Tennessee Business Litigation Lawyers Blog

The Contemporaneous Exchange for New Value Defense

Published on: April 21, 2020 | by J. Ross Pepper

The contemporaneous exchange for new value defense, 11 U.S.C. §547(c)(1), is one of several defenses in the Bankruptcy Code that a creditor may be able to use successfully to defeat the claim of a bankruptcy trustee, or other plaintiff, that the creditor should have to repay money paid to it by the now bankrupt debtor before that debtor filed for bankruptcy. This defense is applicable to all actions filed in bankruptcy courts located in Nashville or other cities in Tennessee.

This defense allows a creditor, which supplied goods or services, at or near the same time that the debtor paid for those services, to avoid liability for what would otherwise be a preferential payment. The purpose of the contemporaneous exchange for new value defense is to encourage a creditor to keep doing business with a customer which is having financial issues.

Although it is not a case decided by the federal circuit in which bankruptcy courts in Nashville and other parts of Tennessee are located (the 6^th Circuit), the case of Payless Cashways, Inc. (8^th Cir. 2004) provides a helpful analysis of the defense, and one that any Tennessee bankruptcy court would be expected to apply.

Here are the basic facts of the case:

The debtor which had filed bankruptcy (“Debtor”) was a business which sold home improvement products at retail
The creditor which was sued by the trustee for the recovery of preference payments (“Creditor”) was a lumber supplier
Creditor had supplied lumber to Debtor before it filed its first bankruptcy
After Debtor filed its first bankruptcy, Creditor required Debtor to pay for lumber on a cash-in-advance basis by Electronic Fund Transfer (“EFT”)
After a while, Creditor somewhat loosened its payment policy
Debtor filed a second bankruptcy
At the time of the preferential payments at issue, Creditor had agreed to ship all lumber via destination contracts, F.O.B. the Debtor’s facilities. The lumber was shipped via truck or rail, and Creditor’s invoice dates were always the date of shipment.
At the time of the preference payments at issue, the Creditor and Debtor had agreed to attempt to match the date the lumber shipments would arrive at Debtor’s facilities with its obligation to pay, and had agreed that all payments would be by EFT.
Payment terms were based on whether the lumber would be shipped by truck or rail. Lumber shipped by rail generally took 12-14 days, while lumber shipped by truck generally took 3-5 days.
During the relevant period, Debtor paid Creditor for rail shipments within 10.9 days after the date of the invoice, on average, and within 3.2 days, on average, for rail shipments
For all shipments, with minor exceptions, Debtor paid Creditor for specific shipments before, or at, the time they arrived at Debtor’s facilities
Neither Creditor nor Debtor kept regular records of when shipments arrived at Debtor’s facilities
The trustee brought a preference action seeking to recover four transfers made by Debtor

Using the Subsequent New Value Defense in a Preference Action

Published on: April 12, 2020 | by J. Ross Pepper

If you, or your company, is facing a claim in a bankruptcy court in Tennessee, or facing a demand letter from a bankruptcy trustee, or other party, for the return of payments made to you by a company or individual now in bankruptcy, you might be able to use what is referred to as the “subsequent new value” defense. This defense, just one defense in the Bankruptcy Code available to a creditor which is the subject of a preferential payment lawsuit, is particularly useful for creditors which maintained open accounts for now bankrupt debtors.

In concept, the defense is fairly easy to understand. In many cases, its successful application will require complex and tedious analysis of the statutory elements in light of the particular facts of the case. Assuming that the trustee, or other party which has filed the adversary proceeding, meets his or her burden of proof that the payments to the creditor by the debtor were preferential payments under 11 U.S.C.A. §547(b), a creditor which can prove the elements of the subsequent new value defense (11 U.S.C.A § 547(c)(4)) can avoid repaying the preference payments, or some portion thereof.

To succeed under the subsequent new value defense, a creditor must, to paraphrase the statute, prove three elements: (1) That it gave new value to the creditor after a preferential transfer (a transfer with respect to which the trustee has proven all of the elements of §547(b)); (2) that the new value given was not secured by a security interest which the trustee cannot avoid; and (3) that the debtor did not repay the debt for the new value with a transfer that the trustee cannot avoid.

Like all statutes and laws, understanding the reason for it is helpful in the analysis of particular factual scenarios. First, it is intended to promote creditors’ willingness to continue to do business with financially troubled accounts, which, ideally, will prevent bankruptcies. Second, when a creditor provides new value to a debtor, the same increases the value of the bankruptcy estate of the debtor, which increases the amount of assets available for distribution to other creditors. Thus, the defense recognizes that it is fair to allow that creditor to offset the value of the new value provided against the amount of the preferential transfers to it.

