In Preference Suit, Seventh Circuit Holds That Debtor’s Assignment of Contractual Rights Does Not Negate Creditor’s New Value Defense
In Levin v. Verizon Bus. Global, LLC (In re OneStar Long Distance, Inc.), 2017 U.S. App. LEXIS 18374 (7th Cir. Sept. 22, 2017), the Seventh Circuit recently addressed a situation where a debtor sought to reduce a creditor’s new value defense in a preference avoidance action. The Seventh Circuit held that the debtor’s assignment of contractual rights to a third party did not constitute a transfer “to or for the benefit of” the creditor, such that the transfer would reduce the creditor’s new value defense under 11 U.S.C. § 547(c)(4)(B).
OneStar Long Distance, Inc. was a telecommunications services provider in Indiana. It bought telecom services wholesale and resold them to its customers. On December 31, 2003, creditors forced OneStar into an involuntary chapter 7 bankruptcy case.
OneStar’s chapter 7 trustee sought to claw back $1.9 million in payments OneStar had made to MCI during the 90-day period before OneStar’s bankruptcy filing (the “preference period”). 11 U.S.C. § 547(b).
A year before the bankruptcy filing, OneStar had contracted with MCI to sell telecom services. MCI periodically billed OneStar under that contract. During the preference period, MCI provided services and billed OneStar approximately $3.7 million. Of that, OneStar paid approximately $1.9 million to MCI.
In an effort to frustrate other creditors, on December 22, 2003—just days before its bankruptcy filing—OneStar shifted its contractual obligations and debt under the MCI agreement to a newly formed affiliate, known as “IceNet.” OneStar, MCI, and IceNet entered into an assignment and assumption agreement. Under that agreement, OneStar assigned its contractual privileges and debt to IceNet, MCI provided IceNet with the services under the contract, and IceNet relayed the services it received under the contract to OneStar.
Preference Action and New Value Defense
OneStar’s chapter 7 trustee brought a preference suit against Verizon (which had purchased MCI) to avoid the $1.9 million payments made by OneStar during the preference period.
Verizon conceded that the $1.9 million in payments from OneStar met the prima facie requirements for avoidance under 11 U.S.C. § 547(b). But Verizon argued that it had a complete new value defense under section 547(c)(4) based on the services that MCI had provided to OneStar in the fall of 2003. A creditor can use new value supplied to a debtor to reduce or eliminate liability for preferential transfers it received in the 90 days before a bankruptcy filing.
In response, the chapter 7 trustee argued that the new value defense was inapplicable. Relying on section 547(c)(4)(B)—which provides an exception to the new value defense where the debtor pays for the new value provided by the creditor—the trustee argued that OneStar’s assignment to IceNet compensated MCI for the new value it had provided. Thus, the trustee argued, Verizon could not invoke the new value defense to escape liability for the admittedly preferential payments.
The Seventh Circuit’s Ruling
The Seventh Circuit—agreeing with the bankruptcy court’s ruling—rejected the trustee’s expansive interpretation of section 547(c)(4)(B).
Looking at that statutory language of section 547(c)(4)(B), the Seventh Circuit concluded that OneStar’s assignment to IceNet was not a “transfer to or for the benefit of” MCI because it did not alter or discharge the debt that OneStar owed. The “only real effect” of that transfer, the Court held, “was to place IceNet between MCI and OneStar as a pass-through intermediary.” 2017 U.S. App. LEXIS 18374, at *8.
The Court also rebuffed the trustee’s argument that the transfer must have conferred a benefit on MCI because MCI would not otherwise have agreed to it. While MCI may have received some benefit from the transaction, since the transfer to IceNet may have stalled other creditors from going after OneStar, the Court held that was at most an “[i]ncidental benefit” that inured to all of OneStar’s creditors, not just MCI. Such “incidental benefit” is not sufficient to negate the new value defense, the Court held—rather, the debtor must show that the transfer itself was “for the creditor’s benefit,” not for the benefit of creditors generally. Id. at *9 (emphasis added).
Additionally, the Court held that the trustee failed to establish that there was a causal relationship between the transfer and the new value, i.e., “the transfer must occur ‘on account of’ the creditor’s new value.” Here, the Seventh Circuit concluded that the reasons for the assignment and assumption agreement were entirely unrelated to the new value services that MCI had provided. Id.