Thursday, November 20, 2014

What is the Ordinary Course to a Preference Claim in Bankruptcy? (Stephen Stapleton)

By Steve Stapleton

The facts: You are owed a substantial sum of money - one million dollars -- on a pre-existing obligation.  But the debtor is having nascent financial issues.  Although he was paying like clockwork - 30 days net -- he still owes $800,000 and has paid you nothing for the last 60 days.  You accelerate and demand payment in full.  And that's what you get: payment in full. Two months later you receive a bankruptcy notice from your erstwhile debtor.  He's filed chapter 7.  No need to worry about that, you tell yourself.  You've already been paid.  But almost two years later, the chapter 7 trustee says that you received a preference and demands that you pay back, in ten days, the $800,000 that you had previously received two years earlier.
 
Assuming the debtor is not paying his creditors in full, under the facts above, you've received a preference. The question now is whether you have a valid defense.
 
A preference is a transfer made to or for the benefit of a creditor, for or on account of an antecedent debt, made while the debtor was insolvent, made on or within 90 days before the bankruptcy filing date (or one year if the creditor was an insider), that enabled the creditor to receive more than it would have received had the debtor been in chapter 7, the transfer had not been made and the creditor had received what he would have been entitled to receive under such chapter.
 
The ordinary course of business defense is available to defeat a preference claim if the transfer (ie, the payment) was made (a) according to ordinary business terms between the parties or (b) according to ordinary industry practice within the debtor's and the creditor's respective industries.
 
Courts have considered a myriad of factors in determining whether a transfer was ordinary as between the parties, "including: (1) the length of time the parties engaged in the type of dealing at issue; (2) whether the subject transfers were in an amount more than usually paid; (3) whether the payments are issue were tendered in a manner different from previous payments; (4) whether there appears to have been an unusual action by the debtor or creditor to collect or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as additional security) in light the of the debtor's deteriorating financial condition." Stanziale v. Southern Steel (In re Conex Holdings, LL)), Adv. Pro. No. 12-51211, at 13 (Bankr. D. Del., October 15, 2014).
 
To determine whether, under our hypothetical, there is a valid ordinary course defense based on the parties' course of dealing, you compare the payments made during the pre-preference period to those made during the preference period - the 90 days before bankruptcy.  If the dates between invoice date and payment date are substantially the same, comparing the preference period to the pre-preference period, you have a valid defense.  If they are not, in other words, "if a preference period payment falls beyond the pre-preference mean" (Davis v. Clarklift-West, Inc. (In re Quebecor World (USA), Inc.), Adv. Pro. No. 10-1568, at 8 (Bankr. S.D.N.Y., October 14, 2014)), you don't.
 
In our hypothetical, on a pre-preference period basis, the debtor was paying "like clockwork," 30 days net between invoice and payment date.  During the preference period, however, he paid only once, more than 60 days after it was due. Because the pre-preference period payments were paid in 30 days and the preference period payment was greater than 60 days past the invoice date, the dates between invoice and payment in the preference period and the pre-preference period are not substantially the same; the preference period payment was beyond the pre-preference mean. You've received a preference that is not saved by the safe harbor attendant to the parties course of dealing. 

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