Prior History: Campbell v. Hanover Ins. Co., 457 B.R. 452 (W.D.N.C. 2011) [USA], noted in 2012 ANNUAL REVIEW OF INTERNATIONAL BANKING LAW & PRACTICE at 381.

Note: To repay existing indebtedness to Hanover Insurance Co. (Financier) and fund costs associated with entering into various government contracts (Initial Contracts), ESA Environmental Specialists (Contractor), a government contractor, borrowed USD 12.2 million from Prospect Capital Corp. (Lender). Contractor also asked Financier to issue surety bonds to collateralize its prospective government contracts (New Contracts). Financier did so but required Contractor to secure them with a standby LC that was issued by SunTrust Bank (Issuer). The standby was intended to collateralize existing debts to Financier for the Initial Contracts as well as the surety bonds for the New Contracts. As collateral, Contractor provided Issuer with a USD 1.375 million CD and borrowed the additional funds from Lender.

Despite being awarded the New Contracts, Contractor's financial condition deteriorated and it filed a Chapter 11 (reorganization) petition in the U.S. Bankruptcy Court for the Western District of North Carolina, causing Financier to draw on the LC. To reimburse itself, Issuer liquidated the CD. The bankruptcy court approved the sale of all of Contractor's assets to Lender and converted Contractor's case from a Chapter 11 proceeding to Chapter 7 (liquidation), appointing Stanley Campbell (Trustee) as trustee.

Trustee sued Financier, alleging that Contractor's transfer of the loan proceeds into the CD was an avoidable preferential transfer under 11 U.S.C. § 547. The bankruptcy court granted summary judgment in Financier's favor and the U.S. District Court for the Western District of North Carolina, Graham, J., affirmed. On appeal, the U.S. Court of Appeals for the Fourth Circuit, Mullen, J., affirmed.

Trustee claimed that the bankruptcy court had improperly ruled that Financier was entitled to raise earmarking as an affirmative defense. He argued that the earmarking defense, a judicially created exception to preferential transfers, did not apply because use of Lender's loan to collateralize both the New Contracts and the Initial Contracts was not, strictly speaking, payment of an antecedent debt. Trustee argued that the contemporaneous new value defense promulgated under 11 U.S.C. § 547(c)(1) was improperly applied because Financier did not prove with specificity the amount of new value it provided. Lastly, Trustee argued that the bankruptcy court improperly relied on equitable grounds, which are not recognized as a defense to avoidable action in bankruptcy.

The appellate court agreed with Trustee's argument on the earmarking defense but affirmed the lower court's judgment based on the contemporaneous exchange for new value defense. For the latter to succeed, Financier was required to show that the New Contracts had value at least as great as the amount of the alleged preferential transfer. After making that showing, Financier would not be required to narrow its valuation to a particular estimate. It was undisputed that the CD was transferred to cover the LC amounted to USD 1.375 million, and the appellate court found that Trustee offered no evidence to contradict the affidavit of Contractor's former CEO, who valued the New Contracts in excess of USD 3.9 million.



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.