Third Circuit Rules That Contemporaneous Exchange for New Value Defense to Preference Claim is Not Barred by Existence of Credit Relationship
Hechinger Inv. Co. of Del. v. Universal Forest Prods., Inc. (In re Hechinger Inv. Co. of Del.), 489 F.3d 568 (3d Cir. 2007) (Circuit Judge Marjorie O. Rendell)
The Third Circuit reversed a Bankruptcy Court decision in an avoidance and recovery action brought by debtors Hechinger Investment Company of Delaware against Universal Forest Products, Inc. that held that the contemporaneous exchange for new value defense to a preference cause of action was not available where the parties intended a credit relationship. Instead, the Third Circuit found that this defense applies to little other than a credit relationship, and remanded to the Bankruptcy Court for a determination of whether the parties intended that the payments in question were intended by the parties to be contemporaneous exchange for new value.
This matter arose out of the bankruptcy of Hechinger Investment Company of Delaware, which filed a petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware on June 11, 1999. In 2001, Hechinger commenced this adversary proceeding by filing a complaint to avoid and recover $16,703,604.57 in payments under sections 547 and 550 of the Bankruptcy Code. Before trial in the Bankruptcy Court, the debtor conceded that $6,576,603.36 of these payments were advance payments, and therefore not avoidable as preferences. The parties also stipulated that the remaining amount at issue was $1,004,216.03, potentially subject to UFP’s contemporaneous exchange for new value and ordinary course of business defenses under 11 U.S.C. § 547(c)(1) and (2).
Prior to trial, the Bankruptcy Court denied, without discussion, UFP’s spoliation motion that asked the Bankruptcy Court to draw an adverse inference from Hechinger’s destruction of documents that might have helped UFP prove that Hechinger intended its preference period payments to be contemporaneous exchange for new value.
Subsequent to a February 25, 2005 trial, the Bankruptcy Court entered judgment in favor of the debtor in the amount of $1,004,216.03, holding that the payments were not protected by the contemporaneous exchange for new value defense because “the nature of a credit relationship is inconsistent with the intent which is required in order to sustain the § 547(c)(1) defense.” The Bankruptcy Court also rejected UFP’s ordinary course of business defense, finding that the payments were not made in the ordinary course between the parties and were not made according to ordinary business terms in UFP’s industry. The Bankruptcy Court also rejected, without discussion, the debtor’s request for prejudgment interest.
The parties then appealed to the District Court, which affirmed.
On appeal, the Third Circuit reversed on the contemporaneous exchange for new value question, finding that not only does the defense apply in the context of a credit relationship, but that it “covers little other than credit transactions” because if the defendant did not extend credit to the debtor, there would be no antecedent debt as required by 11 U.S.C. § 547(b). In that case, the plaintiff would have failed to make a prima facie case for a preference, and defenses would never have been implicated.
Instead, the court held that the relevant question was one of intent, i.e., whether the parties intended a contemporaneous exchange for new value even when the transaction is styled as a credit transaction. The Third Circuit noted that there can be such intent, even when there is delay between the incurrence of debt and payment, and discussed with approval cases so holding. Therefore, the Third Circuit reversed the Bankruptcy Court’s holding that the existence of a credit relationship per se excluded the possibility of contemporaneous exchange for new value, and remanded to the Bankruptcy Court to consider whether the parties intended a contemporaneous exchange for new value.
As to the ordinary course of business defense, the Third Circuit opened its analysis by stating that it would not presume the ordinariness of payments made within credit terms. Instead, the Third Circuit held that ordinariness is assessed “in the context of the relationship of the parties over time.” The court instead found that, because credit terms between the parties changed in a manner that was “so extreme, and so out of character with the long historical relationship between the parties,” that payments made within those new terms were appropriately found by the Bankruptcy Court to be outside the ordinary course of business between the parties. The Third Circuit also held that UFP vigorously enforced its credit limit during the preference period, resulting in marked acceleration of payments during that period. In sum, the Third Circuit found that the Bankruptcy Court correctly founded its ruling on accelerated credit terms, the imposition of a credit limit, UFP’s requirement that Hechinger make large, lump sum wire transfer payments and UFP’s requirement that Hechinger send remittance advices after making payment. These practices were not ordinary in the parties’ relationship.
The Third Circuit affirmed the Bankruptcy Court’s ruling on the spoliation motion, finding that when the debtor destroyed documents to save space following its bankruptcy petition, it did so without the requisite fault, and because there was no evidence that UFP was prejudiced by the destruction.
The Third Circuit also remanded to the Bankruptcy Court for an explanation of its decision not to award pre-judgment interest.
