8th Circuit Expands Application of New Value Defense in Preference Actions

On March 20, 2014, the Court of Appeals for the Eighth Circuit issued an important decision in Stoebner v. San Diego Gas & Electric Co. (In re LGI Energy Solutions Inc.), No. 12-3899, Slip Op. (8th Cir. Mar. 20, 2014) that expands the scope of the “subsequent new value” defense in lawsuits seeking to clawback alleged preference payments.

Prior to the bankruptcy case, debtor LGI Energy Solutions, Inc. and its affiliate debtor LGI Data Solutions Company, LLC provided bill payment services to companies who were large customers of various utility companies.  Utility companies sent invoices directly to LGI, who then provided its clients with a summary of the client’s obligations to the various utilities.  LGI’s clients would then pay LGI for the aggregate amount due to the utilities and LGI would remit the payment to the utility companies in exchange for an additional fee from its clients. The utility companies did not contract with LGI.

After the commencement of LGI’s involuntary Chapter 7 case, the trustee sued two utility companies to recover certain payments made to them by LGI within 90 days of the bankruptcy filing.  The utility companies asserted that the payments were insulated from avoidance by the so-called “subsequent new value” defense, which incentivizes creditors to continue to deal with financially stressed businesses by precluding a trustee from avoiding a transfer to the extent that, after such transfer, the transferee gave “new value” to the debtor.  Notably, the utility companies did not contend that they provided any new value to LGI.  Instead, they argued that the payments that LGI continued to receive from its clients (the customers of the utility companies and the beneficiaries of the allegedly preferential payments) after LGI made the allegedly preferential transfers should constitute new value to defeat the trustee’s clawback action.  The trustee contended that in order for the defense to apply, the new value must be provided by the creditor that received the alleged preference payment.

The Eighth Circuit began its analysis of this non-traditional invocation of the new value defense by affirming the lower courts’ findings that the purpose of the new value defense can be served in three-party relationships where the debtor’s preferential transfer to a third party (i.e. the utility companies) benefits the debtor’s primary creditor (i.e. LGI’s clients), even if the third party is the only defendant of the preference action.  The Court looked to the economic realities of the business arrangement between LGI, the utilities, and LGI’s clients and observed that even though both the utilities and LGI’s clients could have stopped using LGI’s bill-paying services at any time, they both continued to work with LGI right up to the date of the bankruptcy filing in spite of LGI’s financial struggles.  Noting that this commitment to a struggling business is precisely the type of behavior that the new value defense seeks to safeguard, the Court ruled that the new value provided to LGI by its clients could be used by the utility companies in defense of the trustee’s preference action.

The Court’s decision closes a potential loophole in the application of the preference provisions of the Bankruptcy Code in the context of three-party arrangements such as the one at issue in LGI.  Indeed, if the utility companies had not been entitled to utilize the new value provided by LGI’s clients in defense of the trustee’s action, then the LGI bankruptcy estate could have potentially received a windfall from its clients, as LGI would have received payment from its clients without satisfying their obligations to the utility companies as was required under their contractual arrangement.  Such an outcome surely would have prejudiced LGI’s clients and chilled economic activity with financially troubled providers of intermediary business services.  The Eighth Circuit’s pragmatic approach ensured that this inequitable result did not come to pass.

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