Softmart Inc v. ABC-NACO Inc

In the
United States Court of Appeals
For the Seventh Circuit
____________

No. 06-1719
IN RE:
ABC-NACO, INC.,
Debtor-Appellee,
and

OFFICIAL COMMITTEE OF UNSECURED
CREDITORS OF ABC-NACO, INC.,
Appellee.
APPEAL OF:
SOFTMART, INCORPORATED.
____________
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 06 C 274—George W. Lindberg, Judge.
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ARGUED OCTOBER 19, 2006—DECIDED APRIL 9, 2007
____________

Before RIPPLE, MANION, and ROVNER, Circuit Judges.
MANION, Circuit Judge. In the summer of 2001, ABC-
Naco, Incorporated, remitted four payments totaling
$98,641.26 to Softmart, Incorporated, in partial payment for
Microsoft software and equipment that ABC-Naco had
purchased from Softmart in 1998. Less than 90 days later,
ABC-Naco filed for bankruptcy. The unsecured creditors of
2 No. 06-1719

ABC-Naco sought return of the payments to the bank-
ruptcy estate, alleging that it constituted a preferential
transfer. The bankruptcy court held that the payments
were not a preferential transfer, but the district court
reversed. ABC-Naco appeals. We affirm the district court’s
decision that the payments were preferential and should
be returned to the bankruptcy estate for the benefit of
the unsecured creditors.

I.
Softmart’s business included selling computers and
Microsoft software as a “large account reseller.” In this
capacity, in 1998 Softmart entered into a purchase agree-
ment with ABC-Naco. In the agreement, ABC-Naco agreed
to purchase 700 computers and licenses for Microsoft
software on each computer. The agreement further pro-
vided that ABC-Naco would make equal, quarterly pay-
ments of $47,127.50 for three years. In accordance with
Microsoft policy, ABC-Naco also simultaneously signed
two agreements with Microsoft that, in relevant part,
provided Microsoft with the right to revoke the licenses if
ABC-Naco failed to pay Softmart. Softmart was not a
signatory to those two agreements.
Apparently ABC-Naco made regular payments with-
out incident until the third year. In the third year, 2001,
ABC-Naco did not make the April payment of
$47,127.50 until August 8, 2001. ABC-Naco also paid the
July invoice of $47,127.50 on September 6, 2001. In addition,
ABC-Naco paid Softmart $992.28 on August 10, 2001, and
$3,393.98 on August 15, 2001, but it is unclear from the
record the purpose of these payments. Shortly thereafter,
on October 18, 2001, ABC-Naco filed for bankruptcy.
No. 06-1719 3

Because the four payments noted above, which total
$98,641.26, were made within ninety days of ABC-Naco’s
bankruptcy filing, the committee of unsecured creditors
of ABC-Naco claimed that the payments were preferential
payments precluded by bankruptcy law, and requested
that Softmart return the funds to the bankruptcy estate.
After ABC-Naco filed for bankruptcy, but before the
bankruptcy court ruled on whether the payments were
preferential, Meridian Rail Corporation purchased sub-
stantially all of ABC-Naco’s assets. The bankruptcy court
approved that transaction, but the purchase agreement
between ABC-Naco and Softmart did not appear among
the contracts that the bankruptcy court approved for
Meridian’s assumption and assignment. Nonetheless, a
director at ABC-Naco, without consulting counsel, signed
a letter at Meridian’s request stating that the assets sold to
Meridian included the Softmart purchase agreement.
Meridian made a final payment to Softmart of approxi-
mately $45,000 to fulfill the obligations under the pur-
chase agreement.
After Meridian made the final payment, the bankruptcy
court held a hearing on the unsecured creditors’ commit-
tee’s motion to set aside ABC-Naco’s payments to Softmart
as preferential. Softmart responded that ABC-Naco’s
payments were not preferential because ABC-Naco re-
ceived new value in exchange for the payments. Specifi-
cally, Softmart argued that ABC-Naco received new
value in its right to continue using the software and to then
assign the software to Meridian after bankruptcy. Since
new value was provided, Softmart argued, it was entitled
to keep the payments. The bankruptcy court agreed that
Softmart provided new value for the payments and entered
judgment for Softmart. The creditors appealed to the dis-
4 No. 06-1719

trict court, which reversed the bankruptcy court’s judg-
ment. The district court concluded that Softmart’s forbear-
ance from reporting a lack of payment to Microsoft did not
constitute new value and that the payments totaling
$98,641.26 constituted a preferential transfer that Softmart
must return to the bankruptcy estate. The district court
remanded the case to the bankruptcy court, which further
awarded costs as well as pre- and post-judgment interest.
Softmart appeals.