The Ordinary Course of Business Defense to Preferential Payment Actions

Published on: April 5, 2020 | by J. Ross Pepper

If you are the subject of demand by a trustee or other party, whether in a pre-suit demand letter or in a filed adversary proceeding, for the return of money paid to you by an individual or business which is now in bankruptcy, you may be able to keep the money if you can prove that the payments at issue fall within the ordinary course of business exception for preference payments. This is one of the most, if not the most, widely used defense in preference cases, and defendants are successful with it with some frequency. (There are other defenses to preference actions in the Bankruptcy Code, which are not discussed in this post).

Unless the payments at issue are to an “insider,” as defined by the Bankruptcy Code, only payments made within the 90-day period before a debtor files bankruptcy can be attacked as preferences. In addition to proving that the payments were made within the 90-day period, the trustee, or other party making the claim, has the burden of proving a few other elements in order to establish that the payments at issue were preferences. Once that burden is met, the creditor who received the payments can avoid having to disgorge the money at issue if it carries its burden of proof that the payments, though preferences, fall within the ordinary course of business exception in the Bankruptcy Code (11 U.S.C.A. §547(c)(2)).

To help readers better understand this exception, this blog discusses two cases — one in which the defense was successful, and the other in which it was not. Before discussing those cases, it is helpful to understand some basic rules about this exception. Here they are:

The exception can be met by a creditor (who received a preferential payment) proving either the subjective component of the exception or the objective component of the exception.
The subjective component of the exception considers whether the transfer, and the debt for which it was transferred, were made in the ordinary course of business of the debtor and creditor. Like the American Camshaft case discussed below, in many cases, there will be no dispute that the debt incurred by the debtor was incurred in the ordinary course of business, but there will be a dispute about whether the payment for that debt was in the ordinary course of business of the debtor and creditor.
The objective component of the exception considers whether the debt was incurred in the ordinary course of the business of the debtor and creditor and whether the transfer that was the payment for the debt was made “according to ordinary business terms,” meaning ordinary business terms in the industry of the debtor and creditor.
The Bankruptcy Code does not define “ordinary course of business” or “ordinary business terms” and the Sixth Circuit (which is the Circuit in which Tennessee bankruptcy courts are located) has said that there is no “precise legal test” to apply to determine whether either term has been satisfied. Instead, each preference case in which the ordinary course of business defense is raised turns on its own, unique facts.
For the subjective component of the exception, in many cases, the most important factor that a Tennessee bankruptcy court will look at is the timing of the payments made by the debtor to the creditor that occurred within the 90-day preference period compared to the timing of the payments that occurred more than 90 days before the debtor filed bankruptcy.
Under the subjective component of the exception, a creditor’s chances of success will be diminished, if not foreclosed, if it engaged in collection activity during the 90-day preference window that it did not engage in prior to 90 days before the debtor filed for bankruptcy.

In American Camshaft Specialties, Inc. (Bankr. E.D. Mich. 2011), the creditor (“Creditor”) was able to avoid repayment of preferential payments under both the subjective and objective components of the ordinary course of business defense. In that case, the Creditor supplied steel to the debtor (“Debtor”). The trustee for the Debtor filed suit against Creditor to recover a number of payments which had been made to the Creditor during the 90-day preference window. The payments had been made for steel supplied to the Debtor by Creditor. There was no dispute that the debt for the steel was incurred in the ordinary course of the business of the Debtor and Creditor.

Attacking Fraudulent Transfers in Tennessee State and Federal Courts

Published on: March 29, 2020 | by J. Ross Pepper

It happens sometimes that someone, or some company, which owes a debt will transfer assets that could have been used to pay the debt in order to avoid paying it. Such transfers are often to family members, related or successor businesses, or preferred creditors, and often, when the asset transferred is not cash, are made so that the debtor/transferor receives well below the value of the asset transferred.

Fraudulent transfers can come in an endless variety of forms. Some are obvious and easy to spot. (One of the first ones I ran into involved a defendant which had transferred a piece of real estate to another entity just after my client obtained a judgment against it.) Often, however, they cannot be spotted absent access to the transferor’s financial records, and perhaps even, a deposition or two or a review of financial records by a forensic accountant.

Tennessee has adopted the Uniform Fraudulent Transfer Act (the “Act”) to allow creditors to set aside fraudulent conveyances. If the debtor/transferor transferred the asset to a bona-fide purchaser who paid a value reasonably equivalent to the asset, a court may not set aside the transfer, but, in such a situation, it may well be possible to obtain a judgment against the entities or individuals responsible for the transfer, if they are different from the transferor.

