Laker v. Vallette (In Re Toyota of Jefferson, Inc.)

United States Court of Appeals,

Fifth Circuit.

No. 93-3289.

In the Matter of TOYOTA JEFFERSON, INC., Debtor.

Leonard LAKER, Chapter 7 Trustee for Bankruptcy ESTATE OF TOYOTA

OF JEFFERSON, Appellant,

v.

Francelle VALLETTE, Executrix for the Succession of Amelia

Schexnayder Normand, Appellee.

Feb. 28, 1994.

Appeal from the United States District Court for the Eastern

District of Louisiana.

Before KING, HIGGINBOTHAM and BARKSDALE, Circuit Judges.

KING, Circuit Judge:

Leonard Laker, as trustee of the bankruptcy estate of Toyota

of Jefferson, Inc., sought to recover for the estate three

allegedly preferential payments of money from the debtor to one of

its creditors, Amelia Schexnayder Normand, under 11 U.S.C. § 547.

The court below held that all three payments were voidable

preferences, but it nevertheless permitted him to recover only the

final transfer. This appeal followed.

I. BACKGROUND

A. Facts

Louis J. Normand, Sr., was the president and majority

shareholder of Toyota of Jefferson, Inc. (Toyota). Amelia

Schexnayder Normand, now deceased, was the mother of Louis Normand.

Francelle Vallette is the testamentary executrix for the succession

of Amelia Normand.

1

The dispute in the instant case involves a series of

transactions between Toyota and Amelia Normand in 1989 and 1990.

On May 30, 1989, Amelia Normand gave Toyota four checks totalling

$30,830.75. Toyota repaid this amount by two checks dated October

24, 1989, and Amelia Normand deposited the checks into a joint

account she shared with her son on October 25, 1989.

On January 8, 1990, Amelia Normand transferred $82,993 to

Toyota by check, which was deposited in Toyota's account the next

day. Toyota returned this amount to Amelia Normand in four checks

dated January 12-19, 1990. She deposited these checks into her

account over the period from January 17-26, 1990.

On February 22, 1990, Amelia Normand transferred $90,169 to

Toyota by check. Toyota repaid this amount over time, with seven

checks dated February 22, 1990, and two checks dated February 24,

1990. Amelia Normand deposited the checks from Toyota over the

period from March 1-14, 1990.

B. Procedural History

Toyota filed a voluntary petition for relief under Chapter 11

of the United States Bankruptcy Code in the United States

Bankruptcy Court for the Eastern District of Louisiana on September

28, 1990. Leonard Laker was appointed as trustee for Toyota's

estate ("the bankruptcy trustee"), and he remained trustee after

the case was converted into a Chapter 7 proceeding on November 13,

1990. On October 23, 1991, the bankruptcy trustee filed an

adversary proceeding in the bankruptcy court against Vallette in

her capacity as executrix for the succession of Amelia Normand,

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seeking to avoid and recover the payments made by Toyota to Amelia

Normand outlined above (totalling $203,992.75) under 11 U.S.C. §

547.

On May 26, 1992, the district court granted Vallette's

unopposed motion to withdraw reference of the adversary proceeding

from the bankruptcy court. After a telephone conference, the

parties consented to a bench trial before a United States

Magistrate Judge pursuant to 28 U.S.C. § 636(c). See McLeod,

Alexander, Powel & Apffel, P.C. v. Quarles, 925 F.2d 853, 855 (5th

Cir.1991) (noting that a magistrate judge acting under § 636(c) may

conduct a trial and enter judgment for the court in any civil

matter referred to it by the district court if the parties

consent). Trial was held on February 25, 1993. In its order and

reasons filed on March 31, 1993, the court held that the three sets

of payments from Toyota to Amelia Normand from October 25, 1989,

through March 14, 1990, were preferential payments within the

meaning of 11 U.S.C. § 547(b). The court considered and rejected

Vallette's arguments that the "contemporaneous exchange" and

"ordinary course of business" exceptions of § 547(c)(1) and (c)(2)

applied to the transactions. The court further held, however, that

only the final preferential payment, for $90,169, could be avoided

and recovered by the bankruptcy trustee, for the following reasons:

In sum, the Magistrate Judge finds that these payments

from Debtor to Creditor may be recovered by the bankruptcy

estate—they may be avoided. However, this was the same money

being passed back and forth.

