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Quantum Foods – Preference Liability May be Set-off by an Allowed Unpaid Post-Petition Administrative Claims

Official Comm. of Unsecured Creditors of Quantum Foods, LLC v. Tyson Foods, Inc.(In re Quantum Foods, LLC), No. 14-10318, 2016 Bankr. LEXIS 2785 (U.S. Bankr. D. Del. July 25, 2016)

Debtor Quantum Foods, LLC manufactured and distributed protein products such as beef, pork, and poultry, custom ready to cook products etc. and custom menu solutions. Defendant Tyson Foods, Inc. is the processor and marketer of chicken, meat, beef, and pork. Defendant supplied meat products to the Debtor. The Debtor filed for voluntary Chapter 11 bankruptcy petition. Tyson had almost $14 million in preference exposure. Tyson supplied additional meat products to the Debtor post-petition as well and filed a motion for allowance of an administrative expense claim seeking payment for the post-petition deliveries. The Court allowed Tyson’s administrative expense claim pursuant to Sec. 503(b) (1) (A) in the amount of $2,603,841.09.

The creditors committee brought an adversary proceedings against Tyson to avoid preferential transfers under Sec. 547 and to recover those transfers under Sec. 550. Tyson claimed for the right to offset the unpaid administrative claim against preference liability. Tyson denied that the Debtor’s transfers to Tyson constituted avoidable preferences and sought a declaratory judgment that disallowance under Sec. 502(d) applied only to pre-petition claims and they do not interfere with the allowed post-petition administrative claim. Tyson asserted that its claim was an extrinsic setoff claim, wholly unrelated to the concept of new value defense or to the Sec. 547 preference analysis generally. The Committee argued that Tyson’s setoff claim was really a disguised or renamed post-petition new value defense because like a new value defense, it had the effect of reducing the total amount of preferential transfers restored to the estate. The Committee also argued that Sec. 502(d) prohibits set off of Tyson’s administrative claim until the preference is paid in full.

The issue before the court was: Whether an allowed, but unpaid post-petition administrative expense claim can be used to set off preference liabilities?

Citing the Third Circuit’s Friedman’s decision, the bankruptcy court first stated that the preference analysis cannot be affected by post-petition activity. The Court said that it doesn’t make sense to refer to any claim arising outside of the preference period as a new value defense. The Court added that a new value defense necessarily involves pre-petition activity, so association of the term “post-petition” and the term “new value defense” was inappropriate. Tyson’s claim comprised exclusively of post-petition activity and a Sec.547(c) (4) new value defense is limited to pre-petition activity. The Court also rejected the committee’s argument that Tyson’s claim was a disguised new value defense. The Court reasoned that the Tyson’s setoff claim did not affect the bottom line of the preference calculation; rather, setting off Tyson’s administrative claim affected only the amount paid to the estate. Thus, the Court held that the post-petition goods and services may not be counted as subsequent new value under section 547(c)(4) of the Bankruptcy Code.

On the issue of setting off a post-petition administrative claim, the Court pointed out that as per the judicial consensus; “setoff is only available in bankruptcy when the opposing obligations arise on the same side of the . . . bankruptcy petition date” i.e. the setoff applies to mutual, post-petition obligations. The Court stated that the Tyson’s administrative claim was clearly a post-petition obligation of the Debtor and the setoff was permissible in this case only if the allegedly opposing obligation – the preference claim – also arose post-petition. The Court added that as a matter of fact, a preference action is initiated only after the filing of a bankruptcy case or post-petition and preferential transfer claims are post-petition causes of action. Accordingly, Tyson correctly characterized its claim as a setoff claim, rather than as a post-petition new value defense. Thus, the Court concluded that the Tyson’s right to set off its allowed administrative expense claim against its preference liability was permissible.

The Court next rejected the Defendant’s assertion that pursuant to Section 502(d), Tyson was not entitled to any payment, including administrative payments, until the preference payment was satisfied. The Court reasoned that 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 because, under precedent in the District of Delaware, “administrative expense claims…are not subject to section 502(d) and are accorded special treatment under the Bankruptcy Code”.

The Court ruled in favor of Tyson and broadly concluded that the unpaid post-petition administrative claims, meeting the requirements for setoff under the applicable state laws, may be utilized to set off against preference liability.