IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 98-20592
In The Matter of: MICRO INNOVATIONS CORPORATION,
Debtor.
* * * * * * * * * *
RANDY W. WILLIAMS, Trustee,
Appellee,
versus
AGAMA SYSTEMS, INCORPORATED,
Appellant.
Appeal from the United States District Court for the
Southern District of Texas
August 13, 1999
Before GARWOOD, DUHÉ and BENAVIDES, Circuit Judges.
GARWOOD, Circuit Judge:
Appellant Agama Systems, Inc. (Agama) challenges the decision
of the bankruptcy court, subsequently affirmed by the district
court, allowing appellee Randy Williams—the trustee for the debtor
Micro Innovations Corp. (MIC)—to recover as avoidable preferences
$313,292 of payments made by MIC to Agama during the ninety-day
period preceding MIC’s filing of a petition in bankruptcy. Agama
argues that it advanced new value to MIC subsequent to most of the
claimed preferences, and is entitled under the Bankruptcy Code, 11
U.S.C. 101, et seq., to offset the value of these shipments against
the preferences. See 11 U.S.C. § 547(c)(4). We agree and reverse
the judgments of the courts below.
Facts and Proceedings Below
The relevant facts in this case are not in dispute. Agama is
a computer parts wholesaler that supplied components to MIC. During
the 90-day period preceding MIC’s filing of its bankruptcy
petition, Agama made 54 separate deliveries of components to MIC
valued at the time of sale at $279,905. In return, it received 49
MIC checks totaling $313,292. The parties have stipulated as to
the timing and value of these transactions. Each transaction was
fundamentally similar. Agama would invoice and deliver a shipment
and receive a check for the value of that delivery. Each check was
post-dated by at least seven days, however, and the check for a
particular delivery always cleared after that delivery had been
made. Other shipments followed the clearance of most of the
checks, however. Agama’s invoices that accompanied shipments also
stated that “Agama Systems sustains [sic] [a] security interest on
the merchandise stated above.” However, Agama never took the
necessary steps to perfect its security interest in the delivered
goods. During the ninety-day period, Agama monitored MIC’s cash
flow and at one point obtained information about MIC’s finances
without its consent.
MIC initiated bankruptcy proceedings under Chapter 7 on June
6, 1995. Thereafter, the trustee, Randy Williams, initiated this
2
adversary proceeding against Agama to recover as preferences under
11 U.S.C. § 547(b) the payments made by MIC during the ninety-day
pre-filing period. After a trial, the bankruptcy judge determined
that the trustee could recover the full value of all payments made
during the ninety-day period. The bankruptcy court amended the
judgment to clarify Agama’s liability for prejudgment interest.
Agama appealed to the district court, which affirmed in a
memorandum opinion and order filed June 10, 1998. This appeal
followed.
Discussion
When a supplier provides goods and services to a buyer before
he receives payment for those goods, he is engaging in a credit
transaction.1 When a supplier demands payment before he ships
goods and services, he is engaging in a prepayment transaction.
When a supplier demands payment in cash at the same time that he
releases goods, he is engaging in a cash and carry transaction. We
must begin our analysis with these simple definitions because the
position the trustee maintains here in essence means that a section
of the bankruptcy code designed to protect creditors who engage in
credit transactions can only be invoked by a creditor who engages
in cash and carry and prepayment transactions. The trustee also in
effect maintains that an extinguished security interest must be
treated as a live security interest for the purpose of allowing him
1
The parties stipulated that for all relevant purposes a
payment was made by MIC and received by Agama when MIC’s check
cleared its drawee bank. See Barnhill v. Johnson, 112 S.Ct. 1386
(1992).
3
to recover payment, but as an extinguished security interest for
the purpose of allowing him to maintain possession of the
collateral. The bankruptcy court and the district court followed
the trustee’s logic. We cannot, and reverse.
I. Subsequent Advance
The bankruptcy code allows a trustee to recover certain
payments made by the debtor in the ninety-day pre-filing period as
preferences. A recipient of such payments may invoke several
defenses to block the trustee from recovery, however. One of these
defenses has become known as the subsequent advance rule. See 11
U.S.C. § 547(c)(4).2 In In re Toyota of Jefferson, Inc., 14 F.3d
1088, 1091 (5th Cir. 1994), we examined section 547(c)(4). The
creditor in In re Toyota, over the course of several months,
extended three loans to the debtor. Each loan was repaid. The
bankruptcy trustee for the debtor then attempted to recover as
avoidable preferences each of the three loan repayments. We
rejected this attempt, but allowed the trustee to recapture the
2
In pertinent part, 11 U.S.C. § 547(c)(4) states:
“(c) The trustee may not avoid under this section a
transfer—
. . .