II.
In this bankruptcy appeal, we review questions of law
de novo and the bankruptcy court’s findings of fact for
clear error. In re Salem, 465 F.3d 767, 773 (7th Cir. 2006)
(citation omitted). Under the bankruptcy code, a trustee
may recover certain transfers or payments made by a
debtor before bankruptcy. Specifically, 11 U.S.C. § 547(b)
provides that to avoid a transfer as preferential, a “trustee
must show that the transfer (1) was ‘to or for the benefit of
a creditor’; (2) was ‘for or on account of an antecedent
debt’; (3) was ‘made while the debtor was insolvent’; (4)
was made on or within 90 days before the debtor filed
his bankruptcy petition; and (5) enabled the creditor to
receive more than the creditor would have received if the
debtor had not made the transfer.” In re Energy Coop. Inc.,
832 F.2d 997, 1000 (7th Cir. 1987) (quoting 11 U.S.C.
§ 547(b)). However, “[n]ot all transfers that meet § 547(b)’s
criteria are avoidable. Section 547(c) provides six excep-
tions to the avoidable preference provision.” Id. at 1000. In
No. 06-1719 5

this case, Softmart relies on only one exception,1 specifi-
cally the “new value” exception contained in 11 U.S.C.
§ 547(c)(4). That exception provides that even if a pay-
ment is considered preferential, a creditor may retain the
payment if, “after such transfer [of funds], such creditor
gave new value to or for the benefit of the debtor.” 11
U.S.C. § 547(c)(4). “New value” is defined by statute as
“money or money’s worth in goods, services, or new
credit, or release . . . but does not include an obligation
substituted for an existing obligation.” 11 U.S.C. § 547(a)(2).
On appeal, Softmart argues that ABC-Naco received new
value through its continued use of the equipment and
software, citing cases outside this circuit. For example, the
Eighth Circuit held that a college’s continued use of leased
real property constituted new value. S. Tech. Coll., Inc. v.
Hood, 89 F.3d 1381, 1384 (8th Cir. 1996) (“Each month, a
lessee receives new value from its lessor when it continues
to use and occupy the rented property.”). This continued
use “facilitated [the college’s] continued operation”

1
In its reply brief, Softmart also claimed that ABC-Naco’s
payments were not preferential because the creditors failed to
establish one of the five criteria for preferential transfers. In
particular, Softmart claimed that the creditors failed to show
that the payments allowed Softmart to receive more money than
it would if the bankruptcy had been filed “under Chapter 7,” if
“the transfer had not been made,” or if Softmart “received
payment . . . to the extent provided by the provisions of this
title.” 11 U.S.C. § 547(b)(5)(A)-(C). Softmart, however, did not
raise this argument or even cite section 547(b)(5) in its opening
brief, and therefore it has forfeited this argument. J.S. Sweet Co.
v. Sika Chem. Corp., 400 F.3d 1028, 1035 n.2 (7th Cir. 2005) (citing
Employers Ins. of Wausau v. Browner, 52 F.3d 656, 665-66 (7th Cir.
1995)).
6 No. 06-1719