Under the Act, it is important to remember that you do not have to have obtained a court judgment for the amount owed to you before a transfer can be considered fraudulent and set aside. A transfer can be fraudulent as to any creditor who has a “claim” against the transferor. Under the Act, “claim” has a broad definition, and odds are, if you were owed money by the transferor, you can avail yourself of the Act. Moreover, the definition of “claim” includes unliquidated debts, meaning debts the exact amount of which are not known, but which, at some point, can be reduced to a dollar value.

How the Failure to Pay Property Taxes Can Affect Ownership Rights in Tennessee

Published on: March 16, 2020 | by J. Ross Pepper

Tennessee has a statute, T.C.A. §28-2-110, which can come into play in a lawsuit about the ownership of real estate where the party initiating the lawsuit (the “Plaintiff”) is alleged not to have paid property taxes on the property at issue for more than twenty (20) years. To paraphrase the statute, it prevents anyone making a claim to real estate, or rents or profits from it, from bringing a lawsuit where that party, and those through whom that party claims her interest, have failed to pay any state or county taxes owing on the property for more than twenty (20) years.

In my estimation, the critical thing to understand about the statute is that it is a statute of limitations and does not, and cannot, divest a party of title to property or prevent a party from defending its claim to property when it is challenged by another party who initiates a lawsuit. Furthermore, the statute cannot prevent a party who has initiated a lawsuit from defending its claim to the property when the defendant goes beyond invoking §28-2-110 and simply denying the plaintiff’s claim. Where the defendant, through a counterclaim or otherwise, requests that the court adjudicate it to be the owner of the disputed tract, the court cannot use the statute to bar the plaintiff’s claim of ownership.

Maybe, the best way to understand the statute beyond the abstract, is to review how it has affected real parties in lawsuits. So, the following three case summaries are provided to help with that understanding.

Kinder v. Bryant (Tenn. Ct. App. 2018): I selected this case because it seems to be a somewhat common and fairly easy to understand fact scenario in which the statute was employed as a defense. The property at issue was a forty (40) acre tract which the plaintiffs claimed to have purchased in 1980. The plaintiffs had a deed. The plaintiffs did not record their deed until 1995. The defendants’ predecessors in interest purchased the same property in 1994. They received a deed and recorded it before 1995. The plaintiffs filed a lawsuit to have themselves declared the owners of the property. Obviously, since there was no indication that the defendants were not bona fide purchasers without notice of the plaintiffs’ deed, and since the defendants had recorded their deed first, the plaintiffs had no chance of being declared the owners of the property based on the superiority of their title. So, the plaintiffs claimed that they owned the property by adverse possession. Since it was undisputed that the plaintiffs had not paid any of the county taxes due on the property for over twenty (20) years, the court dismissed their case under §28-2-110. This case is an example of the statute barring a claim based on adverse possession.

Alexander v. Patrick (Tenn. Ct. App. 1983): In this case, the plaintiff and defendant claimed ownership of the same fifty (50) acre tract of land. Plaintiff’s claim was based on a deed as was defendant’s, but plaintiff’s deed was prior in time to defendant’s deed. The opinion does not state if, or when, the relevant deeds were filed with the register of deeds. The proof established that defendant, and her predecessors, had paid the property taxes for more than twenty (20) years and that plaintiff, and her predecessors, had not. The court held that the plaintiff’s claim was barred by §28-2-110 and dismissed the plaintiff’s complaint. This case is an example of the statute barring a claim based on title. Continue reading

Practice Pointers: The Tennessee UCC – Sales

Published on: February 16, 2020 | by J. Ross Pepper

The “Sales” chapter of the Uniform Commercial Code (referred to as “Article 2 of the UCC”), which was adopted by Tennessee in 1963, was designed to bring uniformity and efficiency to transactions involving the sales of goods. Article 2 is thorough, to say the least. In any breach of contract case, breach of warranty case or any other case involving goods sold, it should be reviewed carefully as it has provisions that touch on every aspect of transactions involving the sales of goods, including, contract formation, price, terms, delivery, remedies, warranties, and rejection of non-conforming goods.

There is no way, in the space for a blog such as this, to cover all of the potentially important aspects of Article 2, but the following are some observations about it that are helpful to practitioners and litigants.

