Nov 2010 , Vol. VI, No.1

Keeping your Earnings out of Bankruptcy Trustee Hands: The New Value Defense

Builders and Contractors Exchange
Weekly Bulletin: 29 nov 2010

Keeping your Earnings out of Bankruptcy Trustee Hands:  The New Value Defense
By: Shalanda Franklin-Verdell

LAW TIPS

Preference payment: the two most feared words in the bankruptcy code.  Why?  Those seemingly harmless words could require a contractor or subcontractor to return thousands of dollars which it received for its work on a construction project from an owner or general contractor who files for bankruptcy.

The bankruptcy laws authorize a trustee to recover certain payments received by creditors before a debtor files for bankruptcy.  A preference payment is a payment on a debt that a bankruptcy debtor makes to a creditor within ninety days before filing bankruptcy while the debtor was insolvent and which allows the creditor to receive more than it would if the debtor’s assets are liquidated in a chapter 7 bankruptcy. For example, ABC Contractors pays Brick Inc., a subcontractor, $40,000 on May 1st for masonry work Brick, Inc. performed in April.  On June 1st, ABC files for bankruptcy.  The $40,000 payment that Brick Company received on May1st is a preference payment if the Brick Inc. would receive less than $40,000 in a liquidation of ABC’s assets.

Notwithstanding this rule, the bankruptcy law has built-in defenses which allow creditors to keep the money it earned, even though, by definition, that payment is a preference payment.  One defense to a preference payment suit is the “new value” defense.  Under the new value defense, a preference payment is offset by an amount equal to the value of goods or services (ie. the “new value”) that a creditor provides to a debtor after preference payment is made.  This defense will apply if the new value is not secured by an unavoidable lien or other unavoidable transfer. 

For example, on May 5th, Brick Inc. of the earlier example provides $25,000 worth of materials and services to ABC on the construction project.  If Brick Inc. asserts the new value defense, the Brick Company could offset the $40,000 preference payment by $25,000, the amount of the “new value.”  Thus, the Brick Company’s potential preferential payment liability is decreased to $15,000.  Other defenses may be available to further decrease the preference payment liability.  For more information please contact a bankruptcy attorney. 

Authored by attorneys, these articles are meant to bring awareness to these topics and are not intended to be used as legal advice.  For more information, contact Bill Franczek at 757-446-8600.  Visit www .vanblk.com, for our library of Construction Law Tips.  Suggestions for a topic? E-mail bfranczek@vanblk.com.