(4) to or for the benefit of a creditor, to the
extent that, after such transfer, such creditor gave new
value to or for the benefit of the debtor—
(A) not secured by an otherwise
unavoidable security interest; and
(B) on account of which new value the
debtor did not make an otherwise unavoidable
transfer to or for the benefit of such
creditor; . . .”
4
last repayment as a preference. We reasoned that the first two
repayments had been followed by the extension of new value, in the
form of new and separate loans, of greater value than the repayment
they followed. The last repayment, however, was not followed by
the extension of a new loan, and thus new value. There was
therefore no subsequent advance of new value available for offset
of the last repayment, and that repayment was fully recoverable.
In re Toyota involved a credit transaction. To be more
precise, it involved a revolving credit arrangement in which new
loans were extended after the old loans were paid off. We noted
there that it was precisely these kinds of arrangements that the
Bankruptcy Code seeks to protect. Two policy justifications lie
behind this result. First, by limiting the risk of loss incurred
by suppliers who continue ordinary credit arrangements with
troubled companies, the rule encourages transactions that may allow
the debtor to stave off bankruptcy. Second, the protection
provided by the section does not materially harm the other
creditors, since the requirement that an advance be followed by an
extension of new value insures that any injury to the estate is
followed by a subsequent addition to the estate. See In re Toyota,
14 F.3d at 1091. See also In re Kroh Brothers Development Co., 930
F.2d 648, 651, 654 (8th Cir. 1991).
Here, the parties also engaged in a series of credit
transactions. Agama shipped components to MIC, knowing that
payment for those goods would be received later (if at all). The
trustee maintains, and the courts below agreed, that in and of
5
itself this structure defeats the application of section 547(c)(4).
They argue that in every individual transaction, the new value (the
components) was received before making the payment (which occurred
when the post-dated checks cleared the drawee bank) matched to
those particular goods. The extension of new value thus always
preceded the individual preference transfer, rather than being
“after such transfer” as the section 547(c)(4) exception requires.
This argument, while ingeniously simple, is directly contradictory
to our reasoning in In re Toyota. Looked at as individual,
separate transactions, each loan in In re Toyota preceded the
repayment of that particular loan. The fact that the new loan
extended “after such transfer” was part of an entirely different
loan transaction did not prevent us from shielding the prior
repayment from recovery by matching it with the new value provided
by the next, unconnected loan. Other circuits have similarly
assumed that an extension of new value need not be directly
connected to the preceding preference in order to shelter it. See
In re Meredith Manor, Inc., 902 F.2d 257, 258-59 (4th Cir. 1990)
(string of advances under line of credit allowed to shield prior
repayment preferences without discussing lack of any apparent link
between the amounts); In re IRFM, Inc., 52 F.3d 228, 229, 233 (9th
Cir. 1995) (supplier entitled to retain all preferences even though
payment for a particular shipment followed that shipment).
It could hardly be otherwise, since if we applied the
trustee’s reasoning to the facts of In re Toyota we would be left
with the odd result that a creditor could only retain a loan
6
repayment made by a financially troubled debtor if he received
repayment of the loan prior to actually extending the loan. Only
then would the new value loan, on a single transaction basis, be
received “after such transfer” in the manner the trustee maintains
section 547(c)(4) requires. But a loan that one must prepay or
repay simultaneously is of little apparent utility. Applied
generally, the trustee’s rule would have only slightly less odd
results. Creditors would be protected from preference recovery
only to the extent that they eschewed credit transactions entirely.
If they dared to ship goods before receiving cash in hand, they
would run the risk of a court breaking their transactions down as
was done below, and thus deciding that the very extension of
revolving credit that courts have unanimously found is the chief
intended recipient of the statute’s protection is fatal to its
case. This would hardly encourage suppliers to engage in a
significant type of ordinary business credit transactions that
might help troubled companies avoid bankruptcy, which we have
identified as a primary goal of the statute. Neither the courts
below nor the trustee have cited any authority for this novel and
counterintuitive reading of the statute, and we reject it.
