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Home / Case News / A Preference Transfer Made for a Labor Contract May Invoke New Value Defense Only When “Work” Begins After a “Preference”

A Preference Transfer Made for a Labor Contract May Invoke New Value Defense Only When “Work” Begins After a “Preference”

August 1, 2020, Central District of Illinois – Defendant, a radiologist, is a former employee and shareholder of a Debtor. The Defendant began working for the Debtor in 2003. He became a shareholder in 2005 and remained a shareholder until April 2012, at which time he sold his shares in the Debtor to Dr. Aldo C. Ruffolo (“Ruffolo”), the Debtor’s former CEO.

The Defendant entered into an agreement with the Debtor regarding the sale of his shares and his continued employment with the Debtor. Under the terms of the contract, the Defendant agreed to work for the Debtor for an annual salary of $550,000 per year. The second part of the agreement was a stock purchase agreement between the Defendant and Ruffolo individually, whereby Ruffolo agreed to purchase all of the Defendant’s shares in the Debtor for $600,000.

The stock purchase agreement required Ruffolo to pay the Defendant $200,000 within 120 days of the closing date of the agreement. The remaining balance of $400,000 was to be paid in four (4) equal annual installments of $100,000 each. On April 30, 2012, Ruffolo transferred the initial $200,000 payment into the Defendant’s Wells Fargo account. Neither Ruffolo nor the Debtor further complied with their obligations under the agreement. Ruffolo made no further payments under the stock purchase agreement. Similarly, the Debtor failed to timely pay the Defendant’s salary under the agreement resulting in a $216,849.00 claim for unpaid wages. The Debtor testified that he received no salary payments after 2014 except two payments of $12,124.41 each.

The Debtor subsequently filed its bankruptcy petition on April 24, 2015. Two years later, the Trustee filed a complaint against the Defendant to avoid the salary payments as preferential transfers according to 11 U.S.C. § 547(b), avoid the $200,000 stock payment to the Defendant as a fraudulent transfer under 11 U.S.C. § 548(b). On May 20, 2019, hearing, it was stipulated that the salary payments constituted preferential transfers under § 547(b) and the Court was now only tasked with determining if any of the Defendant’s potential defenses were available to him.

The Defendant asserted that he was entitled to a defense under § 547(c) because he gave new value for the benefit of the Debtor and thus salary payments cannot be recovered as preferential transfers. According to the Defendant, the new value he extended to Debtor was his continuing employment. The employment agreement purported to pay Defendant $550,000 for the first three years and this amount could be changed by a vote by the Board of Directors for the last two years.

The Defendant alleged that he worked under this agreement up to Debtor’s bankruptcy and had received two payments totaling $24,248.82 within the 90 days before filing. The Defendant further added that the preferential transfers made by Debtor were to make up for salary payments it already owed to Defendant. The payments were not given to Defendant so that he would start working for Debtor after they were made. The Court relied on Stahl v. Whelan Elec., Inc. (In re Modtech Holdings, Inc.), 503 B.R 737 (Bankr. C.D. Cal. 2013), and concluded that a preference made for a labor contract can invoke the defense under § 547(c)(4) but only when they begin work after the preference.

The Court found that in the case at bar, the Defendant’s continued labor was not new value because he had been providing the labor for the entire duration of the employment agreement and did not begin providing the labor due to the two payments. Thus, the Defendant was not entitled to a defense under § 547(c)(4) and, since no other defenses were brought by Defendant, the Court found that the two payments totaling $24,248.82 were preferential transfers subject to avoidance by Plaintiff.

The Court further added that as at the hearing on May 20, 2019, Defendant’s then counsel had admitted that the stock payment constituted a fraudulent transfer according to § 548. this renders a discussion of avoidability under Counts II and III unnecessary. Accordingly, the Court concluded that the preferential transfers of $24,248.82 and that the fraudulent transfer of $200,000 was avoidable, but the Plaintiff may only recover the preferential transfers totaling $24.248.82 plus interest and costs from the Defendant.