allowing the college to generate income that “replenished
the estate, increased [the college’s] chances of survival, and
benefitted all of [the college’s] creditors.” Id. Softmart also
cites to In re Jet Florida System, Incorporated, 841 F.2d 1082,
1084 (11th Cir. 1988), in which the Eleventh Circuit held
that a debtor did not receive new value for its real estate
lease payments because the debtor did not use the property
during the preference period. Softmart contends that
the reasoning of In re Jet Florida System indicates that new
value would exist if the property had been used in the
preferential period. Finally, Softmart relies on a bankruptcy
court decision from the district of Delaware, which was
affirmed in an unpublished district court decision, in
which a debtor paid a monthly licensing fee to use certain
trademarks. In re Discovery Zone, Inc., 300 B.R. 856, 860-61
(Bankr. D. Del. 2003), aff’d, No. Civ. A.03-1034, 2004
WL 2346002 at *2-3 (D. Del. Oct. 5, 2004). The courts held
that the continued use of the trademarks constituted new
value, allowing the creditor to retain the payments made
during the preferential period. Id.
Softmart’s reliance on the above cases is misplaced
because unlike those cases, in this case, Softmart did not
have the right to interfere with ABC-Naco’s continued use
of the Microsoft software. Under the purchase agreement,
Softmart had no right to revoke the licenses upon default,
unlike the landlords of the real estate or the licensor of
trademarks. Rather, the Enrollment Agreement between
ABC-Naco and Microsoft confirmed that Softmart, as a
large account reseller of Microsoft software, had “no
authority to bind or impose any obligation or liability
whatsoever upon” Microsoft. Moreover, the purchase
agreement between ABC-Naco and Softmart provided
that if ABC-Naco failed to pay Softmart, Microsoft re-
No. 06-1719 7

tained the “option” to “terminat[e] this Enrollment Agree-
ment, revo[ke] or cancel[ ] all licenses and rights to which
[ABC-Naco] is entitled . . . and at the option of [Microsoft],
terminat[e] the Master Agreement.” The right of revocation
remained in Microsoft’s discretion and Softmart had no
authority to revoke the licenses.
Essentially, Softmart asks us to conclude that ABC-
Naco’s payments were necessary to prevent Softmart
from reporting a missed payment to Microsoft, so that
Microsoft in turn could exercise its discretion to terminate
the agreement or revoke the licenses. In other words,
Softmart claims that ABC-Naco received new value for its
payments in Softmart’s forbearance from reporting a
breach to Microsoft. Such a forbearance does not constitute
new value. In re Jet Fla. Sys., 841 F.2d at 1084; In re Jones
Truck Lines, Inc., 130 F.3d 323, 327 (8th Cir. 1997) (noting
that “such forbearance [from terminating benefits] is
usually not new value”); In re Air Conditioning, Inc., 845
F.2d 293, 298 (11th Cir. 1998) (“Forbearance from exercis-
ing pre-existing rights does not constitute new value
under section 547(a)(2).” (citations omitted)). The District
of Columbia Circuit provided a clear rationale for deter-
mining that such forbearance should not constitute new
value, writing:
We think it plain that a payment to an unsecured
creditor in return for that creditor’s agreement not to
force the debtor into bankruptcy can never be treated
as new value. Otherwise the preference provisions of
the bankruptcy code would be nullified, because all
creditors could extract payments within the preference
period under that exception. Similarly, an agreement
by an undersecured creditor to forgo his right to
foreclose on collateral could not be treated as new
8 No. 06-1719

value without unfairly prejudicing general creditors. It
is a basic axiom of bankruptcy law that a secured
creditor is protected only to the extent of his security
interest. If an agreement not to foreclose—to for-
bear—were treated as new value, however, then a
debtor’s payment of the entire debt (both secured and
unsecured portions) in return for that agreement could
be sheltered from the Code’s preference provisions.
The undersecured creditor, in other words, could
leverage his security to cover the unsecured portion of
the debt. . . . Therefore forbearance alone—at least of
this kind—cannot constitute new value without under-
mining basic premises of the Code.
Drabkin v. A.I. Credit Corp., 800 F.2d 1153, 1159 (D.C. Cir.
1986) (footnote omitted). Similarly, we conclude that
Softmart’s forbearance in not reporting a breach to
Microsoft could not constitute new value. Softmart had
no authority to revoke the licenses and therefore Softmart
did nothing to provide new value to ABC-Naco.2
Softmart also claims that it cannot be required to return
the payments to the bankruptcy estate because its con-