Our rejection of the trustee’s proposed reading of the statute
does not resurrect the old net result rule, as he claims. Under
the net result rule, any and all extensions of value during the
preference period were available to be offset against all of the
preferences. Thus in In re Toyota under the net result rule we
would have simply totaled the new value and subtracted it from the
7
total loan repayments. Instead we looked at each individual
repayment preference to see if it was followed by the extension of
a new loan. Since the last repayment was not, that repayment could
be avoided regardless of excess new value the creditor had advanced
prior to that repayment. Similarly, here Agama does not—and
cannot—argue that it may retain any portion of the preference
payments represented by checks that cleared after the last shipment
of new value was received, although under the old rule such
payments might have been offset against any sufficient prior
extensions of value. All that we have done here is read the plain
language of the statute in light of its manifest purpose, shielding
payments to the extent that thereafter Agama extended new value to
the estate.
In order to avoid the obvious implications of In re Toyota,
the trustee attempts to focus our attention on the fact that post-
dated checks were used in the transactions. In particular, he
focuses on two cases that have discussed post-dated checks in the
avoidance context. Both are readily distinguishable. In In re New
York City Shoes, 880 F.2d 679 (3d Cir. 1989), a company with a
standard revolving credit arrangement with the debtor refused to
ship more goods until payment. The debtor then paid for the prior
shipment with a post-dated check. Before this check cleared or the
date that it bore was reached, the company shipped more goods.
That was its last shipment. No other payments were involved and
the last shipment was never paid for. The debtor then attempted to
recover the amount of the post-dated check as a preference. The
8
City Shoes court held that section 547(c)(4) did not shield the
payment, since payment of the post-dated check should be considered
as occurring when the check actually cleared or when the date which
it bore arrived, not when the check was received by the creditor.
Accordingly, there was no extension of new value that followed the
challenged payment and thus nothing that could be set off against
it under the statute. Id. at 685. In substantially similar
circumstances, a supplier released a shipment of goods upon receipt
of a series of post-dated checks that covered a prior shipment.
Following City Shoes, the court found that when the date the checks
bore arrived and the checks cleared after the extension of new
value was received, the new value could not be applied against the
last sequence of checks under section 547(c)(4). See In re Samar
Fashions, Inc., 109 B.R. 136, 138 (Bank. E.D. Pa. 1990).
Both City Shoes and Samar are fully in keeping with our
approach to section 547(c)(4) here. Once those courts clarified
that the post-dated check payment fell on the date the check bore
or cleared, and not on its delivery, it was clear that the
challenged preferences followed the last possible new value that
the creditor might seek to use to shield what would otherwise be an
avoidable preference. Just as we did not allow the creditor in In
re Toyota to retain the last loan repayment, and just as Agama here
does not claim that it is entitled to retain the last series of
payments it received, the City Shoes and Samar courts merely
insured that the final payment by the debtor could be recovered.
These cases do not establish some unique rule barring invocation of
9
section 547(c)(4) by those creditors who accept post-dated checks.
Rather, they establish when a post-dated check can be considered
paid for the purposes of applying the standard statutory analysis.
Since under this rule the check payments followed the new value,
section 547(c)(4) could not be invoked. Here, in contrast,
several extensions of new value occurred after the post-dated check
payments were made, the payment dates all being based on the
stipulation of the parties (note 1, supra). It is fully consistent
with these cases’ reasoning and our precedent to allow the new
value to be applied against such preceding preferences.
The City Shoes court did state that “postdating checks is not
business as usual.” City Shoes, 880 F.2d at 683. This statement,
however, was made in the context of the court’s assumption that
where the debtor pays by a currently dated check the debtor’s
payment for purposes of section 547(c)(4) is made when “the check
is delivered to the creditor,” and only as a basis for the court’s
holding that, in contrast, when the debtor pays by post-dated check
payment is not made when the check is delivered but rather when the
date on the face of the check arrives or when the check clears the
drawee bank. Id. at 683-84.3 That is not at issue here, as the
parties have stipulated that the relevant transfers or payments by
MIC occurred, with respect to each check, when that check cleared
the drawee bank (see note 1, supra). We attach no other
significance to the “not business as usual” language of City Shoes.
