All bankruptcy lawyers (and most long-suffering trade creditors) know that creditors who receive payments from a debtor within the “preference period” – 90 days before a voluntary bankruptcy case was filed, or 1 year if the creditor is an “insider” of the debtor – are at risk of lawsuit to return those payments to the bankruptcy estate. Pre-petition claims the creditor hold are no automatic defense.  However, the Bankruptcy Court for the District of Delaware recently ruled, as a matter of first impression in that Court, that an allowed post-petition claim of the creditor can be used to set off the creditor’s preference liability. See Official Comm. of Unsecured Creditors of Quantum Foods, LLC v. Tyson Foods, Inc. (In re Quantum Foods, LLC), 2016 WL 4011727 (Bankr. D. Del. Jul. 25, 2016).  Here is a copy of the case.

The background of the case is simple. The Unsecured Creditors Committee filed various preference actions.  In the Quantum Foods preference case, the Committee sought to avoid and recover over $13 million in pre-petition transfers to two related Defendants.  The Defendants claimed, among other defenses, a right to set off a previously allowed administrative expense claim for $2.6 million in food products they had supplied to the Debtors post-petition.[1]

The Committee asserted that the Defendants’ setoff argument was a guise for a “post-petition new value defense.”  This would be improper, the Committee asserted, as a creditor’s new value defense is determined as of the bankruptcy petition date.  [The seminal decision on this is from Bankruptcy Judge Lundin, holding that “the preference window of § 547 close[s] on the date of the filing of the bankruptcy petition and post-petition payments [cannot] be used to deplete pre-petition ‘new value.'”  See here.]  However, while that is the rule in Delaware too under Friedman’s, the Court was not persuaded that this had anything to do with the new value defense.  It reasoned that a new value defense exclusively involves pre-petition activity, whereas the Defendants’ setoff claim was purely based on post-petition activity.  In short, post-petition activity (such as delivery of goods) will not give rise to a preference defense under the strict confines of the Bankruptcy Code, but may give rise to a plain old setoff defense under common law.

Thus, the question became not a matter of the new value defense under Section 547 of the Bankruptcy Code, but rather, the well-established doctrine of setoff.  In deciding whether the Defendants had valid setoff rights, the Court relied on the long-cited authority that, “setoff is only available in bankruptcy when the opposing obligations arise on the same side of the . . . bankruptcy petition date.”  Accordingly, setoff would only be permissible if the opposing obligation, i.e. the preference claim, also arose post-petition.  A “claim” in bankruptcy is defined as a “right to payment.”  Thus, the Court ruled, a preference claim is a “right to payment” which necessarily can only arise post-petition because a preference cause of action does not exist until after a bankruptcy case is initiated.

This is an important decision, from an important court.  It provides comfort to creditors that supply goods post-petition – non-payment for those goods, while a stinging result, can at least be used to reduce preference liability.

[1] The opinion did not address issues of mutuality of obligor and obligee.  That is, if Defendant A holds the $2.6 million post-petition claim, then it will be hard (actually, impossible) for that claim to be used as an offset against Defendant B’s liability.  So we will have to watch how this shakes out once the actual facts and mutuality of the claims among multiple parties are determined during discovery.