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Velde v. Kirsch: BANKRUPTCY - replacement check for dishonored one a contemporaneus exchange for new value in these circcumstances; exception to preference transfer avoidance

1The Honorable Ralph R. Erickson, United States District Judge for the District
of North Dakota, sitting by designation.
2The Honorable Richard H. Kyle, United States District Judge for the District
of Minnesota.
United States Court of Appeals
No. 07-2017
David G. Velde, Chapter 7 Trustee, *
Appellant, **
Appeal from the United States
v. * District Court for the
* District of Minnesota.
David Kirsch, *
Appellee. *
Submitted: January 16, 2008
Filed: September 24, 2008
Before COLLOTON and SHEPHERD, Circuit Judges, and ERICKSON,1 District
ERICKSON, District Judge.
David G. Velde, a bankruptcy trustee for the District of Minnesota, appeals the
decision of the district court2 reversing and vacating a prior decision of the bankruptcy
court in an adversary proceeding. The trustee contends that the check received by
David Kirsch in replacement of a dishonored check was a payment made within the
ninety-day period prior to the filing of a bankruptcy and was thus a prohibited
preference under the Bankruptcy Code 547(b). Because the replacement check
resulted in the release of Kirschs banks security interest in collateral, it constitutes
a contemporaneous exchange for new value falling within an exception to the trustees
avoidance powers. We therefore affirm.
On February 3, 2004, an involuntary Chapter 7 bankruptcy petition was filed
against Daniel Miller, the owner of Danielson Grain, a crop storage elevator located
in East Grand Forks, Minnesota. Miller converted the involuntary case to a Chapter
11 proceeding. On September 29, 2004, the Bankruptcy Court converted Millers
petition back to a Chapter 7 case and appointed David Velde as trustee of Millers
bankruptcy. The trustee commenced several adversary proceedings, including this
case, to recover the value of checks that Miller issued during the ninety-day period
prior to the bankruptcy filing. This case arises out of a ,995.14 check Miller
issued on October 27, 2003, to pay for soybeans Kirsch had previously delivered to
Miller. The check was dishonored by Millers bank. Miller replaced the dishonored
check with a bank check within the ninety days prior to the original bankruptcy filing.
Both checks were made payable to Kirsch and his bank. Only after receiving
payment on Kirschs replacement check did Kirschs bank release its security interest
in the soybeans.
The Trustee brought an adversarial proceeding against Kirsch asserting that the
replacement check was a preferential transfer under the Bankruptcy Code. The
Bankruptcy Court held that a payment to cure a dishonored check cannot be a
contemporaneous exchange for value. Appeal was then taken to the district court.
The court reasoned that the release of the security agreement by the bank after receipt
of the replacement check constituted a contemporaneous exchange for new value, and
reversed. This appeal followed.
The issue presented is whether a trustee may avoid a prebankruptcy transaction
pursuant to 11 U.S.C. 547 where a debtor issues a replacement check jointly payable
to a creditor and its bank for a check which was previously issued and dishonored, or
whether a contemporaneous exchange for value occurs when the bank releases a
security interest in the debtors property only after receipt of payment from the second
check. We have jurisdiction over this appeal pursuant to 28 U.S.C. 158(d). We sit
as a second court of review in bankruptcy matters, applying the same standards of
review as the district court, and review the bankruptcy courts findings of fact for clear
error. M & S Grading, Inc. v. Killips (In re M & S Grading, Inc.), 526 F.3d 363, 367
(8th Cir. 2008). The bankruptcy courts conclusions of law are reviewed de novo. Id.
Here, the facts are not in dispute, and the interpretation of the Bankruptcy Code is
reviewed de novo.
Section 547 (b) of the Bankruptcy Code authorizes a bankruptcy trustee to avoid
preferential transfers made to creditors in the ninety days immediately prior to a
bankruptcy filing if the debtor was insolvent on the date of the transfer, the transfer
was in payment of an antecedent debt, and the recipient creditor received more than the
pro rata share it would have received in a Chapter 7 liquidation. Peltz v. Edward C.
Vancil, Inc. (In re Bridge Info. Sys., Inc.), 474 F.3d 1063, 1066 (8th Cir. 2007).
Section 547 serves two purposes. First, by permitting the trustee to avoid transfers
made in the ninety days before bankruptcy, creditors are discouraged from a race to the
courthouse during the slide into bankruptcy. Danning v. Bozek (In re Bullion Reserve
of N. Am.), 836 F.2d 1214, 1217 (9th Cir. 1988), cert. denied, 486 U.S. 1056 (1988).
Second, it furthers the prime policy of the Bankruptcy Act of an equal distribution of
the debtors assets among similarly situated creditors. Id. The trustee may avoid the
transfer of a debtors property to a creditor that diminishes the bankruptcy estate or
creates inequality among creditors, if the debtor was insolvent and the transfer was
made within ninety days of the filing of the bankruptcy petition. Stevenson v. Leisure
Guide of Am., Inc. (In re Shelton Harrison Chevrolet, Inc.), 202 F.3d 834, 837 (6th Cir.
