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Eighth Circuit Holds ''Improvement in Position'' Defense Presupposes Creditor Held a Perfected Lien Prior to the Preference Period

Tuesday, September 13, 2011

Lange v. Inova Capital Funding, LLC (In re Qualia Clinical Serv., Inc.), No. 11-1201, 2011 BL 222786 (8th Cir. Aug. 30, 2011) The United States Court of Appeals for the Eighth Circuit affirmed a bankruptcy court’s ruling avoiding a creditor’s lien recorded in a debtor’s receivables during the preference period as a preferential transfer under 11 U.S.C. § 547(b). In so ruling, the Eighth Circuit rejected the creditor’s reliance on the "improvement in position" defense in 11 U.S.C. § 547(c)(5) and, particularly, its assertion that the lien did not improve its position because the value of the receivables exceeded the amount advanced. Alternatively, the Eighth Circuit resolved that the "improvement in position" defense presupposes that the creditor held a perfected lien prior to the preference period and provides that a creditor which enters the preference period without a perfected lien is deemed to have an interest of zero value for purposes of § 547(c)(5).

Inova Records a Lien in Debtor’s Accounts Receivable during the Preference Period

In 2007, Qualia Clinical Service, Inc. ("Debtor") entered into an invoice purchase agreement ("IPA") with Inova Capital Funding ("Inova"), pursuant to which Inova provided financing to Debtor by advancing payment on Debtor’s outstanding invoices. While the IPA permitted Debtor to "sell" its invoices to Inova, the agreement included a full recourse provision under which Debtor remained liable to Inova for the full amount of the each invoice "sold." Moreover, as collateral, the IPA granted Inova a security interest in Debtor’s property, including its accounts receivable. In February 2009, some eighteen months after execution of the IPA, Inova filed a UCC-1 financing statement in Nevada, Debtor’s state of incorporation. Approximately one month later, Debtor filed a petition for chapter 7 bankruptcy protection.

Bankruptcy Court Concludes Inova’s Lien Was an Avoidable Preference

Thereafter, the chapter 7 trustee ("Trustee") filed a complaint against Inova, seeking to avoid its lien on Debtor's accounts receivable as a preferential transfer under § 547. Inova then moved for summary judgment, asserting that it had an affirmative defense under 11 U.S.C. § 547(c)(5)(A), which excludes from avoidance, liens placed on a debtor’s inventory or accounts receivable if the lien did not improve the creditor’s position. In this regard, Inova argued that it did not improve its position in the preference period because the value of the receivables at all times exceeded the amount that had been advanced. As additional defenses, Inova relied upon 11 U.S.C. § 547(c)(5)(B), which limits a trustee’s avoidance of a preferential transfer to the extent that the creditor provided "new value" during the preference period, and asserted that the IPA was not a financing agreement, but rather a "true sale" of invoices, such that its lien was not on account of an antecedent debt as required by § 547(b). Ultimately rejecting Inova’s arguments and granting summary judgment in favor of the Trustee, the bankruptcy court concluded that Inova’s filing of the financing statement improved its position, regardless of the value of the receivables, because Inova was unperfected prior to the petition date. The bankruptcy court also held that the IPA was not a true sale given its recourse provisions. Following an appeal to the Bankruptcy Appellate Panel for the Eighth Circuit, which affirmed the bankruptcy court’s decision, Inova appealed to the Eighth Circuit.

Overview of the "Improvement of Position" Defense under § 547(c)(5)

Rendering its decision on appeal, the Eighth Circuit began by explaining that, under the "improvement in position" test set forth in § 547(c)(5)(A), a trustee is prevented from avoiding a creditor’s lien in a debtor’s receivables or inventory to the extent that the creditor did not improve its position as a result of the transfer. In applying this test, the Eighth Circuit determined that a court is first required to measure the difference between the amount of the debt owed to the creditor and the value of the property securing the debt on both the 90th day prior to the petition date and on the petition date. If there has been a reduction in the amount by which the debt exceeded the value of the security during this 90 day preference period, the Eighth Circuit found that the court must conclude that the creditor’s position has been improved and any transfers that create a perfected floating lien are voidable to the extent of such improvement. Samson v. Alton Banking & Trust Co. (In re Ebbler Furniture & Appliances, Inc.), 804 F.2d 87, 89-90 (7th Cir. 1986).

Eighth Circuit Rules "Improvement in Position" Defense Presupposes a Perfected Lien

Considering the "improvement in position" defense in the present case, the Eighth Circuit rejected Inova’s argument that its lien did not improve its position because it was oversecured at all times during the preference period and therefore, its position was not improved. Alternatively resolving that the value of a perfected security interest necessarily exceeds that of an unperfected one, the Eighth Circuit was guided by the legislative history of § 547(c)(5), which indicated that the purpose of the defense was intended to limit the rights of perfected floating lienholders vis-

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