A now-bankrupt telecommunications provider cannot avoid making payments invoiced by its supplier prior to the filing of an involuntary bankruptcy petition because the supplier has a legitimate defense under the “new value” concept in U.S. Bankruptcy Code, the 7th Circuit Court of Appeals has ruled.
In April 2002, telecommunications retailer OneStar entered into a contract requiring MCI to supply OneStar with telecommunications services. But in October 2003, OneStar’s senior secured lender sent a default notice, prompting the company’s principals to move business to a newly formed affiliate, known as IceNet, to avoid creditors.
On Dec. 22, OneStar, MCI and IceNet entered an agreement assigning OneStar’s contractual privileges and debt to IceNet, resulting in a system in which OneStar owed IceNet, IceNet owed MCI and MCI was obligated to provide services to IceNet. Thus, from Dec. 23 to Dec. 31, IceNet received services from MCI and relayed them to OneStar.
However, this plan to avoid creditors fell apart on Dec. 31, when a creditor filed an involuntary Chapter 7 bankruptcy petition against OneStar. During the 90-day preference period — or the time frame when debtors can reverse payments made during the 90 days before bankruptcy — MCI invoiced roughly $3.7 million in services to OneStar. One star paid MCI roughly $1.9 million during the preference period, while its debt to MCI grew to more than $9.8 million near the end.
The company’s bankruptcy trustee sought to avoid the prepetition payments as preferential transfers under Section 547 of the Bankruptcy Code. But Verizon Business Global, LLC, which had purchased MCI, claimed the preferential payments were unavoidable because MCI provided OneStar with new value — the services provided on the invoices during the preference period — after receiving those payments. Verizon also claimed the payments were made in the ordinary course of business.
Using a per diem method of analysis, the bankruptcy judge determined MCI had advanced enough new value after its receipt of OneStar’s preferential transfers to cover the amount of those transfers, while also holding that OneStar’s debt assignment did not compensate MCI for the new value, so Verizon was entitled to a complete new-value defense. The judge also rejected Verizon’s ordinary-course defense, and the U.S. District Court for the Southern District of Indiana affirmed that ruling.
The 7th Circuit Court of Appeals also affirmed those rulings on appeal in the case of In Re: OneStar Long Distance, Inc., Elliott D. Levin v. Verizon Business Global, LLC, 16-1940 and -2094. In a footnote to the Friday opinion, Judge Diane Sykes wrote that now-retired Judge Richard Posner, who heard arguments in the case, did not participate in the decision, so it was resolved by a quorum of the appellate panel.
Sykes then went on to write that Section 547(c)(4) excepts a preference transfer from avoidance “to the extent that, after such transfer, (the) creditor gave new value to or for the benefit of the debtor.” Section (c)(4)(B) contains one exception to that exception, but that section cannot apply here because OneStar’s assignment of debt to IceNet wasn’t a “transfer to or for the benefit of” MCI, but rather was only a mechanism for OneStar to avoid its creditors, Sykes said.
The 7th Circuit further found that there was “no reason to think that the per diem method misallocated new value in a manner that disadvantaged the trustee,” as the trustee argued. Thus, the bankruptcy judge’s ruling in favor of Verizon was affirmed, and the appellate court declined to consider Verizon’s cross-appeal of the rejection of its ordinary-course defense.