It is undisputed that the replacement check in this case is a preferential transfer.
Miller, the debtor, was insolvent, the replacement check paid a preexisting obligation,
and Kirsch received one hundred percent of what he was owed, which was paid to his
bank rather than the pro rata share he would have received as an unsecured creditor.
Congress, however, has created an exception to this avoidance power if the
transfer is intended by the debtor and the creditor for whose benefit such a transfer was
made to be a contemporaneous exchange for new value given to the debtor, and is in
fact a substantially contemporaneous exchange. Official Plan Comm. v. Expediters
Intl of Washington, Inc. (In re Gateway Pac. Corp.), 153 F.3d 915, 917 (8th Cir.
1998). The purpose of this exception is to protect transactions that do not result in a
diminution of the bankruptcy estate. Anderson-Smith & Assocs., Inc. v. Xyplex, Inc.
(In re Anderson-Smith & Assocs., Inc.), 188 B.R. 679, 688 (Bankr. N.D. Ala. 1995).
If new value is given, a contemporaneous exchange does not diminish the estate. Endo
Steel, Inc. v. Jonas (In re JWJ Contracting Co. Inc.), 371 F.3d 1079, 1081 (9th Cir.
2004). Thus, in a cash transaction with the debtor, goods may be purchased or sold,
reducing the estate, but if cash is paid over for the value of the goods, the estate is
restored to the same position it had before the transaction occurred. A
contemporaneous exchange for new value occurs when a debtor incurs debt and pays
it by check at the same time, if the payor bank honors the check. Morrison v.
Champion Credit Corp. (In re Barefoot), 952 F.2d 795, 798 (4th Cir. 1991). In this
case, if the debtors check in payment of the soybeans had cleared the bank when
presented, it would have been a cash transaction and the Trustee could not have set it
aside. However, the debtors check was dishonored.
In the usual case, the substitution of a bank check for a previously dishonored
check from the debtor would not satisfy the new value requirement. Stewart v. Barry
County Livestock Auction, Inc. (In re Stewart), 282 B.R. 871, 874 (B.A.P. 8th Cir.
2002). That is because a dishonored check creates a debtor-creditor relationship
between the party issuing the check and the party who was not paid. The debtors
dishonored check is the functional equivalent of a promissory note. In re Barefoot, 952
F.2d at 800. Thus the holder of the dishonored check receives money in payment of
an unsecured antecedent debt when a replacement check is received. Id. The goal of
the Bankruptcy Code is to treat unsecured creditors equally, and substitution of a new
bank check diminishes the estate on the basis of a previous obligation.
Here, however, Kirschs bank did not release its security interest when Kirsch
received the first (subsequently dishonored) check payable to it and Kirsch. Rather,
the bank only released its security interest when it was actually paid on the second
check, which was jointly payable to Kirsch and the bank. This fact distinguishes the
cases relied upon by the Trustee. In In re Stewart, the trustee brought an avoidance
action to recover the proceeds of two cashiers checks issued to cover dishonored
personal checks delivered by the debtor on the day he purchased cattle at a livestock
auction. 282 B.R. at 873. The auction company argued that the replacement checks
were delivered because the company would not allow the debtor to participate until the
dishonored checks were paid. Id. The court concluded the intent of the debtor and
creditor was to satisfy a preexisting obligation, and the right to participate in
subsequent auctions after repayment did not constitute new value. Id.
In In re Barefoot, a mobile home dealer had five mobile homes on a floor plan
financing agreement with the creditor. 952 F.2d at 795. The creditor had taken all
necessary steps to perfect its security interest in the mobile homes. Id. at 797. Upon
receipt of a check by the creditor, it released its security interest in the mobile homes.
Id. Thereafter the check was dishonored within ninety days prior to its bankruptcy
filing. Id. The court concluded that the wire transfer payments in replacement of the
dishonored checks was a preferential transfer and ordered the return of the payments
to the bankruptcy estate. Id. at 802.
The same result was reached in JWJ Contracting Co., Inc. v. Janas (In re JWJ
Contracting Co., Inc.), 371 F.3d 1079 (9th Cir. 2004). There the trustee sought to
avoid new payments made to subcontractors to replace insufficient funds checks. Id.
at 1080. The subcontractors gave unconditional releases of their liens in exchange for
checks which were subsequently dishonored by the bank. Id. at 1081. The court
reasoned that the release of the liens at the time of the receipt of the insufficient funds
checks turned the transaction into a credit transaction and the subcontractors became
unsecured creditors. Id. at 1082.
In this case, however, Kirschs bank did not release its security interest until it
received the proceeds of the second check. Because the debtor held soybeans it could
not sell until the security interest was released, the debtor received new value for the
replacement check. Kirschs bank held a security interest in the soybeans that had not
been released. The debtor could not sell the beans for the benefit of the unsecured
creditors until he received a release of the security interest from Kirschs bank. The
bank would not release the security interest until it was paid. Under these
circumstances the estate received new value, soybeans now free and clear of the
security interest, in return for the bank check issued to Kirsch and the bank.
For these reasons, the judgment of the district court is affirmed.


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