The same money was borrowed and repaid three times. To

allow the recovery of the total—$203,992.75—would be an unjust

increase of the bankruptcy estate (and an unjust decrease of

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the deceased Creditor's estate). Only the final and largest

transfer from Debtor to Creditor, in the amount of $90,169.00,

may be avoided.

The bankruptcy trustee timely filed his notice of appeal to this

court, appealing the portion of the order limiting his recovery of

the preferential payments to $90,169.

II. STANDARD OF REVIEW

We review a judgment rendered by a magistrate pursuant to 28

U.S.C. § 636(c) as we would a judgment rendered by a district

judge. See 28 U.S.C. § 636(c)(3); James v. Hyatt Corp., 981 F.2d

810, 812 (5th Cir.1993). Thus, we review issues of law de novo and

findings of fact under the clearly erroneous standard. James, 981

F.2d at 812.

III. ANALYSIS

The sole issue for our decision is whether the court below

properly limited the bankruptcy trustee's recovery to $90,169, the

amount of the last preferential payment from Toyota to Amelia

Normand.1 The bankruptcy trustee argues that the court below erred

in limiting the bankruptcy estate's recovery from Amelia Normand to

less than the full $203,992.75 sought. In the trustee's view, once

the court below decided that neither § 547(c)(1) nor (c)(2) applied

1

The appellee, Vallette, argues in her brief that the court

below erred in holding that the "contemporaneous exchange" and

"ordinary course of business" exceptions did not apply. We

decline to consider her arguments because, absent a cross appeal,

the appellee cannot attack the decision of the court below with a

view either to enlarging her own rights thereunder [or lessening

the rights of her adversary.] Morley Constr. Co. v. Maryland

Casualty Co., 300 U.S. 185, 191, 57 S.Ct. 325, 327, 81 L.Ed. 593

(1937); Securities and Exch. Comm'n v. AMX, Int'l, Inc., 7 F.3d

71, 74 n. 4 (5th Cir.1993); Speaks v. Trikora Lloyd P.T., 838

F.2d 1436, 1439 (5th Cir.1988).

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to the preferential payments, the court was bound to award the

bankruptcy estate the full amount of the preferential payments.

Vallette argues, however, that the "subsequent advance" exception

found in § 547(c)(4) supports the decision by the court below.

That section of the Bankruptcy Code provides as follows:

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

transfer—

* * * * * *

(4) to or for the benefit of a creditor, to the extent

that, after such transfer, such creditor gave new value to or

for the benefit of the debtor—

(A) not secured by an otherwise unavoidable security

interest; and

(B) on account of which new value the debtor did not

make an otherwise unavoidable transfer to or for the

benefit of such creditor[.]

11 U.S.C. § 547(c)(4). Although the court below did not expressly

rely on § 547(c)(4), Vallette is entitled to offer alternative

bases for upholding the judgment, provided there is record support

for her arguments. Cox v. Sunbelt Sav. Ass'n, 896 F.2d 957, 959 n.

2 (5th Cir.1990).

We consider first the role § 547(c)(4) was intended to play by

the drafters of the Code. The exception "most obviously applies to

revolving credit relationships." Raymond T. Nimmer, Security

Interests in Bankruptcy: An Overview of Section 547 of the Code,

17 HOUS.L.REV. 289, 299 (1980). Two policy considerations support

the exception. First, without the exception, a creditor who

continues to extend credit to the debtor, perhaps in implicit

reliance on prior payments, would merely be increasing his

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bankruptcy loss. Id. at 300. Second, the limited protection

provided by the subsequent advance rule encourages creditors to

continue their revolving credit arrangements with financially

troubled debtors, potentially helping the debtor avoid bankruptcy

altogether. Id. at 300-01. Protecting the creditor who extends

"revolving credit" to the debtor is not unfair to the other

creditors of the bankrupt debtor because the preferential payments

are replenished by the preferred creditor's extensions of new value

to the debtor. Kroh Bros. Dev. Co. v. Continental Constr. Eng'rs,

Inc. (In re Kroh Bros. Dev. Co.), 930 F.2d 648, 652 (8th Cir.1991).

