Angell, Trustee v. Ray J. Pennington, Inc.

UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF NORTH CAROLINA
WILMINGTON DIVISION
IN RE:
PARTITIONS PLUS OF WILMINGTON, INC., 	Case No. 04-06776-8-JRL
D/B/A PARTITIONS, INC., D/B/A STORM 	Chapter 7
PROTECTION SYSTEMS,
Debtor.
JAMES B. ANGELL, CHAPTER 7 TRUSTEE
FOR PARTITIONS PLUS OF WILMINGTON, INC.,
D/B/A PARTITIONS, INC., D/B/A STORM 	Adversary Proceeding No.
PROTECTION SYSTEMS, 	L-06-00148-8-AP
Plaintiff,
v.
RAY J. PENNINGTON, INC. and RAY J.
PENNINGTON,
Defendant.
______________________________________________________________________________
ORDER
This case is before the court on the complaint of James B. Angell, chapter 7 trustee for
Partitions Plus of Wilmington, Inc., against Ray J. Pennington, Inc. and Ray J. Pennington
(“Defendant”) to avoid certain preferential transfers and to recover such transfers for the benefit of
SO ORDERED.
SIGNED this 20 day of March, 2008.
________________________________________
J. Rich Leonard
United States Bankruptcy Judge
____________________________________________________________
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1Defendant previously established that the three preferential payments were made on
account of work performed on projects that were divisible into three categories: (1) government
projects with government-required payment bonds; (2) public projects with surety bonds; and (3)
materialman’s lien rights projects. For payments resulting from projects involving
materialman’s lien rights, the court held that Defendant could not establish a valid new value
defense because it had no lien rights with respect to the property of the debtor pursuant to
Precision Walls, Inc. v. Crampton, 196 B.R. 299 (E.D.N.C. 1996), since it never perfected its
lien and gave up nothing by accepting payment.
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the estate. On February 27, 2008, a trial was held in Raleigh, North Carolina.
FACTS AND BACKGROUND
Partitions Plus of Wilmington, Inc. filed a chapter 11 bankruptcy petition on September 1,
2004. The case was converted to one under chapter 7 on November 9, 2004. Prior to the debtor’s
bankruptcy filing, Defendant worked as a sub-subcontractor for the debtor on several jobs. Within
ninety days prior to the debtor’s bankruptcy filing, Defendant received three checks from the debtor
totaling $7,305.48.
On July 14, 2006, the trustee filed this adversary proceeding, and an amended complaint was
later filed on August 23, 2006. The amended complaint alleges that the three payments to Defendant
constitute preferential transfers. Defendant answered by asserting, inter alia, that the payments
could not be avoided because they were a contemporaneous exchange for new value given to the
debtor under 11 U.S.C. § 547(c)(1). Both parties filed summary judgment motions. The court’s
order resolving these motions concluded that the three payments were preferential transfers under
§ 547(b). Angell v. Ray J. Pennington Inc. et al. (In re Partitions Plus, Inc.), Adv. Pro. 06-00148-8-
AP (Bankr. E.D.N.C. June 11, 2007). In addressing Defendant’s new value defense for payments
arising out of projects involving government-required payment bonds and surety bonds,1 the court
held that Defendant did not establish a new value defense at that time, but that it could later do so
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by presenting sufficient evidence that (1) it would have timely filed a claim against the project bond
had it not received payment from the debtor, and (2) at the time, the debtor was still owed funds by
the general contractor on which the bonding company could have asserted a lien. Id.
Both parties again filed cross-motions for summary judgment addressing this issue. 	In
support of its claim that it would have filed a bond claim had it not received the preferential
payment, Defendant presented evidence that (1) it filed a bond claim in the only other instance in
which the debtor did not tender payment to the Defendant, and (2) the bonding company paid this
claim in full. The trustee contended that this evidence was too speculative to establish as a matter
of law that Defendant would have filed a timely bond claim in these other instances. The court ruled
that Defendant’s evidence was sufficiently corroborative of its likely conduct to create a genuine
issue of material fact, but that it was insufficient to sustain its defense as a matter of law. Angell v.
Ray J. Pennington Inc. et al. (In re Partitions Plus, Inc.), Adv. Pro. 06-00148-8-AP (Bankr. E.D.N.C.
