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Note: ESA Environmental Specialists, Inc. (Contractor/Applicant) obtained payment and performance bonds from The Hanover Insurance Company (Insurer/Beneficiary) as a prerequisite to performing U.S. Government construction contracts. Because of Applicant's precarious financial position, Insurer/Beneficiary required Applicant to pay the bond premiums, obtain a standby LC in its favor, and execute an LC collateral agreement before Beneficiary would issue bonds for government projects. Applicant agreed that SunTrust Bank (Issuer) agreed to issue a standby LC in the amount of US$1,375,000, provided that Applicant post a Certificate of Deposit for the same amount. Applicant approached Prospect Capital (Guarantor) and amended the credit agreement increasing it by an additional US$1,550,000, $1,375,000 of which was posted in a certificate of deposit with Issuer.

After Applicant filed a voluntary U.S. Bankruptcy Code Chapter 11 petition, Beneficiary drew on the LC for $1,375,000. The bankruptcy court then ordered the sale of substantially all Contractor/ Applicant's assets to Guarantor, including the assumption and assignment of contracts bonded by Beneficiary to Guarantor's affiliate. When Guarantor's affiliate failed to complete the contracts, the court permitted the Beneficiary to exercise its right as surety and complete the jobs. The Bankruptcy court then entered a stipulation between the Applicant's Chapter 7 Trustee ("Trustee") and the Guarantor, allowing Trustee to pursue an avoidance action with 25% of the proceeds belonging to Trustee and 75% to Guarantor. The stipulation approved Guarantor's unsecured claim of US$11,775,000, for pro rata distribution between Trustee and Guarantor. Beneficiary objected to the stipulation.

Trustee then filed an adversary proceeding against Beneficiary, claiming that Beneficiary was an indirect beneficiary of the transfer of Guarantor's funds, and that the transfer of Guarantor's funds was avoidable as a preferential transfer under 11 U.S.C. § 547. The court granted Beneficiary's motion for summary judgment in the adversary proceeding, since (1) Beneficiary had a complete earmarking defense, because the Guarantor's funds were not property of the Applicant, its bankruptcy estate, and the Trustee had failed to meet the burden of proof under § 547(b); and (2) a complete new value defense, because the transfer of Guarantor's funds was a contemporaneous exchange for new value given to Applicant by Insurer/ Beneficiary in the form of new bonds and the ability to begin performance on federal contracts.

On appeal, The United States District Court for the Western District of North Carolina, in an opinion by Mullen, J., affirmed.

[JEB/jes]

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