Third Circuit Trend toward Rejecting the “Remain Unpaid” Rule in Preference Actions

Kegler Brown Creditors' Rights + Bankruptcy Alert

At the "Troubled Waters" seminar last week, we discussed the subsequent new value defense for preference actions. I explained that some court circuits follow a "remain unpaid" rule wherein the court disregards a subsequent new value defense if the new value is paid for before the debtor files its bankruptcy. According to a court decision that was released after the seminar, it appears that the Third Circuit may now reject that rule, which had posed a significant challenge for creditors defending preference actions.

On October 15, 2009, a Delaware bankruptcy court ruled that subsequent new value need not remain unpaid in order to shield prior preference payments in Wahoski, Trustee v. American & Efrid, Inc., Bankruptcy Court for the District of Delaware Case No. 05-52131. Courts in the Third Circuit, in which Delaware sits, had previously ruled that subsequent new value must remain unpaid in order to be used as a defense to a preference action. However, in the creditor-friendly ruling, the bankruptcy court found that the prior appellate opinion enforcing the "remain unpaid" rule was not controlling.

In a well-reasoned opinion, the bankruptcy court explained that the creditor can use subsequent new value to shield payments so long as the new value is not paid for by an "otherwise unavoidable transfer." Since the trustee is typically seeking to avoid, or recover, all payments made to the creditor, subsequent new value will typically be a viable defense for creditors.

The bankruptcy court's opinion may reflect a Third Circuit shift toward rejection of the harsh "remain unpaid" rule. A rejection of the rule would bring the Third Circuit in line with other circuits that currently have a more creditor-friendly standard. The ruling is particularly important given the number of corporate bankruptcies that are filed in Delaware. The impact of the change would be most beneficial for creditors who engaged in a number of transactions with the debtor during the preference period.