December 3, 2007).
ANALYSIS
I. New Value Defense – Background
The Bankruptcy Code provides that a trustee may avoid a pre-petition transfer of a debtor’s
property, if it is shown that the transfer was:
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer
was made;
(3) made while the debtor was insolvent;
(4) made . . . on or within the 90 days before the date of the filing of the petition . .
.; and
(4) that enables such creditor to receive more than such creditor would receive if
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the
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provisions of this title.
11 U.S.C. § 547(b). The legislative history of the preference statute reveals its two-fold purpose:
First, by permitting the trustee to avoid prebankruptcy transfers that occur within a
short period before the bankruptcy, creditors are discouraged from racing to the
courthouse to dismember the debtor during his slide into bankruptcy. The protection
thus afforded the debtor often enables him to work his way out of a difficult financial
situation through cooperation of all his creditors. Second, and more important, the
preference provisions facilitate the prime bankruptcy policy of equality of
distribution among creditors of the debtor. 	Any creditor that received greater
payment than others of his class is required to disgorge so that all may share equally.
H.R. Rep. No. 595, 95th Cong., 1st Sess. 177-78, reprinted in 1978 U.S. Code Cong. & Admin.
News 5787, 5963, 6138.
Certain transfers that would otherwise qualify as preferential transfers are often made for
purposes that do not frustrate § 547(b)’s goals, and the Code exempts these transfers from the
trustee’s avoidance power. See § 547(c)(1)-(5). 	This case is concerned solely with the
“contemporaneous exchange of new value” defense under § 547(c)(1). According to § 547(c)(1),
a trustee may not avoid a preferential transfer “to the extent that such transfer was (A) intended by
the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous
exchange for new value given to the debtor; and (B) in fact a substantially contemporaneous
exchange.” As used § 547(c)(1), “new value” is defined as
money or money’s worth in goods, services, or new credit, or release by a transferee
of property previously transferred to such transferee in a transaction that is neither
void nor voidable by the debtor or the trustee under any applicable law, including
proceeds of such property, but does not include an obligation substituted for an
existing obligation.
11 U.S.C. § 547(a)(2). The primary justification for the new value exception is that the transfer of
new value to the debtor will offset the payment and, therefore, the bankruptcy estate will not be
depleted to the detriment of other creditors. 1 DAVID G. EPSTEIN ET AL., BANKRUPTCY § 6-
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2In re J.A. Jones, Inc., 361 B.R. 94 (Bankr. W.D.N.C. 2007) summarized the “indirect
transfer” theory in the context of the release of a subcontractor’s lien rights as new value.
Although this case involves the release of a subcontractor’s bond claim as opposed to lien rights,
the “indirect transfer” theory is equally applicable. See Angell v. Ray J. Pennington Inc. et al.
(In re Partitions Plus, Inc.), Adv. Pro. 06-00148-8-AP (Bankr. E.D.N.C. June 11, 2007).
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25, at 592 (1st Cir. 1992).
II. The “Indirect Transfer” Theory
The new value defense is frequently raised in cases in which a general contractor has filed
for bankruptcy relief. In this context, subcontractors who received alleged preference payments
defend the preference suit by invoking a specific theory of the new value defense – the “indirect
transfer” theory.2 In its purest form, the “indirect transfer” theory is premised on the following
assumption: had a debtor general contractor not paid a subcontractor for work performed on a
project secured by a payment bond, the subcontractor would have filed a bond claim. The bonding
company, who would be forced to pay the subcontractor, would then seek indemnification from the
owner for funds owed to the debtor general contractor. In re J.A. Jones, Inc. 361 B.R. at 102. The
crux of the “indirect transfer theory” is that the debtor general contractor’s estate is not diminished
to any greater degree by the preferential payment to the subcontractor than it would have been had
the subcontractor enforced its right to collect on the project bond and prevented the funds from ever
reaching the debtor’s estate.
A. Prima Facie Case
In order to establish a valid new value defense using an “indirect transfer” theory in a case
involving a subcontractor, a defendant must show that (1) it would have timely filed a claim against
the project’s payment bond and been paid in full had it not received payment from the debtor, and
(2) at the time, the debtor was still owed funds by the general contractor on which the bonding
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company could have asserted a lien.
