The issue of whether lease payments constitute preferential payments under 11 U.S.C. §547 may seem obvious at first. After all, they were made in the ordinary course of business, were they not? If the answer is no, and therefore the lessee untimely made its lease payments, then perhaps the new value defense(s) applies. After all, the lessor did not terminate the lease immediately upon default, which one might argue is new value. Assuming no additional consideration, i.e., additional lease space, is granted to the lessee, the issue therefore becomes whether mere forbearance constitutes new value.

Although many reading this article will quickly offer a negative opinion upon the subject, many courts are holding that forbearance may equal new value under the right circumstances. Thus, the answer may be more complicated than it first appears. The question is, therefore, when does a lessor's forbearance from lease termination support a new value defense, and which defense does it support?

The Application of New Value

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 property, but does not include an obligation substituted for an existing obligation. 11 U.S.C. §547(a)(2).

Stated otherwise, new value is not "esoteric or intangible benefits," and "must actually and in real terms enhance the worth of the debtor's estate so as to offset the reduction in the estate that the transfer caused." Miller v. Bodek & Rhodes Inc., 184 B.R. 224, 228 (E.D. Pa. 1995); see, also, Kroh Brothers Development Co. v. Continental Construction Engineers Inc., 930 F.2d 648, 652 (8th Cir. 1991) (where the court stated that "the relevant inquiry is whether the new value replenishes the estate"). New value, however, does not require that additional assets are available for distribution to creditors, but rather that actual new value was available to the debtor in the conduct of its business. Brown v. Morton, 201 B.R. 563, 565 (Bankr. W.D. Wash. 1996).

Consequently, since actual new value is required, i.e., a new benefit to the estate, mere forbearance does not equal new value. Bernstein v. RJL Leasing, 50 B.R. 403 (Bankr. D. Colo. 1985). In Bernstein, the court found that a lessor's forbearance from lease termination did not constitute new value under §547(c)(1) as the debtor/lessee did not economically benefit by the lessor's forbearance. Bernstein v. RJL Leasing, 50 B.R. at 409. More particularly, the debtor/lessee made all lease payments after the alleged preferential payments, which circumvented the application of the subsequent new value defense. Id.

While Bernstein is a good example of how mere forbearance does not equal a contemporaneous exchange for new value, it is not alone in its holding. In fact, numerous other courts reached similar conclusions that mere forbearance does not equal new value, at least for the contemporaneous exchange defense. See, e.g., Matter of Duffy, 3 B.R. 263, 266 (Bankr. S.D.N.Y. 1980) (where the court, reasoning that an obligation substituted for an existing obligation is expressly excluded from the definition of new value under §547(a)(2) and, therefore, the lessor's forbearance was not new value); Bavely v. Merchants National Bank, 36 B.R. 582, 584 (Bankr. S.D. Ohio 1983) (where a lessor's forbearance from evicting a debtor/lessee from leased premises increased the value of the estate, thereby enabling the sale of assets, the court nevertheless held that substitution of one obligation for another is not new value since no actual new value was given); Chase Manhattan Bank v. Dent, 78 B.R. 351, 354-55 (Bankr. S.D. Fla. 1987) (where the court found that a lessor's forbearance following a debtor/lessee's default did not constitute new value). Thus, courts are somewhat uniformly holding that mere forbearance does not equal the contemporaneous exchange for new value defense.

However, and as stated by one leading commentator more than 10 years ago, subsequent new value may include "the value of leased equipment when the lessor permitted the debtor-lessee to continue using the equipment to produce inventory after default in rental payments." Countryman, "The Concept of a Voidable Preference in Bankruptcy," 38 Vand. L. Rev. 713, 785-86 (1985). Based on this concept, courts are holding that forbearance may not support the contemporaneous exchange for new value defense, but may support the subsequent new value defense.

