N AT I O N A L A S S O C I AT I O N O F C R E D I T M A N A G E M E N T JANUARY 2013 THE PUBLICATION FOR CREDIT & FINANCE PROFESSIONALS $7.00 S e l e c t e d t o p i c S e l e c t e d t o p i c Bruce NathaN, esq. Bruce NathaN, esq. Standby Letter of Credit Payments Can Be Hazardous to Your New Value Preference Defense A A creditor defending a preference claim can assert numerous defenses to reduce its exposure. One such defense, the subsequent new value defense arising under Section 547(c)(4) of the Bankruptcy Code, allows a creditor to reduce its preference liability on a dollar- for-dollar basis by the amount of new value the creditor had extended to the debtor subsequent to an alleged preference payment. Well what happens if a trade creditor, wise in the ways of risk mitigation, obtains a standby letter of credit to reduce the risk of non-payment from a troubled cus- tomer? Following the customer’s bankruptcy fjling, the creditor obtains payment of its claim from the letter of credit issuing bank by presenting all of the documents required by the letter of credit. Tie letter of credit pay- Tie United States Bankruptcy Court for the Southern ment should not be recoverable as a preference. How- District of Florida, in In re All American Semiconductor, ever, what about the payments the creditor received Inc., recently addressed this question. While the credi- from the debtor within 90 days of the bankruptcy? Tiey tor had no preference liability as a result of the payment it had received on the letter of credit, the creditor’s pref- One of the requirements of the erence risk increased as a result of the loss of the new value defense for the invoices paid from the proceeds of subsequent new value defense, contained the letter of credit. in section 547(c)(4)(B), is that the creditor’s Preference claims and the New Value Defense new value was not paid by an otherwise A trustee can recover a preference by satisfying all of the unavoidable transfer by the debtor to or requirements of Bankruptcy Code Section 547(b). A creditor can assert one or more defenses to preference for the creditor’s benefit. liability under Section 547(c) of the Bankruptcy Code. One such defense is the subsequent new value defense are at risk of recovery as preferences, subject to the arising under Bankruptcy Code Section 547(c)(4). A creditor’s defenses, such as the subsequent new value creditor can prove the new value defense to the extent of defense. But what if the creditor’s invoices subject to its the new goods and/or services that the creditor had sold new value defense are paid from the proceeds of the and delivered to the debtor, on credit terms, subsequent creditor’s letter of credit draw prior to the bankruptcy? to the preference. 1 B u s i n e s s C r e d i t J a n u a r y 2 0 1 3
Tie subsequent new value defense protects a creditor from the benefjciary upon the presentation of all of the documents preference risk because the debtor’s creditors were not harmed required by a letter of credit, regardless of any contractual dis- by a preference where the creditor had provided new inven- pute between the seller and buyer and/or the bank’s inability tory and/or services to the debtor afuer the payment. Tie cred- to obtain payment of its reimbursement claim. In addition, if itor’s new value repaid the preference and, therefore, did not the bank rejects a benefjciary’s presentation of conforming deplete or diminish the debtor’s bankruptcy estate. Tie new documents, the bank is in breach of its obligation to pay on value defense is also supposed to encourage creditors to con- the letter of credit and is subject to the benefjciary’s assertion tinue extending credit to fjnancially troubled companies and of a wrongful dishonor claim. promote equality of treatment among creditors. the problem with samsung’s One of the requirements of the subsequent new value defense, subsequent new value defense was contained in Section 547(c)(4)(B), is that the creditor’s new that samsung was the beneficiary value was not paid by an otherwise unavoidable transfer by the debtor to or for the creditor’s benefjt. In All American Semicon- of a standby letter of credit. ductor, Inc., the creditor received payment of a portion ($1 million) of the invoices, included as part of its new value defense, as part of the creditor’s draw on a standby letter of the Facts of the all american semiconductor case credit that All American Semiconductor had caused Harris On April 25, 2007, (the “petition date”), All American Semi- Bank to issue for the creditor’s benefjt. Tie court ruled that conductor and its affjliates fjled their Chapter 11 petitions the creditor’s invoices that were subsequently paid by Harris with the United States Bankruptcy Court for the Southern Bank did not count as eligible new value to reduce the credi- District of Florida. In April 2009, the bankruptcy court tor’s preference liability. approved the creditors’ committee’s Chapter 11 plan of liqui- dation, which transferred all preference claims to a liquidat- Overview of standby Letters of credit ing trust created under the plan. Trade creditors frequently rely on a standby letter of credit as a backstop to protect them from the risk of nonpayment of Tiat same month, the liquidating trustee commenced a law- their invoices by a fjnancially troubled customer. A letter of suit against Samsung Semiconductor Inc. (“Samsung”) to credit arrangement involves three parties and three indepen- recover, as preferences, certain payments by All American dent contracts. Semiconductor totaling approximately $4.9 million that Samsung had received during the 90-day period prior to the Tie fjrst contract frequently involves a sale of goods or provi- petition date. Samsung fjled an answer to the complaint, sion of services between a seller and a buyer. Tie wrinkle is asserting several defenses, including the subsequent new that a seller may condition extending credit or otherwise value defense. Samsung claimed, as new value, approximately doing business with a buyer upon the buyer’s obtaining a let- $4 million of new goods that Samsung had sold and delivered ter of credit in favor of the seller. to All American Semiconductor subsequent to the alleged preferential payments. As part of the second contract, the buyer, as the letter of cred- it applicant, enters into an agreement with the bank issuing Tie problem with Samsung’s subsequent new value defense the letter of credit. Tie buyer agrees to repay the bank, fre- was that Samsung was the benefjciary of a standby letter of quently on a secured basis, for the bank’s payments made to credit that Harris Bank had issued at the request of All Amer- the benefjciary upon the presentation of conforming docu- ican Semiconductor. Harris Bank’s reimbursement claim ments, together with the bank’s charges and commissions against All American Semiconductor for letter of credit pay- earned from issuing the letter of credit. ments was secured by cash collateral (funds in a bank account) that All American Semiconductor had pledged to Harris Tie third contract is the standby letter of credit that the bank Bank. Shortly before the petition date, Samsung drew on the issues in favor of the seller, as benefjciary. When the benefj- letter of credit and applied the payment received from Harris ciary submits documents to the issuing bank, the bank’s sole Bank toward certain invoices comprising Samsung’s claimed duty is to examine the documents and determine whether new value. Harris Bank then set ofg its secured reimburse- they comply with the terms of the letter of credit. When the ment claim against All American Semiconductor, arising bank determines that the benefjciary has presented all of the from its $1 million payment to Samsung, against the $1 mil- documents required by the letter of credit, the issuing bank lion of All American Semiconductor’s cash collateral pledged must pay the amount requested by the benefjciary. to Harris Bank. Tie bank’s obligation to pay a conforming draw on a letter of Tiere was no question that Samsung’s receipt of payment for credit is independent of the benefjciary’s performance of the its proper letter of credit draw was not subject to preference underlying contract for which the letter of credit was issued risk. However, that did not address Samsung’s preference risk and the bank’s ability to recover its reimbursement claim for the payments it had received from All American Semicon- against the buyer/letter of credit applicant. Tie bank must pay ductor within 90 days of the petition date. Tie All American 2 B u s i n e s s C r e d i t J a n u a r y 2 0 1 3
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