B. First Element: Filing of a Bond Claim and Payment in Full
Although this framework is seemingly straightforward, application of the first element can
be particularly difficult because proving that a subcontractor would have timely filed a bond claim
and been paid in full by the bonding company requires a degree of speculation since a subcontractor
can only hypothesize as to what actions it would have taken. In re J.A. Jones, Inc., 361 B.R. 94
(Bankr. W.D.N.C. 2007) attempted to remove the uncertainty of this speculation in the context of
a release of lien rights by adopting an objective approach that asks “what would a reasonable
materialman have done in response to that nonpayment.” Id. at 103. With little difficulty, the court
concluded that a “reasonable subcontractor would assert his legal rights, liening the project,
perfecting those liens and forcing payment through the owner.” Id.
The court finds this objective approach problematic for two reasons. First, it relieves the
subcontractor of the burden of proving a necessary element of its defense. A party asserting a new
value defense has the burden of proving each element. 11 U.S.C. § 547(g). However, assuming,
as the objective approach does, that a reasonable subcontractor would file a timely bond claim
effectively eliminates the subcontractor’s burden of proof regarding this issue.
The second and perhaps most troubling problem with the objective approach is that it is not
always entirely clear how a reasonable subcontractor would react to nonpayment. Subcontractors
that have appeared before this court have stated that they do not always file timely claims when
faced with nonpayment. Their primary justification is that they do not want a reputation of being
unyieldingly harsh in their business dealings. 	These subcontractors assert that it is difficult,
especially in competitive markets, to maintain good business relationships with general contractors
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if the general contractor fears that the subcontractor will file a bond or lien claim based on the
slightest delinquency in payment. 	For these reasons, the court finds the objective approach
unworkable.
A subjective approach, on the other hand, remedies both problems of the objective approach.
First, it remains consistent with § 547(g) by keeping the burden of proving each element of the new
value defense on the subcontractor. Second, it eliminates the objective approach’s assumption that
reasonable subcontractors would always file a bond claim and replaces it with a requirement of
competent proof of the subcontractor’s intention. The subjective approach, admittedly, requires
some amount of speculation. Given the proper evidentiary showing, however, a subcontractor can
sufficiently negate speculation with respect to the actions it would have taken to meet its burden of
proof.
The question remains: just how much evidence is necessary to make this showing? The
evidentiary requirement differs depending on the stage of the litigation. In the summary judgment
context, a subcontractor must present evidence beyond its own unsupported assertion that it would
have filed a bond claim. See Callaway v. Kiddco, Inc. (In re Jacobsen Constr., Inc.), Adv. Pro. S-
06-00028-5-AP (Bankr. E.D.N.C. March 26, 2007). For example, a subcontractor could show that
it filed bond claims in the only other instances in which the debtor did not tender payment to the
defendant. Angell v. Ray J. Pennington Inc. et al. (In re Partitions Plus, Inc.), Adv. Pro. 06-00148-8-
AP (Bankr. E.D.N.C. December 3, 2007). Practice in the industry, or conduct with regard to other
general contractors, may be relevant.
The proof requirement obviously increases as the litigation progresses to trial. Although
there is no controlling authority listing the quantum of evidence necessary to make this showing, the
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3The court is well aware that future subcontractors attempting to establish a similar new
value defense may not have faced the necessity of filing a previous bond claim. In no way does
the court’s opinion today establish the requirement that a subcontractor have filed a bond claim.
Instead, this particular fact is used only in conjunction with the other facts in order to most
accurately predict how Defendant would have reacted.
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court finds that Defendant’s cumulative evidence in this case is sufficient to establish that it would
have filed a bond claim had it not been paid. First, Robert L. Pennington, one of Defendant’s two
employees, testified that it is Defendant’s general practice of over twenty years to file bond claims
if faced with nonpayment. In fact, Pennington testified that Defendant collects in full on 98% of all
overdue invoices, and that the only invoices for which it does not collect in full are those in which
it credits the general contractor for a specific reason. This testimony seems to imply that Defendant
collects, by some method, on 100% of all overdue invoices. Additionally, as noted in a previous
order, Defendant filed a bond claim and was paid in full in the only instance of nonpayment by this
debtor. That Defendant took action consistent with its stated intentions is indicative that it likely
would have taken the same course of action had it earlier been faced with nonpayment.3 Finally,
Pennington testified at trial that he personally addresses all overdue invoices in a manner the
protects Defendant’s right to timely file liens or bond claims. Pennington testified that it is his
policy to address all invoices that are overdue by at least ninety days in order to keep track of the
invoice in case it becomes necessary to file a lien or bond claim by the 120th day, the last day in
which such lien or bond claims are often permitted. 	This policy only adds further support to
Defendant’s claim. While no single piece of Defendant’s evidence would have been sufficient, by
itself, to carry the burden of establishing the new value defense, Defendant’s evidence, taken as a
whole, amply supports its contention that it would have filed a bond claim had it not been paid.