We turn next to the elements of the § 547(c)(4) exception

itself. Commentators have noted that "[t]here are two keys to the

application of (c)(4). The creditor must have given (1) "new

value' and must have done so (2) after the preferential transfer."

1 DAVID G. EPSTEIN ET AL., BANKRUPTCY § 6-34, at 628 (1992). Two other

caveats must be observed. The new value given by the creditor must

not be secured by "an otherwise unavoidable security interest," §

547(c)(4)(A), and the debtor must not have made "an otherwise

unavoidable transfer to or for the benefit of such creditor" on

account of the new value, § 547(c)(4)(B).

The transfers in this case may be summarized as follows.

Preferential

Date Payment New Value

Oct. 1989 $30,830.75

Jan. 9, 1990 $82,993.00

Jan. 12-19, 1990 $82,993.00

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Feb. 1990 $90,169.00

Mar. 1990 $90,169.00

-----

Under the "net result rule," which was applied by some courts under

pre-Code bankruptcy law, bankruptcy courts would simply total the

preferential payments and the advances of new value and offset them

against each other. 1 EPSTEIN, supra, at 629. Because § 547(c)(4)

requires the new value to be given by the creditor after the

preferential transfer to the creditor, its scope is narrower in

operation than the net result rule. Id.; see also Waldschmidt v.

Ranier (In re Fulghum Constr. Corp.), 706 F.2d 171, 174 (6th Cir.)

("Congressional metamorphosis has transformed the judicially

created net result rule into what may be characterized as a

subsequent advance rule...."), cert. denied, 464 U.S. 935, 104

S.Ct. 342, 78 L.Ed.2d 310 (1983).

The bankruptcy trustee argues that none of the preferential

transfers made by Toyota qualify for the § 547(c)(4) exception

"because [Toyota] repaid all the funds that Amelia Normand lent it.

There was no subsequent advance by Amelia Normand which [Toyota]

did not repay." Phrased another way, the bankruptcy trustee's

argument is that the final preferential payment of $90,169

destroyed Amelia Normand's ability to rely on § 547(c)(4) to retain

the first two preferential payments.

We disagree with the bankruptcy trustee's interpretation of

§ 547(c)(4), believing it to be contrary to the statute's plain

language. As an aid to our analysis, we may compare the instant

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case with the following hypothetical.

Preferential

Date Payment New Value

Oct. 1989 $30,830.75

Jan. 9, 1990 $82,993.00

Jan. 12-19, 1990 $82,993.00

Feb. 1990 $90,169.00

-----

It is clear that § 547(c)(4) would prevent the bankruptcy trustee

from setting aside either preferential payment in this

hypothetical. See Crichton v. Wheeling Nat'l Bank (In re Meredith

Manor, Inc.), 902 F.2d 257, 258-59 (4th Cir.1990); Boyd v. The

Water Doctor (In re Check Reporting Servs., Inc.), 140 B.R. 425,

439 (Bankr.W.D.Mich.1992). Each preferential payment has

effectively been returned to the estate by an even greater

extension of new value by the creditor. The transactions have not

harmed the other creditors of the bankruptcy estate, because they

have occasioned no diminution to the estate; indeed, they have

augmented it by almost $60,000. See In re Kroh Brothers, 930 F.2d

at 652 ("[T]he relevant inquiry under section 547(c)(4) is whether

the new value replenishes the estate."). Of course, if a creditor

has retained an unavoidable security interest in an extension of

new value, or if the debtor has subsequently repaid the new value

by means of "an otherwise unavoidable transfer," § 547(c)(4)(A) and

(B) prevent the creditor from relying on the exception because no

effective replenishment of the estate has occurred.

