The debtor, Friedman's Inc. (Friedman's) made a preferential payment in the amount of $81,997.57 to Roth Staffing Companies, LP. (Roth). After this payment, but before the filing of the bankruptcy petition, Roth provided new value in the amount of $100,660.88 for which it was not paid. This completely eliminated Roth's preference liability, because the new value exceeded the preferential payment. However, after Friedman's filed for bankruptcy, it received permission under a critical vendor order to pay some of Roth's prepetition invoices that constituted new value in the amount of $72,412.71.

Friedman's argued that the postpetition payment of $72,412.71 relates back to the preference period and therefore reduces the amount of Roth's subsequent new value defense from $100,660.88 to $28,248.17. This argument increases Roth's preference liability to $53,749.40.

The Bankruptcy Court, relying on the US Court of Appeals for the Third Circuit's (Third Circuit) analysis in New York City Shoes, held that the filing of the bankruptcy petition fixes the preference analysis as of the petition date. To reduce its preference liability, a creditor may invoke the subsequent new value defense under section 547(c)(4) of the Bankruptcy Code (see Practice Note, Preferential Transfers: Overview and Strategies for Lenders and Other Creditors: Subsequent Advance of New Value). In analyzing this section, the Third Circuit held that the subsequent new value defense has three elements:

(see New York City Shoes, Inc. v. Bentley Int'l Inc., 880 F.2d 679 (In re New York City Shoes, Inc.) (3d Cir., July 12, 1989)).

Focusing on the third element, the Bankruptcy Court found that the emphasized language supports fixing the preference analysis as of the bankruptcy petition date. As a result, a creditor cannot reduce its preference liability by providing new value to the debtor after the bankruptcy filing has been made. Similarly, a debtor's postpetition payment of unpaid, prepetition new value cannot increase a creditor's preference liability.

The Bankruptcy Court further explained that its ruling was consistent with the purpose of preference law, which is intended to reduce damaging, prepetition behavior. However, preference law becomes unnecessary once a bankruptcy filing is made because the automatic stay, coupled with court supervision, ensures that similar claims generally receive similar treatment.

This decision can be favorable to both parties to a preference action, depending on the facts of the case. Creditors defending preference claims in Delaware can use this decision to argue that prepetition extensions of new value are not reduced (and therefore preference liability is not increased) by a debtor's postpetition critical vendor payments. They can also argue that other types of postpetition payments, such as section 503(b)(9) administrative claims for the value of goods received by the debtor within 20 days of bankruptcy, similarly do not disqualify new value (see Practice Note, Reclamation Rights in Bankruptcy: Section 503(b)(9) Claim as Alternative Remedy). Conversely, plaintiffs to preference actions in Delaware can use this decision to argue that any postpetition extensions of new value by a creditor do not qualify as new value and therefore cannot be used to reduce preference liability.

Other courts have expressed concerns that allowing a creditor to both offset the value of goods received by the debtor within 20 days of bankruptcy against preference exposure and to assert an administrative claim for payment would result in double recovery for the creditor. The US Bankruptcy Court for the Eastern District of Virginia resolved this issue by temporarily disallowing the administrative claim pending the outcome of the preference actions (see In re Circuit City Stores, Inc., 426 B.R. 560, 571 (Bankr. E.D. Va. 2010)). This runs contrary to the holding in Friedman's Inc. v. Roth Staffing Companies, L.P., which fixes the preference analysis as of the petition date.

For more information on preferential transfers and the automatic stay, see Practice Notes, Preferential Transfers: Overview and Strategies for Lenders and Other Creditors and Automatic Stay: Overview.