That Defendant has convinced the court that it would have filed a bond claim had it not
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received the preferential payments does not fully resolve the issue, however. Defendant must further
show that its bond claim would have been paid in full. In this case, Defendant submitted evidence
that it was, in fact, paid in full for a subsequent bond claim in this project. In light of the trustee’s
lack of contradictory evidence, this court has no reason to believe that a solvent bonding company
that later paid a bond claim in full would have been unable or unwilling to pay a prior bond claim
in full as well. Based on the foregoing evidence, the court concludes that Defendant has established
that it would have filed a bond claim had it not received the preferential payments, and that the
bonding company would have paid the bond claim in full.
C. Second Element: Money Available for Bonding Company To Assert Lien
The second element of the “indirect transfer” theory is that the subcontractor must prove that
the debtor general contractor was still owed money on which the bonding company could have
asserted a lien. 	Without this evidence, the “indirect transfer” theory fails because the
subcontractor’s release of its bond claim would have no value if the bonding company was unable
to enforce the debtor general contractor’s obligation on the payment bond. 	In most cases, the
viability of an “indirect transfer” theory appears to hinge on this factor. In re J.A. Jones, Inc. 361
B.R. at 103; see also Askenaizer v. Seacoast Redimix Concrete, LLC (In re Charwill Constr., Inc.),
2007 Bankr. LEXIS 4379 (Bankr. D.N.H. Dec. 21, 2007).
In this case, Defendant’s evidence consists of (1) the fourteen invoices whose payments are
the subject of this preference action, and (2) Defendant’s answers to the trustee’s first set of written
interrogatories, which contain Defendant’s 	uncontradicted statements that the debtor received
certain disbursements after the invoice dates. Defendant asserts that the bonding company could
have asserted a lien on these disbursements. However, that the debtor received disbursements after
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the invoice dates is insufficient. Instead, the debtor must have received these payments during a
time in which the bond claim would have been filed. In this case, the relevant time period in which
to look is 90 to 120 days after the invoice date because this is the time period during which
Pennington testified that a bond claim would have been filed.
Based on the invoices submitted by Defendant, the court concludes that only two of the
invoices meet this test. The first eligible invoice is Invoice Number 312, which was invoiced on
March 22, 2004, in the amount of $500.00 for work performed on the University of South Carolina,
Beaufort project. 	According to Defendant’s 	evidence, the debtor received a subsequent
disbursement from Brookwood Construction in the amount of $59,625.00 on July 13, 2004. Thus,
this disbursement was made 113 days after the invoice date, and assuming that Defendant would
have filed a timely bond claim and been paid in full, the bonding company could have asserted a lien
on these funds. The second eligible invoice is Invoice Number 317, which was invoiced on March
26, 2004, in the amount of $2,000.00 for work performed on the Cape Fear Community College
project. According to Defendant’s evidence, the debtor received a subsequent disbursement from
Lee F. Cowper, Inc. in the amount of $163,632.40 on June 28, 2004. Thus, this disbursement was
made 94 days after the invoice date. Again assuming that Defendant would have filed a timely bond
claim and been paid in full, the bonding company could have asserted a lien on these funds as well.
In none of the other payments is there evidence that the debtor received money from the general
contractor after the bond claim would have been filed.
CONCLUSION
Based on the foregoing, Defendant has successfully established a new value defense with
respect to $2,500.00 of the preferential payments. 	Therefore, the trustee is entitled to recover
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$4,805.48 of the preferential payments for the benefit of the estate. The clerk is directed to enter
judgment accordingly.
“END OF DOCUMENT”
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