December 15, 2015
Chief Judge Stark (D. Del.) Issues a Pair of Opinions Addressing New Value, Ordinary Course of Business, and Earmarking Defenses (Part II)
By Evan T. Miller
The second of Chief Judge Stark’s two September 2015 opinions is Prudential Real Estate v. Burtch (In re AE Liquidation, Inc.), 2015 WL 5301553 (D. Del. Sept. 10, 2015). The pertinent facts of that case are as follows: in May 2006, the Debtor engaged the defendant/appellant, Prudential Real Estate and Relocation Services, Inc. and Prudential Relocation, Inc. (“Prudential”), to perform various relocation services for the Debtor’s employees. The agreement contemplated that the Debtor would pay Prudential for services within 30 days of receiving an invoice. While the Debtor was timely with its payment of invoices during the first year and a half of the parties’ agreement, the Debtor began to fall behind. As a result, Prudential placed the Debtor on “billing review,” which implemented the following conditions: (1) Prudential would not accept new employee transfers, (2) the Debtor would begin paying Prudential on a weekly, instead of monthly, basis, (3) the Debtor would pay a $900,000 lump sum to reduce the outstanding accounts receivable balance, and (4) Prudential would eventually terminate the agreement if the conditions were not satisfied. By January 18, 2008, the Debtor had complied with these terms and Prudential removed the Debtor from the payment plan.
In August 2008, Prudential learned that the Debtor had terminated 650 of its employees in light of financial difficulties. That same month, Prudential again placed the Debtor on billing review due to late payments. This second payment plan implemented the same conditions as the first plan, except for varying payment amounts. On November 25, 2008, the Debtor filed for chapter 7 bankruptcy relief in the United States Bankruptcy Court for the District of Delaware.
In the 90 days prior to the petition date, the Debtor had made 12 payments to Prudential totaling $781,702.61, which the Trustee sought to recover as preferential transfers under 11 U.S.C. §§ 547 and 550. Following trial, the Bankruptcy Court awarded judgment in favor of the Trustee for $653,323.20, which represented $781,702.61 of preferential transfers, reduced by $128,379.40 of “new value” that Prudential had provided under 11 U.S.C. § 547(c)(4). Both parties filed timely appeals to the District Court.
Prudential argued on appeal that the transfers were not preferential because they occurred in the “ordinary course of business” as defined by 11 U.S.C. § 547(c)(2). The Trustee cross-appealed, alleging that Prudential’s “new value” defense impermissibly included amounts provided after the petition date, plus the Bankruptcy Court failed to provide prejudgment interest to his judgment. The District Court first addressed the ordinary course of business defense under 11 U.S.C. § 547(c)(2). This defense provides that: “The trustee may not avoid under this section a transfer—(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms”. Chief Judge Stark noted that courts have considered the following factors to assess if a transfer occurs in the ordinary course of business: (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 at issue were tendered in a manner different from previous payments; (4) whether there appears to be an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor’s deteriorating financial condition.
Prudential argued that the Bankruptcy Court erred by finding that the Debtor’s faster payments during the preference period (during which the average payment time dipped from 45.3 days historically to 28 days) meant that they were not in the ordinary course of business. Citing In re Archway Cookies, 435 B.R. 234 (Bankr. D. Del. 2010), Chief Judge Stark found that the proper inquiry is whether the change in payment timing was significant, regardless of whether it was faster or slower, as “small deviations in the timing of payments may not be so significant as to defeat the ordinariness of such payments[,] [whereas] courts have held greater deviations . . . sufficiently significant to defeat the ordinariness of such payments.” In this case, the District Court found that the Bankruptcy Court’s ruling that a 40% increase in payment timing was significant–especially when paired with the fact that Prudential insisted on the quicker payment schedule–was not clearly erroneous.