The UCC – Sales Only Applies to Sales of “Goods”

Article 2 only applies to transactions involving the sales of goods. If your case involves an investment, a real estate dispute, a shareholder divorce, or some type of service, you need to look to Tennessee common law or to some other statute. With some frequency, transactions will involve both the sales of goods and services. For example, the purchase and installation of computer software and hardware by a business will entail both the provision of goods and services (which the UCC refers to as “non-goods”). In such cases, the UCC will apply if the predominate assets transferred were goods. One of the leading Tennessee cases on this topic is Hudson v. Town & Country True Value Hardware, Inc., which was decided by the Supreme Court of Tennessee in 1984.

Different Rules in Article 2 May Apply If the Sale Involves a “Merchant”

A party considered a “merchant” under Article 2, in many important situations, may find that it is subject to different rules and standards under that Article. To generalize, under Article 2, you are a “merchant” if you are a professional in a business involving the type of goods involved with the transaction. (See T.C.A. § 47-2-104 for the precise definition of “merchant”). Keep in mind that, to be considered a merchant with respect to a transaction in goods, you have to be a professional with respect to the type of goods involved. If a lighting manufacturer buys a forklift, it will not be considered a merchant with respect to that transaction. If it buys filament for the bulbs it manufactures, it will be.

An LLC Member’s Obligation to Contribute to Loan Debt for Which All Members Are Personally Liable

Published on: January 14, 2020 | by J. Ross Pepper

In Thompson v. Davis, an LLC dispute case, the Court of Appeals of Tennessee issued an opinion that is informative on two different fronts: (1) An LLC member’s obligation to contribute his pro rata share to repay loans taken for the benefit of the LLC, but for which all members are personally liable; and, (2) under what circumstances a member can reduce the amount of his pro rata obligation based on alleged distributions received by the other members, but not by that member.

Before diving into the facts of, and result in, that case, it is helpful to review a couple of provisions of the Tennessee Revised Uniform Limited Liability Company Act (the “Act”) which come into play with some frequency, as well as the Tennessee statute requiring contribution by a party who is liable on a debt. First, under the Act, when an LLC is not successful, and is dissolved and liquidated, its assets must be distributed first to creditors. (Creditors, critically, includes members who have made loans to the LLC.) If there are any assets left to distribute after creditors are fully paid, which is infrequent in my experience, they must then be distributed to members who did not receive distributions to which they were entitled. If there are assets left over after those distributions are made, they must be distributed to members first for the return of contributions, and second, for their membership interests in the LLC. The statute that controls distributions upon liquidation is T.C.A. §48-249-620.

The Act also has its own fraudulent transfer provision embedded in it at T.C.A. §48-249-306. That statute provides that members may be liable for distributions which left the LLC unable to pay its debts as they became due in the ordinary course of business or which left it in the red, so to speak. (The preceding is a generalization, so review the statute for the details).

Apart from the Act, and also at issue in the Thompson v. Davis case, was the Tennessee contribution statute related to instruments, T.C.A. §47-3-116. That statute provides that a party who pays an obligation on an instrument, such as a bank note, is entitled to seek contribution from others who were also liable for the payment of the note. The statute provides that those others must contribute their pro rata share. For example, if A, B, and C borrow $750,000, interest free, and agree to be jointly and severally liable to the lender for the obligation, and A pays off the obligation, A is entitled to file suit against B and C and collect $250,000 apiece from B and C. A does not have to sue both for contribution, but A cannot collect more than $250,000 from either.

Old Age Alone Not Enough to Prove Undue Influence or Lack of Mental Capacity

Published on: December 8, 2019 | by J. Ross Pepper

In a recent case involving a challenge to an amendment to a revocable trust, the Court of Appeals of Tennessee upheld the trial court’s grant of a directed verdict to the defendants and against the two sons who had challenged the amendment. The case is significant because it demonstrates that basing a challenge to a will or trust exclusively on the argument that the deceased was of advanced age, and, therefore, must have had reduced mental capacity and increased dependence on others, will not carry the day (as it should not). Although the case was not technically a will contest, the principles and law applied were the same as those applied in will contest cases.

Based on the facts set forth in the opinion in the case, the sons who challenged the trust amendment on the grounds of undue influence and lack of mental capacity must have pretty much expected to prove both just by proving that their father was older and that one of their sisters lived with him. They had no medical proof that would support either that their father was lacking mental capacity, or that he was so physically infirm that he was susceptible to his live-in daughter establishing a dominant relationship over him.

Summary judgments and directed verdicts, both of which were granted by the trial court in this case, are pretty rare in will contest cases where undue influence or lack of testamentary capacity are at issue. That they are makes this case worth analyzing and understanding.