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We hold that the existence of the final preferential payment

in this case does not allow the bankruptcy trustee to overcome

Vallette's § 547(c)(4) defense to avoidance of the first two

preferential payments. In the words of one commentator:

The prevailing interpretation seems to be the correct

one. If the debtor has made payments for goods or services

that the creditor supplied on unsecured credit after an

earlier preference, and if these subsequent payments are

themselves voidable as preferences (or on any other ground),

then under section 547(c)(4)(B) the creditor should be able to

invoke those unsecured credit extensions as a defense to the

recovery of the earlier voidable preference. On the other

hand, the debtor's subsequent payments might not be voidable

on any other ground and not voidable under section 547,

because the goods and services were given C.O.D. rather than

on credit, or because the creditor has a defense under section

547(c)(1), (2), or (3). In this situation, the creditor may

keep his payments but has no section 547(c)(4) defense to the

trustee's action to recover the earlier preference. In either

event, the creditor gets credit only once for goods and

services later supplied.

Vern Countryman, The Concept of a Voidable Preference in

Bankruptcy, 38 VAND.L.REV. 713, 788 (1985) (emphases added)

(footnotes omitted); see also 1 EPSTEIN, supra, at 632 ("[T]he

debtor's payment of the new value does not affect the application

of (c)(4) if the payment itself is avoidable."). The final

preferential payment in the instant case is voidable; § 547(c)(4)

offers Vallette no solace because the $90,169 payment was not

followed by an extension of new value. Once this payment is

avoided, the situation is identical to the hypothetical presented,

supra, and fits neatly within Professor Countryman's analysis.

Many bankruptcy courts have adopted this approach to § 547(c)(4).

See, e.g., Brown v. Shell Canada, Ltd. (In re Tennessee Co.), 159

B.R. 501, 518 (Bankr.E.D.Tenn.1993); Successor Comm. of Creditors

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Holding Unsecured Claims v. Bergen Brunswig Drug Co. (In re Ladera

Heights Community Hosp., Inc.), 152 B.R. 964, 967-68

(Bankr.C.D.Cal.1993); Hyman v. Stone Lumber Co. (In re Winter

Haven Truss Co.), 154 B.R. 592, 596 (Bankr.M.D.Fla.1993); Mosier

v. Ever-Fresh Foods Co. (In re IRFM, Inc.), 144 B.R. 886, 889-93

(Bankr.C.D.Cal.1992); Allied Companies, Inc. v. Broughton Foods

Co. (In re Allied Companies, Inc.), 155 B.R. 739, 743-44

(Bankr.S.D.Ind.1992); In re Check Reporting Services, 140 B.R. at

432, 439. The subsequent advances following the first two

preferential payments were repaid, but with preferences that were

not "otherwise unavoidable." The result reached by the court below

is therefore correct.2

IV. CONCLUSION

For the foregoing reasons, the judgment of the court below is

AFFIRMED.

2

Some of our sister circuits have, in dicta, described §

547(c)(4)(B) as requiring the subsequent advance to go "unpaid."

See In re Kroh Brothers, 930 F.2d at 652; New York City Shoes,

Inc. v. Bentley Int'l, Inc. (In re New York City Shoes, Inc.),

880 F.2d 679, 680 (3d Cir.1989); Charisma Inv. Co., N.V. v.

Airport Sys., Inc. (In re Jet Florida Sys., Inc.), 841 F.2d 1082,

1083 (11th Cir.1988); In re Prescott, 805 F.2d 719, 731 (7th

Cir.1986). Although this description may be an adequate

shorthand description of § 547(c)(4)(B), a more complete

statement of the (c)(4) exception would be that a creditor who

raises it has the burden of proving that (1) new value was

extended after the preferential payment sought to be avoided, (2)

the new value is not secured with an otherwise unavoidable

security interest, and (3) the new value has not been repaid with

an otherwise unavoidable transfer. Cf. In re Prescott, 805 F.2d

at 731 ("The creditor that raises a "subsequent advance' defense

has the burden of establishing that new value was extended, which

remains unsecured and unpaid after the preferential transfer.").

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