3
We note that City Shoes was handed down before Burnhill v.
Johnson, 112 S.Ct. 1386 (1992).
10
Here, Agama, by accepting post-dated checks, exposed itself to
the risk that the check would be dishonored and thus that at least
its current shipment would not be paid for. To be sure, by the way
it actually operated under this credit structure—on several
occasions multiple shipments were delivered before a check given
for an earlier shipment had cleared—Agama in fact some times
exposed itself to the risk of more than one shipment. However, as
part of an ongoing, prudent credit arrangement such an exposure is
not unusual, or preclusive of the application of section 547(c)(4).
See Meredith Manor, 902 F.2d at 258-59 (applying section 547(c)(4)
to a line of credit arrangement in which several independent
advances followed each periodic payment). Here, Agama used the
post-dated check mechanism to limit its risk to a set window in
time, rather than a single shipment. Since shipments would
presumably stop as soon as a check was dishonored, its risk was
limited to the number of shipments made during the post-dating
delay. Nothing in this credit structure takes the creditor out of
the protection of section 547(c)(4).4
4
A distinction based on the number of shipments outstanding at
any given time would serve no useful purpose. In this context,
there is no reason to treat a creditor who is at risk for several
smaller shipments differently from one at risk for fewer, larger
shipments.
The trustee also attempts to paint a picture of nefarious
behavior by Agama, claiming that this inequitable conduct precludes
application of the new value defense. In particular, the trustee
professes outrage that Agama monitored MIC’s cash flow and obtained
information about its bank account balance. Caution on the part of
lenders dealing with troubled companies is not unusual. Without
endorsing the specific conduct complained of, we find its general
pattern cannot preclude Agama’s recourse to section 547(c)(4).
11
II. “Otherwise Unavoidable” Security Interest
Section 547(c)(4) does not allow all extensions of new value
to be offset against prior preferences. Only new value that is
“not secured by an otherwise unavoidable security interest” may be
used. Section 547(c)(4)(A). Here, Agama retained a security
interest in the new value goods at the time of shipment. However,
it is undisputed that Agama never took any action to perfect its
security interests. These unperfected security interests could not
be, and were not, enforced by Agama. Moreover, subsequent payment
by MIC would also bar enforcement of the security interests under
Texas law. See, e.g., Barr v. White Oak State Bank, 677 S.W.2d
707, 710 (Tex.App.--Tyler 1984, writ ref’d). The trustee
nevertheless argues, and the courts below agreed, that Agama may
not invoke section 547(c)(4) because at one time it reserved a
security interest. It concedes that this security interest is not
enforceable, but reads the statute to require that for an extension
of new value to be available for set off, any security interest
attached to it must be subject to the trustee’s avoidance power.
The argument is that since the security interests here were in fact
extinguished by payment (the payment asserted as a preference), not
by the actual operation of the avoidance powers, the security
interests were “unavoidable” and the shipments which were subject
thereto can not constitute new value applicable against prior
preferences.
The trustee’s argument necessarily assumes that Congress was
concerned with the mere existence, at any time, of security
12
interests, rather than their enforcement and subsequent diminishing
of the estate. However, the text of the statute indicates clearly
that this is not the case. The statute concerns itself not with
all security interests, but only with “otherwise unavoidable”
security interests. This indicates that the proper temporal focus
is not on the historical existence of security interests, but
rather the existence of such interests at the time of bankruptcy.
If security interests exist at that time and the new value rule is
invoked, the court should not allow the thus secured new value to
be set off against past preferences if the security interests are
otherwise unavoidable. However, if at the time of bankruptcy no
such interest exists, the once secured new value may be applied
against such preferences. Since no security interest existed at
the relevant time, section 547(c)(4)(A) is facially inapplicable.
This interpretation of the statute is the only sensible, real
world result. A key justification for the new value exception is
that while the payment of preferences to the creditor diminished
the estate, other creditors are not really worse off since the
subsequent advance of new value replenishes the estate. See In re
Toyota, 14 F.3d at 1091. This logic is obviously undercut if the
creditor retains a valid, enforceable security interest in the new
value. If section 547(c)(4)(A) did not exist, such a creditor
could not only shield a past preference, but also enforce the
security interest and recover the new value. The net effect on the
estate would no longer be neutral, and the other creditors would
have cause for complaint. But if the security interest originally
13
attached to the new value is unenforceable—either because it has
been extinguished or is avoidable—the mere fact it once existed
cannot disadvantage the other creditors. The new value remains
firmly fixed in the estate and available to all the creditors.