Here are the key facts of the case:

Father had six children comprised of three sons and three daughters
The opinion, remarkably, does not provide Father’s age, though it is clear he was elderly
In 2008, Father executed a will and revocable trust
Father appointed one of his daughters as his personal representative
In 2010, Father executed an amendment to the trust
Although the opinion does not state how Father’s assets were to be distributed under the 2010 amendment, it is clear from the opinion that, under that amendment, two sons were bequeathed less than what was bequeathed to some, or all, of the other siblings
After Father died in 2011, the above two sons (the “Plaintiff Sons”) filed a lawsuit challenging the 2010 amendment on the grounds that Father was unduly influenced to make the amendment and lacked the testamentary capacity to understand the consequences of the amendment

Preliminary Injunctions in Tennessee Non-Compete Cases: A Comparison of Two Cases

Published on: November 24, 2019 | by J. Ross Pepper

In cases involving non-competition agreements, the battle is almost always fought, and won or lost, at the preliminary injunction stage. Once the court rules on whether the former employer (or other party which has obtained a non-compete agreement) is, or is not, entitled to a preliminary injunction, in my experience, a trial rarely occurs. Thus, the importance of prevailing, or not, at the preliminary injunction stage cannot be overstated.

Broadly speaking, one of the main types of relief typically sought in a motion for a preliminary injunction arising out of an employment agreement is that the court enter an order prohibiting the former employee from competing with his or her former employer. The exact terms of an order obtained at the preliminary injunction stage will vary according to the terms of the non-compete agreement at issue and the court’s modification of those terms, if it modifies them (which it is empowered to do).

In deciding whether to grant a motion for a preliminary injunction, a court will consider the following factors: (1) Whether the former employer is likely to prevail on the merits at trial; (2) whether, without an injunction, the former employer will suffer irreparable harm; (3) whether the preliminary injunction will cause substantial harm to the former employee or others; and (4) the public interest. In my experience, the most important factor is (1), followed by (3).

Our firm has handled many of these cases over the years and factors (2) and (4) have mostly been inconsequential. With respect to factor (2), irreparable harm means harm which has occurred, but for which a court cannot calculate damages, and thus, for which it cannot award damages. There is a large body of case law that supports the conclusion that a former employer will suffer irreparable harm from unfair competition by a former employee. This is so because it is almost always impossible for a former employer to prove, with any degree of specificity, the damages it will incur from lost business and lost opportunities resulting from the former employee, even when they will most assuredly occur without an injunction. Thus, in our experience, once a court determines that the former employer is likely to prevail on the merits, it is infrequent that a preliminary injunction is not granted on the basis that the former employer did not prove irreparable harm.

When a Written Change Order Requirement May be Waived Under Tennessee Law

Published on: November 4, 2019 | by J. Ross Pepper

Most construction contracts, including those based on the American Institute of Architects (“AIA”) forms, contain terms requiring that any change orders be in writing and signed. Tennessee courts have, with some frequency, not enforced those provisions. Usually, the legal theory used by those courts is waiver.

Two Tennessee construction cases involving construction contracts with change order requirements, and in which the courts reached different outcomes, provide a good view of the legal landscape in which a contractor which has not strictly complied with a written change order provision will find itself. The first case is Moore Construction Company, Inc. v. Clarksville Department of Electricity (Tenn. Ct. App. 1985). Here are the key facts in that case:

The project was for the construction of a new office building
The owner contracted with two prime contractors, Moore and Kennon
Moore was to perform the site work and other exterior work
Kennon was to construct the building
All parties understood that Moore would be able to complete only part of its work before Kennon finished constructing the building, and that, it would not be able to complete its work until Kennon had finished constructing the building
Moore completed its initial work timely
Once Kennon started, it fell behind schedule due to its subcontractors
In September of 1981, Moore began to complain that it could not complete its work due to the delays by Kennon
A meeting was held among the owner, Moore and Kennon at which meeting it was agreed that the parties would have to adjust their schedules
No written change order was prepared after this meeting, but the owner prepared a job site memo stating that the parties had agreed to extend the time for Moore to complete its work
When Moore went back to work, the owner directed it to perform extra work and it did
The extra work was done without a change order and the owner ultimately paid Moore for that extra work without protest
Moore requested that the owner pay it an additional $22,000 in delay damages above the contract price which resulted to Moore from the delays caused by Kennon

The owner refused to pay Moore the delay damages. It argued that it had no obligation to do so because it had not signed a change order for an increased contract price. The construction contract in the Moore case incorporated the AIA General Conditions which provided: “If the Contractor wishes to make a claim for an increase in the Contract Sum, he shall give the Architect written notice thereof within twenty days after the occurrence of the event giving rise to such claim.” Article 12.1 of the General Conditions also required that the contractor obtain a written change order to enlarge the scope of work.

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