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Security Interest Determined as of the Date of Petition, Not the Transaction, for Purposes of Stating a Preference Claim Under Section 547(b)(5)

Simplexity, LLC v. Sprint Corp. (In re Simplexity, LLC), 578 B.R. 255 (Bankr. D. Del. 2017)

In this Opinion, the Delaware Bankruptcy Court addressed when a security interest is determined for purposes of stating a preference claim under section 547(b)(5) of the Bankruptcy Code.  Distinguishing an earlier ruling by the Court in the context of insurance premium financing, Judge Kevin Gross ruled that security interests generally must be determined as of the petition date rather than the transaction date.  Judge Gross also set forth guidelines for how the valuation should be conducted using an “add back” method.

Under the facts of the case, the Chapter 7 Trustee (the “Trustee”) for Simplexity, LLC, et al. (the “Debtors”) sued defendant Sprint Corporation (“Sprint”) to avoid and recover $958,198.58 of preferential transfers the Debtors allegedly made to Sprint in the 90 days before the Debtors’ petition date.  Op. at 256-261.  Among the arguments in its defense, Sprint asserted that the Trustee failed to state a claim under section 547(b)(5) of the Bankruptcy Code because Sprint was a fully secured creditor at the time of each transfer as a result of a purchase money security interest (“PMSI”) it held in equipment in the Debtors’ possession.  Id. at 263-64.  Sprint’s position was based in significant part on the Court’s previous ruling in Forman v. IPFS Corp. of the South (In re Alabama Aircraft Indus.), 2013 WL 6332688 (Bankr. D. Del. Dec. 5, 2013), in which the Court held that an insurance premium financier’s security interest in an unearned premium must be determined on the transaction date.  Id.

However, the Trustee distinguished Alabama Aircraft and other authorities cited by Sprint.  It argued that those cases are limited to circumstances involving diminishing or floating liens.  Where collateral has a more stable value, the Trustee argued that the history behind section 547(b)(5) – in particular the Supreme Court’s decision in Palmer Clay Products Co. v. Brown, 297 U.S. 227 (1936) – mandates valuation of security interests as of the petition date.  To rule otherwise, the Trustee asserted, would conflate the statutory requirements of section 547(b)(5) with the defenses available under section 547(c). Id. at 264-66.

The Court agreed with the Trustee.  While acknowledging that a different result might ensue in a case involving a floating lien, Judge Gross found the limited scope of Sprint’s PMSI required valuation of the related collateral as of the petition date.  Id.  This ruling then left open the issue of how the valuation would be determined.  Sprint argued that section 547(b)(5) required the Trustee to trace the proceeds of Sprint’s collateral to show them insufficient to pay Sprint in full for the alleged transfers, and that the Trustee failed to meet this burden.  However, the Court rejected Sprint’s position in favor of a simpler “add back” valuation advocated by the Trustee.  Under this method, the Court compared the value of Sprint’s collateral to the Debtors’ liabilities to Sprint as of the petition date, and then “added back” the amount of the alleged preference transfers to the Debtors’ liabilities.  Utilizing this approach, the Court found the value of Sprint’s PMSI was clearly less than the amounts it was owed by the Debtors. As a result, Judge Gross found the Trustee had sustained his burden under section 547(b)(5).  Id. at 266-69.