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Set Off of Administrative Claim Against Preference Liability is Permissible and Not a “Disguised New Value Defense”

Official Comm. of Unsecured Creditors of Quantum Foods, LLC v. Tyson Foods, Inc. (In re Quantum Foods, LLC), No. 15-50254 (KJC), 2016 WL 4011727 (Bankr. D. Del. July 25, 2016)

In this Opinion, the Delaware Bankruptcy Court addressed a question that remained in the wake of the Third Circuit’s Opinion in Friedman’s: although post-petition goods and services may not be counted as subsequent new value under section 547(c)(4) of the Bankruptcy Code, may they still be used to offset alleged preference liability?  See Friedman’s Liquidating Tr. v. Roth Staffing Co., LP (In re Friedman’s Inc.), 738 F.3d 547 (3d Cir. 2013).  In answering this question of first impression, the Court ruled that they may.  In its holding, the Court also confirmed earlier rulings that section 502(d) may not be used to disallow administrative claims.

Under the facts of the case, the Official Committee of Unsecured Creditors (the “Committee”) of Quantum Foods, LLC and its affiliated debtors (the “Debtors”) exercised derivative standing to bring a preference claim and other claims against Tyson Foods, Inc. and an affiliate (together, “Tyson”).  The Committee sought to avoid and recover as preferences and/or fraudulent transfers more than $13.5 million from Tyson as well as to disallow its claims against the Debtors pursuant to section 502(d) of the Bankruptcy Code until the alleged liability was paid to the Debtors’ estates.

The issue before the Court was not the merits of the Committee’s claims, but rather the narrow issue of whether Tyson could set off the amount of an allowed but unpaid administrative claim of more than $2.6 million against its alleged preference liability.  The Committee moved for judgment on the pleadings, arguing that Tyson’s attempt to set off its post-petition claim was a “disguised new value defense” precluded by Friedman’s.  Op. at *4-6.  In ruling, Judge Kevin J. Carey distinguished Friedman’s.  Op. at *4-8.  While the Third Circuit held in Friedman’s that new value for purposes of section 547(c)(4) must be determined as of the petition date—and therefore, by implication, post-petition new value may not be counted in determining preference liability under section 547—Judge Carey found that Friedman’s did not address whether administrative expense claims could nonetheless be set off against preference claims under other applicable law.

Rather, the Court’s analysis of the issue hinged on whether a preference claim is a pre-petition or a post-petition claim.  His Honor noted that setoff is only available “when the opposing obligations arise on the same side of the…bankruptcy petition date.”  Op. at *7 (citations omitted).  While it is clear that an administrative claim arises post-petition, the Court noted that preference claims involve pre-petition facts.  Notwithstanding, Judge Carey found a preference claim can only be asserted “after the filing of a bankruptcy petition” and that the bankruptcy trustee’s right to payment on a preference claim “necessarily arises only post-petition.”  Op. at *8 (emphasis in original).  Therefore, His Honor concluded that Tyson’s right to set off its allowed administrative expense claim against its preference liability was permissible.

In addition to Friedman’s, the Committee argued that section 502(d) prohibited Tyson from setting off its administrative claim.  While section 502(d) requires courts to disallow claims of preference recipients and recipients of other transfers avoidable under chapter 5 of the Bankruptcy Code until all liability has been paid to an estate, the Court disagreed that it could be used to prevent Tyson’s administrative claim setoff, simply noting that under precedent in the District of Delaware, “administrative expense claims…are not subject to section 502(d).”  Op. at *8 (citing In re Lids, Corp., 260 B.R. 680, 683 (Bankr. D. Del. 2001)).

This Opinion is significant because it gives an answer—and a succinct and clear one at that—to the question left by Friedman’s of how post-petition new value (i.e., an administrative expense claim) should be handled in the context of preference actions.  If unpaid—and otherwise meeting the requirements for setoff under applicable state law—administrative expense claims may be set off against preference liability.