There thus is really no reason to prevent the set-off of this new
value against prior preferences. See Kroh Brothers, 930 F.2d at 654
(stating that the availability of section 547(c)(4) “depends on the
ultimate effect on the estate” and thus if a party could assert a
secured claim against the estate the defense could not be invoked).
Neither the trustee nor the courts below cite any case in which the
prior existence of a security interest that was not capable of
being asserted against the estate was relied on to defeat
invocation of section 547(c)(4)’s protection. We therefore hold
that section 547(c)(4)(A) prevents the application of new value
against prior preferences only if that new value is subject to a
security interest that is valid and enforceable at the time of the
bankruptcy.
III. Method of Calculation
Since we conclude that section 547(c)(4) applies here, the
only remaining question is the method which should be used to
calculate the amount of preferences as reduced by the allowable new
value. Two approaches have arisen. The first, majority, rule
allows a given extension of new value to be applied against any
preceding preference. Thus, for example, where two or more
successive preferences are followed by the initial extension of new
value and it is in an amount larger than the most recent of the
14
prior preferences, the excess may be applied to shield the earlier
preference (or preferences) to the extent that such excess is not
larger than the total value of all such earlier preferences
(similarly, a large preference payment may “carry over” past one
subsequent small extension of new value and ultimately be fully
sheltered by one or more still later extensions of new value).
See, e.g., in re Thomas Garland, Inc., 19 B.R. 920 (Bank. E.D. Mo.
1982).5 The minority rule allows a given extension of new value to
be applied only to the immediately preceding preference, so that,
for example, if two or more successive preferences are followed by
the first extension of new value and it is in an amount larger than
the most recent of the prior preferences, then all that excess is
always recoverable by the trustee. See Leathers v. Prime Leathers
Finishers Co., 40 B.R. 248 (D. Maine 1984). According to the
parties, under the Garland rule the trustee may recover some
5
The trustee mischaracterizes the Garland rule in his brief as
allowing creditors to “obtain an offset for new value advanced
prior to a given preferential payment.” That is not what Garland,
the cases adopting it, or our decision here allows. Under the
express terms of the statute, a given extension of new value may
never be applied to offset a subsequent preference. The Garland
rule allows prior preferences to be carried forward and offset
against extensions of new value that followed them. It does not
allow new value to be carried forward and offset against later
preferences. Some of the language in Meredith Manor implies that
the district court allowed the offset of the last preference
payment by prior as well as latter extensions of new value.
However, the court specifically indicated that this was an
incorrect approach. See Meredith Manor, 902 F.2d at 259 (creditor
may apply new value against “the immediately preceding preference
as well as against all prior preferences”(emphasis added)). The
court’s decision to affirm in the face of this apparent error must
be viewed as linked to the fact that the difference between the
proper Garland approach and the district court’s calculations given
the history of payment was only eight dollars.
15
$33,368 of the check payments as preferences. Usage of the
Leathers rule would increase the trustee’s recovery to
approximately $157,393.
Both circuit courts that have addressed the question have
embraced the Garland rule and rejected Leathers. See Meredith
Manor, 902 F.2d at 259; In re IRFM, 52 F.3d at 233. The language
of section 547(c)(4) purports to shield all preferences to the
extent of subsequent new value (not disqualified under clauses (A)
or (B)) and nothing in its language purports to limit the amount of
such new value shield by the amount of the most recent of multiple
prior preferences. Moreover, as the Ninth Circuit has highlighted,
the Garland rule furthers section 547(c)(4)’s goal of encouraging
creditors to continue to deal with troubled companies. Creditors
“will be more likely to continue to advance new value to a debtor
if all these subsequent advances may be used to offset a prior
preference.” In re IRFM, 52 F.3d at 233. We join our sister
circuits and hold that Garland articulates the proper method for
calculating recoverable preferences when section 547(c)(4) applies.
On remand, the district court should calculate the trustee’s
recovery accordingly.
Conclusion
For the reasons stated, the judgment of the district court is
reversed, and the case is remanded for further proceedings
consistent with this opinion.
REVERSED and REMANDED
16
17