoices LGI had received, and instead of paying their utility bills directly to the Utilities, the Restaurants would remit payment to LGI, which would then pay the invoices by remitting payment to the Utilities. In the time period leading up to the bankruptcy filing, the debtor transferred substantial sums (the “Transfers”) to the Utilities to pay outstanding invoices. After the Transfers were made, the Restaurants continued to send payments to LGI (the “Post-Transfer Payments”); however, LGI did not forward those amounts to the Utilities.
After the filing, LGI’s bankruptcy trustee (the “Trustee”) sued the Utilities to recover the Transfers. On appeal, no party challenged the preferential nature of the Transfers**; the sole issue presented was whether the Utilities could claim a defense under 11 USC § 547(c)(4), based on the “new value” provided in the form of the Post-Transfer Payments.
The Trustee argued that “new value” must be provided by the creditor receiving a preferential transfer, based on the language of 11 USC § 547(c)(4), which provides that a transfer cannot be avoided “to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor…” (emphasis added). The Court rejected that reading, and held that the statutory reference to “such creditor” includes a creditor who benefits from a preferential transfer and subsequently replenishes the estate with new value. In this case, the Court held that the Restaurants benefited from the Transfers (because their debts to the Utilities were reduced dollar-for-dollar), and then subsequently replenished the estate with new value (in the form of the Post-Transfer Payments). The Court noted its decision was consistent with the law of other jurisdictions and also with the policy of the Bankruptcy Code to encourage parties to continue to do business with struggling companies. The Court noted that the result advocated by the Trustee also would have allowed the estate to receive the benefits of both the Post-Transfer Payments and the recovered Transfers, thus “doubly replenishing” the estate at the expense of the utilities.
**Notably, the parties to the litigation agreed on appeal, that the Transfers from LGI to the Utilities were to “creditors” “on account of antecedent debt” as required under 11 USC § 547(b)(1) and (2), even though the Utilities had no separate contracts with LGI. The Eighth Circuit noted in passing, correctly, that “it seems open to serious question” whether the Utilities were in fact creditors of LGI, but that issue was not before the Court.
Takeaway: The Eighth Circuit reached the right result – elevating the reality of the business arrangement over the Trustee’s formalistic reading of 11 USC § 547(c)(4). However, had the Utilities not conceded they were “creditors” of the estate in the first place (notwithstanding the absence of any contractual relationship with LGI), they likely would have prevailed on that issue as well.