Rudolph J. Di Massa Jr.

Chad E. Odhner

With the U.S. Court of Appeals for the Third Circuit’s holding in Friedman’s Liquidating Trust v. Roth Staffing (In re Friedman’s), 738 F.3d 547 (3d. Cir. 2013), it became settled law in the Third Circuit that post-petition activities cannot be used to affect the calculation of preference liability or of “new value” defenses against such liability. The court’s rationale in Friedman’s was based largely on the concept that “new value” is something that can be provided strictly during the preference period (for noninsiders of the debtor, the “preference period” is the 90-day period immediately preceding the debtor’s bankruptcy filing). However, the question not answered by Friedman’s was whether, if allowed as an administrative expense claim, the value of post-petition goods and services could be set off against preference liability. In Official Committee of Unsecured Creditors of Quantum Foods v. Tyson Foods (In re Quantum Foods), No. 15-50254, 2016 (Bankr. D. Del. July 25), the Delaware Bankruptcy Court addressed whether a meat supplier could use its allowed post-petition administrative expense claim to set off its preference liability, or whether such an attempt would be akin to a subsequent new value defense in disguise (and therefore prohibited by the holding in Friedman’s). In holding that setoff is permissible in this context, the Quantum Foods court confirmed that a supplier that continues to do business with a debtor after bankruptcy will likely either be paid for its post-petition sales to the debtor, or may otherwise avail itself of the opportunity to reduce any preference liability it might face. 

The Facts

Tyson Foods Inc. and Tyson Fresh Meats Inc. (Tyson) supplied meat products to Quantum Foods, both before and after Quantum Foods filed a Chapter 11 bankruptcy petition. The U.S. trustee in the bankruptcy case appointed an official Committee of Unsecured Creditors, which was empowered by the bankruptcy court to investigate potential preference claims that Quantum Foods might have against creditors. During the preference period, Tyson received approximately $13.6 million for goods delivered to the debtor. Tyson also provided meat products to the debtor after Quantum Foods’ peti-tion was filed. Tyson sought allowance of an administrative expense claim for its post-petition sales to Quantum Foods in the amount of about $2.6 million. The bankruptcy court allowed Tyson’s claim in July 2014.

In March 2015, while Tyson’s allowed administrative expense claim remained unpaid, the committee brought a preference action against Tyson seeking to avoid the $13.6 million transferred to Tyson during the preference period (the transfers) and asking the bankruptcy court to disallow Tyson’s administrative expense claim until the transfers were repaid in full. In response, Tyson asserted various counterclaims and defenses. In particular, Tyson argued that it was entitled to set off its unpaid administrative expense claim against any preference liability it might have. The committee in turn moved for judgment on the pleadings, arguing that Tyson’s purported setoff claim was really a disguised “subsequent new value” defense, which would be precluded by the Third Circuit’s holding in Friedman’s.  

The Court's Analysis

The bankruptcy court began its analysis by noting the parties’ agreement that the rationale of Friedman’s prohibits the use of post-petition sales to the debtor in calculating a “subsequent new value” defense for purposes of determining preference liability under Sections 547(b) and (c)(4) of the Bankruptcy Code. Section 547(c)(4) of the code states that otherwise preferential transfers are not avoidable “to the extent, after such transfer, [the transferee] gave new value to or for the benefit of the debtor ... on account of which new value” the debtor did not compensate such transferee. Because the parties agreed that post-petition sales to the debtor could not provide the basis for a “new value” defense, the issue came down to whether Tyson’s claim should be characterized as an impermissible post-petition “new value” defense, or as an ordinary setoff claim.

While the committee and Quantum Foods insisted on labeling Tyson’s claim as a “new value” defense, the bankruptcy court determined that Tyson correctly characterized its claim as a setoff claim. The bankruptcy court reasoned that preference calculations must be confined to activities that occurred during the preference period while administrative claims arise post-petition. The court concluded, therefore, that it made “no sense” from a definitional standpoint to refer to any claim arising outside of the preference period as a new value defense.

The bankruptcy court also rejected the committee’s argument that Tyson’s setoff claim nonetheless constituted a disguised new value defense because it effectively reduced Tyson’s preference liability. In Friedman’s, according to the bankruptcy court, the Third Circuit held that all preference calculations, including any “new value” alleged as a defense, must be calculated as of the date of the bankruptcy petition. Thus, Friedman’s implicitly prohibits use of post-petition new value in calculating preference liability. The court went on to point out the issue that Friedman’s did not address: whether an administrative claim could be set off against preference liability, once the preference calculation is completed. As the bankruptcy observed, Tyson’s setoff claim “does not affect the bottom line of the preference calculation ... only the amount paid to the estate.”  

Having concluded that Tyson’s claim constituted a claim for setoff, the bankruptcy court turned to the question of whether Tyson’s claim would be permitted under the Bankruptcy Code. The court recognized that setoff is available in bankruptcy cases only where the opposing obligations arise on the “same side” of the petition date. Although a preference action involves only pre-petition facts, the preference claim itself “necessarily arises only post-petition,” and thus may be set off against a post-petition administrative expense claim, the court reasoned.

The court also disagreed with the committee that Tyson’s administrative claim should be disallowed under Section 502(d) of the code. Although Section 502(d) prohibits a claim from being paid to a preference transferee until such transferee has satisfied its preference liability in full, the bankruptcy court pointed to case law recognizing that administrative expense claims receive “special treatment” and are not subject to the restrictions of Section 502(d). Similarly, the Committee unsuccessfully argued on policy grounds that such an outcome would entail an unequal distribution to creditors. The bankruptcy court rejected this argument, reasoning that the many exceptions found in the Bankruptcy Code limit the general rule that creditors must be treated “equally.” Consequently, the bankruptcy court denied the committee’s motion to disallow Tyson’s administrative expense claim and held that Tyson would be allowed to set off its administrative expense claim against any preference liability it might have.

Conclusion

As explained above, the bankruptcy court’s holding applies only to administrative expense claims, as Section 502(d) prohibits payment of a general unsecured claim in this context. Despite this narrow application, the case should provide some comfort to suppliers doing business on a post-petition basis with debtors. These suppliers are now armed with a well-reasoned opinion providing that they will not be required to satisfy preference claims in full before they receive credit for their allowed administrative expense claims. Debtors will instead be required to either pay such allowed administrative expense claims or accept discounted preference judgments.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditor's rights. 

Chad E. Odhner is an associate at the firm in the Philadelphia office and practices in the area of financial restructuring and bankruptcy law.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.