2
Because Softmart lacked the authority to revoke the licenses,
we need not consider whether a creditor who does possess the
right to revoke a license grants “new value” under 11 U.S.C.
§ 547(c)(4) by forbearing to revoke the right. For the same
reason, we need not decide whether a license could constitute
“money or money’s worth in goods, services, or new credit”
under 11 U.S.C. § 547(a)(2), or whether the payments under the
purchase agreement were analogous to lease payments for the
future use of the software, or installment payments for a license
already sold–a distinction that could prove important in
assessing the presence of new value.
No. 06-1719 9

tract with ABC-Naco had been assumed by Meridian,
and under the bankruptcy code an executory contract
cannot be assumed unless all money due under the con-
tract is paid. 11 U.S.C. § 365; see also In re Superior Toy &
Mfg. Co., Inc., 78 F.3d 1169, 1174 (7th Cir. 1996). In In re
Superior Toy, this court held that payments made on
executory contracts that are assumed pursuant to 11 U.S.C.
§ 365 cannot also be avoidable preferences: “[s]ection 547
and § 365 are mutually exclusive avenues for a trustee.” In
re Superior Toy & Mfg. Co., Inc., 78 F.3d at 1174. Applying
this principle, Softmart argues that since the purchase
agreement was an executory contract assumed by Merid-
ian, Softmart is entitled to retain the payments that were
due prior to the assumption.
“An executory contract is a contract ‘on which perfor-
mance remains due to some extent on both sides.’ ” In re
Superior Toy & Mfg. Co., Inc., 78 F.3d at 1172 n.3 (emphasis
added) (quoting 2 Collier on Bankruptcy ¶ 365.02 at 365-21
(15th ed. 1995)). As an initial matter, we note that the
purchase agreement between Softmart and ABC-Naco is
arguably not an executory contract, as Softmart had no
further obligation under the contract; ABC-Naco alone
bore the obligation to continue paying for software and
computers that had already been delivered. See, e.g.,
Gouveia v. Tazbir, 37 F.3d 295, 298 (7th Cir. 1994) (“[T]he
typical executory contract . . . requires [ ] affirmative
performance in the future.”). If the purchase agreement is
not an executory contract, it could not be assumed by
Meridian, and therefore the unsecured creditors could seek
the return of the money as preferential payments.
Regardless, even assuming that the purchase agree-
ment is an executory contract, Softmart’s argument still
fails because the bankruptcy court never authorized an
10 No. 06-1719

assignment of the purchase agreement to Meridian. The
assumption or assignment of an executory contract is
“subject to the court’s approval.” 11 U.S.C. § 365(a) (as-
sumption); 11 U.S.C. § 365(f)(2)(A) (assignment). In this
case, the bankruptcy court never approved of the assump-
tion or assignment of the purchase agreement. Softmart, in
its opening brief, concedes that the purchase agreement
at issue was struck from the order assuming and assign-
ing various contracts to Meridian. In the context of the
preference hearing, the bankruptcy court made an oral
factual finding that Meridian continued to use the soft-
ware and licenses and had effectively assumed the con-
tracts. This finding, to the extent that it contradicts the
bankruptcy court record, is clearly erroneous; the assump-
tion was never approved by the bankruptcy court. As this
court has previously noted, “ ‘[a]ssumption or adoption of
the contract can only be effected through an express order
of the judge.’ ” In re Whitcomb & Keller Mortg. Co., 715 F.2d
375, 380 (7th Cir. 1983) (quoting In re Am. Nat’l Trust,
426 F.2d 1059, 1064 (7th Cir. 1970) (quoting 6 Collier on
Bankruptcy 576-80 (14th ed.))). Since the purchase agree-
ment was not assumed, the unsecured creditors were not
precluded from seeking the return of the payments as
preferential transfers, and, as discussed above, because
ABC-Naco did not receive new value, the unsecured
creditors may recoup the payments.

III.
Because ABC-Naco did not receive new value in ex-
change for its payments to Softmart, the $98,641.26 in
payments constituted preferential transfers which must
be returned to the bankruptcy estate. Accordingly, we
AFFIRM the judgment of the district court in favor of the
unsecured creditors of ABC-Naco.
No. 06-1719 11

A true Copy:
Teste:

_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit

USCA-02-C-0072—4-9-07