Replacing a Bad Check Could Be ‘New Value’

When a check bounces, making good on it is normally just paying off a debt owed.   If that happens during the 90-days before a bankruptcy is filed, it would be an avoidable preference. But if a lender plays its cards right, it may be able to protect itself after all.

In the normal scenario of a financial meltdown, bad checks are sometimes written.  If the bad check is the payoff on a secured debt — like a car loan or mortgage — some lenders have released their lien on the collateral when they receive the check.  Only to find out the check is no good.  Lenders are understandably upset when checks bounce and will often threaten to take back the collateral or even prosecute the debtor for writing a bad check.  So often debtors will rush to make good on those checks.

If that payment on the bad check comes within the 90-days prior to a bankruptcy filing, many courts hold that it is payment on an unsecured debt.  As such it might be an avoidable preference — the bank would have to give the money back to the trustee — for the benefit of all creditors.

The Eighth Circuit today identified a narrow loophole through which a bank might protect itself from a bankruptcy trustee.  In this case, the bank had received a bad check from the debtor to pay off a secured debt.  But the bank was careful and did not release the lien on the collateral until it was later paid with a good check.

The Eighth Circuit concluded this provided “new value” for the payment because the debtor received the collateral (in this case, soybeans) free of liens which could then be sold.  So the debtor’s estate was not in fact diminished.

One can quibble with the Court over whether this was “new value” or simply the bank receiving what it would have been entitled to receive under a Chapter 7 liquidation based on its security interest in estate property (under 547(b)(5)) as opposed to “new value” (under 547(c)(4)) but the result is the same:  A careful secured lender can avoid preference liability when a debtor is melting down.

See, Velde v. Kirsch (In re Miller), #07-2017 (8th Cir. 9/24/08)