Fourth Circuit Finds Bankruptcy Preference Even Though Creditor Would Have Been Paid In Full By Construction Surety

If this blog were a dartboard, cases involving corporate and LLC governance issues would be at the bullseye. A bankruptcy case would be pretty far from the center, sometimes maybe even off the board.

With that perspective in mind, coupled with a dearth of bullseye type cases lately, this post is about the Fourth Circuit's decision last Friday in United Rentals, Inc. v. Angell, affirming a decision from the Eastern District of North Carolina.

The decision concerned a bankruptcy trustee's action to recover a preference paid to an equipment supplier (United) by the Debtor on a construction project. The Debtor had a surety bond, on which United had not made a claim, but which nevertheless formed the basis for its arguments that payments received by it during the ninety days preceding the Debtor's bankruptcy petition were not a preference.

United had two main arguments. It said that the Trustee could not show that the transfer enabled it to receive more than it would have received in the Chapter 7 case if the transfer had not been made. That's an essential element of a preference, per 11 U.S.C. § 547(b)(5). United also said that the transfer was a "contemporaneous exchange for new value" under 11 U.S.C. § 547(c)(1), a preference exception.

United said that if the transfer hadn't been made, it would have made a claim against the Debtor's surety bond and that it would have been paid in full by the surety. It argued that it therefore hadn't received more than it would have it the transfer hadn't been made, and that the Trustee therefore couldn't satisfy the requirement of Section 547(b)(5).

Judge Traxler made short work of this argument. He said that the inquiry was whether the creditor would have been paid the money in question out of the bankruptcy, not whether it would have been received from a third party. He held that "the Sec. 547(b)(5) inquiry focuses 'not on whether a creditor may have recovered all of the monies owed by the debtor from any source whatsoever, but instead upon whether the creditor would have received less than a 100% payout' from the bankruptcy estate."

The second argument -- that the payments were a contemporaneous exchange for new value -- was more complicated. United said (1) it had the right to a materialman's lien against the project, (2) the surety for the Debtor would have satisfied that lien it it had been asserted, (3) the surety then would have been equitably subordinated to the Debtor's right to be paid by the general contractor, and (4) there was "new value" because United had not pursued its lien and bond rights and the Debtor therefore had eventually been paid by the general contractor instead of having that money go to reimbursement of the surety.

United's argument was that the new value was the money the Debtor received later from the general contractor as a result of United foregoing pursuit of its lien claim. The Court said that even if this were so, United had not shown when this "new value" was received by the Debtor. It held "regardless of whether the transfers set in motion a chain of events that resulted in the Debtor's recoupment of the amounts paid, United did not show that such new value was 'given to the debtor' . . . as part of a "contemporaneous exchange.'" 

The Court found the argument regarding the possible payment by the surety and the anticipated following events to fall outside the purpose of the contemporaneous exchange exception, which it said was "to accommodate the need of financially unsteady companies to use checks to pay for new transactions."