The Subsequent New Value Savior

Under 11 U.S.C. §547(c)(4), the subsequent new value defense states that a trustee may not avoid a transfer 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...on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor. The subsequent new value defense thus differs from the contemporaneous exchange for new value defense in that the new value came after the preferential payment, as opposed to a substantially contemporaneous exchange. See 11 U.S.C. §547(c)(1) and (4).

Based on §547(c)(4)'s language, some courts have reasoned that when the value to the debtor/lessee of using leased equipment exceeds the total amount of the preferential payments, the lessor has provided subsequent new value. In re Quality Plastics Inc., 41 B.R. 241 (Bankr. W.D. Mich. 1984). In Quality Plastics, the court found that unpaid subsequent lease payments provided new value, in the form of free rent for preferential lease payments. Id. at 243-44. The court made this determination based on the fact that since each lease payment was due and payable as the lease term progressed, and as the lessee occupied the premises, each lease payment was an independent obligation. Id. at 244, citing In re Mindy's Inc., 17 B.R. 177, 179 (Bankr. S.D. Ohio 1982). Thus, the court concluded that when the value of subsequent but independent obligations exceeds the preferential payments, the subsequent new value defense bars avoidance.

Similarly, and more recently, another court held that under §547(c)(4), a defendant/lessor could offset the full amount of lease payment defaults against the alleged preferential payments if the debtor/lessee defaults after the preferential payments. Brown v. Morton, 201 B.R. 563, 566 (Bankr. W.D. Wash. 1996). Thus, Brown expressly rejected the idea that a lessor's forbearance from lease termination cannot constitute new value when a lessor also provides a debtor/lessee with premises for a period that had not yet begun as of the date of the preferential payment. Id.

As in Quality Plastics, the court based its determination on the debtor/lessee's obligation to pay rent as the lease term progressed, and the debtor/lessee's right to possession over time as long as it was not in default. Id. at 566. Consequently, by allowing the debtor/lessee to remain in possession of the premises without paying rent, the landlord extended value that did not exist at the time the lease was executed. Id. at 567.

The proposition has also been adopted by the Eighth Circuit, which held that a debtor/lessee could not avoid prior late lease payments to the extent that the debtor/lessee remained in possession thereafter without paying any rent since such possession facilitated the continued operation and income generation and, in turn, increased the chances of survival of the debtor, benefiting all creditors. Southern Technical College Inc. v. Hood, 89 F.3d 1381, 1385 (8th Cir. 1996). Accordingly, the rent-free use of the property constituted a "material benefit" to the debtor, thereby replenishing the bankruptcy estate after the alleged preferential payment, which supports the application of the subsequent new value defense. Id. However, in Southern Technical, as well as in all of the above-cited cases, the resolution focused on circumstances where subsequent new value, in the form of additional time under the lease, remained unpaid and unsecured. Thus, despite the express language of these cases, courts are not actually holding that mere forbearance equals new value, but instead that free rent is subsequent new value. This distinction, though clouded by case law, goes to the root of the subsequent new value defense in that an actual new benefit was received by the debtor, not just mere forbearance.

Nevertheless, courts are stating that the subsequent new value defense applies to a lessor's forbearance as summarized by Sunbeam Oyster Co. Inc. v. Lincoln Liberty Ave. Inc., 145 B.R. 823 (W.D. Pa. 1992). In Sunbeam, the court stated, "we agree with the bankruptcy court that forbearance by a lessor from exercising its rights under a lease does not constitute new value when the debtor is not using the property." Id. at 830.

Conclusion

Despite the language of the cases cited herein, a closer examination reveals that forbearance alone does not equal new value. The fact of the matter is that the above-cited subsequent new-value cases contain factual scenarios where an additional benefit was actually given in the form of free rent as opposed to mere forbearance. Since the debtor/lessee received free rent, the subsequent new value defense applied. Thus, practitioners must not overlook the obvious; free rent is an additional benefit that differs from mere forbearance.