The District Court went on to reject Prudential’s arguments, based on In re Global Tissue L.L.C., 106 F. App’x 99 (3d Cir. 2004) and In re AE Liquidation, Inc., 2013 WL 5488476 (Bankr. D. Del. Oct. 2, 2013) respectively, that (i) six “extremely late” invoices out of 3,500 may have improperly skewed the average payment time and (ii) that the Bankruptcy Court was inconsistent in finding a 40% increase in payment time was significant whereas a 10-15% increase in payment time (as found in the earlier, unrelated AE Liquidation case) was not. To the former, the District Court found that the late payment pattern in Global Tissue was established consistently over two months, while in this case, it was comparatively minimal. As to the earlier AE Liquidation case, Chief Judge Stark saw nothing inconsistent with finding a 40% deviation significant and 10-15% insignificant, given the subjective nature of these types of cases.
The District Court next found that Prudential had knowledge of the Debtor’s financially deteriorating condition and subsequently used this knowledge to extract better repayment terms. Chief Judge Stark rejected the relevance of the parties’ past payment plans, a holding which he found to be congruent with In re Hechinger Inv. Co. of Delaware, Inc., 489 F.3d 568 (3d Cir. 2007). He found that the payment plans were a deviation from the “baseline” relationship the parties had established; i.e., once the conditions that precipitated the payment plan went away, the parties returned to their baseline relationship. Thus, they were not representative of the parties’ normal, ordinary arrangement.
Chief Judge Stark then turned to the Trustee’s appeal, specifically whether an improper amount of new value was allocated to Prudential. For this position, the Trustee argued that approximately $71,000 of Prudential’s $128,000 new value was provided after the petition date, which violates the precedent issued by the Third Circuit in In re Friedman’s Inc., 738 F.3d 547 (3d. Cir. 2013); see also Evan T. Miller, “The Third Circuit Draws a Line in the Sand on New Value in Friedman’s,” ABI Unsecured Trade Creditors Committee Newsletter, Vol. 12, No. 1, April 2014. Since the Bankruptcy Court did not distinguish between prepetition and postpetition payments for new value purposes, the District remanded the matter for a determination of the same.
The District Court likewise remanded the Trustee’s prejudgment interest claim to the Bankruptcy Court, so that the lower court could–as consistent with the Hechinger opinion– explain its reasoning for denying an award of prejudgment interest.
© 2016 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Link to article.
The second of Chief Judge Stark’s two September 2015 opinions is Prudential Real Estate v. Burtch (In re AE Liquidation, Inc.), 2015 WL 5301553 (D. Del. Sept. 10, 2015). The pertinent facts of that case are as follows: in May 2006, the Debtor engaged the defendant/appellant, Prudential Real Estate and Relocation Services, Inc. and Prudential Relocation, Inc. (“Prudential”), to perform various relocation services for the Debtor’s employees. The agreement contemplated that the Debtor would pay Prudential for services within 30 days of receiving an invoice. While the Debtor was timely with its payment of invoices during the first year and a half of the parties’ agreement, the Debtor began to fall behind. As a result, Prudential placed the Debtor on “billing review,” which implemented the following conditions: (1) Prudential would not accept new employee transfers, (2) the Debtor would begin paying Prudential on a weekly, instead of monthly, basis, (3) the Debtor would pay a $900,000 lump sum to reduce the outstanding accounts receivable balance, and (4) Prudential would eventually terminate the agreement if the conditions were not satisfied. By January 18, 2008, the Debtor had complied with these terms and Prudential removed the Debtor from the payment plan.
In August 2008, Prudential learned that the Debtor had terminated 650 of its employees in light of financial difficulties. That same month, Prudential again placed the Debtor on billing review due to late payments. This second payment plan implemented the same conditions as the first plan, except for varying payment amounts. On November 25, 2008, the Debtor filed for chapter 7 bankruptcy relief in the United States Bankruptcy Court for the District of Delaware.
In the 90 days prior to the petition date, the Debtor had made 12 payments to Prudential totaling $781,702.61, which the Trustee sought to recover as preferential transfers under 11 U.S.C. §§ 547 and 550. Following trial, the Bankruptcy Court awarded judgment in favor of the Trustee for $653,323.20, which represented $781,702.61 of preferential transfers, reduced by $128,379.40 of “new value” that Prudential had provided under 11 U.S.C. § 547(c)(4). Both parties filed timely appeals to the District Court.
