On June 7, 2007, the U.S. Court of Appeals for the Third Circuit issued a decision in the In re Hechinger Investment Company case holding that the "contemporaneous exchange for new value" defense to preference claims can apply even if the payments were made in the context of a credit arrangement. The key is whether the parties intended the payments involved to be contemporaneous exchanges for new value, the linchpin of this particular preference defense. A copy of the Third Circuit’s decision is available here.

Bankruptcy Preferences. As a reminder, preferences are payments or other transfers made in the 90 days prior to a bankruptcy filing, on account of antecedent or pre-existing debt, at a time when the debtor was insolvent, that allow the transferee (the preference defendant) to be "preferred" by recovering more than it would have had the transfer not been made and the defendant instead had simply filed a proof of claim for the amount involved. The 90-day reachback period is extended to a full year prior to the bankruptcy petition for insiders such as officers, directors, and affiliates.

The Contemporaneous Exchange Defense. This defense, found in Section 547(c)(1) of the Bankruptcy Code, is short and to the point:

(c) The trustee may not avoid under this section a transfer–

(1) to the extent that such transfer was–

(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and

(B) in fact a substantially contemporaneous exchange.

In interpreting this language, the Bankruptcy Court held that a "credit relationship is inconsistent with the intent required in order to sustain" the defense. Essentially, under its view the defense would presumably be limited to situations in which no credit was allowed to remain outstanding but instead a C.O.D. purchase or other similarly immediate "goods for cash" swap was involved.

The Third Circuit’s Focus On Intent. The Third Circuit reversed the Bankruptcy Court’s ruling, explaining its reasoning as follows:

The Bankruptcy Court found that the disputed transfers were not intended by the parties to be contemporaneous exchanges because the transfers were credit transactions. In reaching this result, the Court relied upon several factually distinguishable cases, none of which stand for the proposition that parties can never intend credit transactions to be contemporaneous exchanges under § 547(c)(1)(A). We disagree with the Bankruptcy Court’s conclusion. Indeed, it would appear that § 547(c)(1) covers little other than credit transactions. The § 547(c)(1) defense applies only to transfers that the debtor has shown are payments on an “antecedent debt” under § 547(b). See 11 U.S.C. § 547(b)(2) (definition of avoidable transfers). If there is no delay between when the debt arises and payment of the obligation, then the transfer is outside the scope of § 547(b), and § 547(c)(1) is not implicated. The existence of a delay between the creation of a debt and its payment is a hallmark of a credit relationship, which is, by definition, a relationship in which the creditor entrusts the debtor with goods without present payment. OXFORD ENGLISH DICTIONARY (2d ed. 1989) (defining “credit” as “[t]rust or confidence in a buyer’s ability and intention to pay at some future time, exhibited by entrusting him with goods, etc. without present payment.”).

We do not think that the District Court’s interpretation of the Bankruptcy Court’s order – namely, as concluding that the parties intended to have a credit relationship – necessarily resolves the question. The inquiry still remains: even if a credit relationship was intended, was it nonetheless their intent that the ongoing payments would be contemporaneous exchanges for new value? A court may find the parties intended a contemporaneous exchange for new value even when the transaction is styled as a “credit” transaction. See In re Payless Cashways, Inc., 306 B.R. 243 (8th Cir. BAP 2004), aff’d, 394 F.3d 1082 (8th Cir. 2005). The question is one of intent, and although a delay between the incurrence of the debt and its payment can evidence that the exchange was not intended to be contemporaneous, the passage of time does not necessarily negate intent.

(Footnotes omitted.)

The Bottom Line. Under this decision, a contemporaneous exchange defense to a preference is available even if the defendant has extended credit to the debtor. Nevertheless, to prevail the defendant will have to prove that it and the debtor actually intended the payments to be contemporaneous exchanges for new value and they were, in fact, substantially contemporaneous with the exchange of goods or services.

A Final Note. The Third Circuit decision covered other issues as well, including the ordinary course of business defense and whether prejudgment interest is available for preference claims. For more on those issues, plus a copy of the Bankruptcy Court’s decision below, be sure to read the detailed post on the case by the Delaware Business Bankruptcy Report.