Prudential argued on appeal that the transfers were not preferential because they occurred in the “ordinary course of business” as defined by 11 U.S.C. § 547(c)(2). The Trustee cross-appealed, alleging that Prudential’s “new value” defense impermissibly included amounts provided after the petition date, plus the Bankruptcy Court failed to provide prejudgment interest to his judgment. The District Court first addressed the ordinary course of business defense under 11 U.S.C. § 547(c)(2). This defense provides that: “The trustee may not avoid under this section a transfer—(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms”. Chief Judge Stark noted that courts have considered the following factors to assess if a transfer occurs in the ordinary course of business: (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 at issue were tendered in a manner different from previous payments; (4) whether there appears to be an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor’s deteriorating financial condition.
Prudential argued that the Bankruptcy Court erred by finding that the Debtor’s faster payments during the preference period (during which the average payment time dipped from 45.3 days historically to 28 days) meant that they were not in the ordinary course of business. Citing In re Archway Cookies, 435 B.R. 234 (Bankr. D. Del. 2010), Chief Judge Stark found that the proper inquiry is whether the change in payment timing was significant, regardless of whether it was faster or slower, as “small deviations in the timing of payments may not be so significant as to defeat the ordinariness of such payments[,] [whereas] courts have held greater deviations . . . sufficiently significant to defeat the ordinariness of such payments.” In this case, the District Court found that the Bankruptcy Court’s ruling that a 40% increase in payment timing was significant–especially when paired with the fact that Prudential insisted on the quicker payment schedule–was not clearly erroneous.
The District Court went on to reject Prudential’s arguments, based on In re Global Tissue L.L.C., 106 F. App’x 99 (3d Cir. 2004) and In re AE Liquidation, Inc., 2013 WL 5488476 (Bankr. D. Del. Oct. 2, 2013) respectively, that (i) six “extremely late” invoices out of 3,500 may have improperly skewed the average payment time and (ii) that the Bankruptcy Court was inconsistent in finding a 40% increase in payment time was significant whereas a 10-15% increase in payment time (as found in the earlier, unrelated AE Liquidation case) was not. To the former, the District Court found that the late payment pattern in Global Tissue was established consistently over two months, while in this case, it was comparatively minimal. As to the earlier AE Liquidation case, Chief Judge Stark saw nothing inconsistent with finding a 40% deviation significant and 10-15% insignificant, given the subjective nature of these types of cases.
The District Court next found that Prudential had knowledge of the Debtor’s financially deteriorating condition and subsequently used this knowledge to extract better repayment terms. Chief Judge Stark rejected the relevance of the parties’ past payment plans, a holding which he found to be congruent with In re Hechinger Inv. Co. of Delaware, Inc., 489 F.3d 568 (3d Cir. 2007). He found that the payment plans were a deviation from the “baseline” relationship the parties had established; i.e., once the conditions that precipitated the payment plan went away, the parties returned to their baseline relationship. Thus, they were not representative of the parties’ normal, ordinary arrangement.
Chief Judge Stark then turned to the Trustee’s appeal, specifically whether an improper amount of new value was allocated to Prudential. For this position, the Trustee argued that approximately $71,000 of Prudential’s $128,000 new value was provided after the petition date, which violates the precedent issued by the Third Circuit in In re Friedman’s Inc., 738 F.3d 547 (3d. Cir. 2013); see also Evan T. Miller, “The Third Circuit Draws a Line in the Sand on New Value in Friedman’s,” ABI Unsecured Trade Creditors Committee Newsletter, Vol. 12, No. 1, April 2014. Since the Bankruptcy Court did not distinguish between prepetition and postpetition payments for new value purposes, the District remanded the matter for a determination of the same.
The District Court likewise remanded the Trustee’s prejudgment interest claim to the Bankruptcy Court, so that the lower court could–as consistent with the Hechinger opinion– explain its reasoning for denying an award of prejudgment interest.
© 2016 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Link to article.