The United States Bankruptcy Court for the Western District of Texas (the “Court”) recently addressed an interesting question – can a preference defendant establish an ordinary course of business defense to a trustee’s suit even though a pre-preference period change in defendant’s ownership also changed the course of its business with the debtor? According to Judge Davis in Satija v. Cen-Tex Plaster, Inc. (In re Sterry Industries, Inc.), 2016 WL 3357266 (Bankr. W.D. Tex. June 9, 2016), the answer is yes, with the pertinent comparison being made between the “new ownership” pre-preference period and the preference period. Using this approach, the Court held that the trustee (“Trustee”) could not avoid the subject transfers to the defendant.
The Parties’ Prepetition Relationship and Defendant’s Ownership Change
Prior to the September 2013 petition date (“Petition Date”), Sterry Industries, Inc. (“Debtor”) utilized Hines/Harvey Interests, LLC dba Cen–Tex Plaster, Inc. (“Defendant”) in their pool construction business. The Debtor did so by faxing a work order to Defendant, following which Defendant fulfilled the work order and sent an invoice to Debtor. The Debtor would then finish the pool construction and seek payment from the owner.
Until six months prior to the Petition Date, Defendant’s invoices were on “Net 30” terms, pursuant to which the Debtor would typically mail Defendant a check, but sometimes a representative from Defendant would pick up the check at the Debtor’s offices.
About six months pre-prepetition, however, Defendant was sold to a new owner, which changed the business practice between Defendant and the Debtor in two ways: (1) the invoice payment deadline changed from “Net 30” to “Due upon Receipt,” although witnesses for both parties testified that this still meant due within 30 days; (2) instead of waiting for the Debtor to mail the check, Defendant would send a representative to pick up each check at Debtor’s offices. This pattern was consistently observed for three transfers (“Transfers”) Defendant received in the Preference Period and the three months immediately prior to the preference period (the “Prior Period”).
The Preference Action
The Court began its analysis by comparing the preference period, the Prior Period, and the period beyond the Prior Period (the “Historical Period”):
|Factor||Historical Period||Prior Period||
|Payment Range (Days)||53-112 days||1-17 days||14-22 days|
In light of this, the Court found as follows:
- payments were generally late until the Prior Period, at which time the new owner took over
- payments during the Prior Period and the Preference Period itself were substantially the same: Defendant would pick up the check within a few weeks of the invoice date.
Interestingly, the Court found that if it looked at the entire payment history between Defendant and the Debtor (i.e. the Prior Period and the Historical Period), “without considering the ownership change, the payments at issue might look preferential because [the Debtor] began paying its invoices timely only three months before the preference period.” The Court refused to ignore the ownership change, because “with that change came an agreed change in the business relationship between the two entities. Since this new business relationship began three months prior to the preference period, that three-month period of time is the relevant baseline to compare to the preference period.”
In addition to the fact that the parties’ practices were similar in the Preference Period and the Prior Period, the Court noted that the time period between the invoice and check dates actually increased during the Preference Period. The Court also found that the invoice language changing from “Due upon Receipt” instead of “Net 30” did not remove the Transfers from the ordinary course of business, as the Parties understood “Due upon Receipt” to mean the same thing as “Net 30”: the Debtor had to pay the invoice within 30 days. Lastly, the Court found that while the practice of personally picking up the check is more coercive than simply mailing an invoice and demanding a check, it was not out of the ordinary in the context of their relationship under a subjective analysis and possibly under an objective analysis as well – the latter because there was testimony that other vendors picked up checks from time to time as well.
Thus, the Court found that the Transfers were within the ordinary course of business between the Debtor and Defendant, and thus protected from avoidance.
This case provides a unique look at a preference defendant’s ordinary course of business defense and the ramifications of an internal ownership shift. In the Western District of Texas, at least, the baseline of dealings established in the pre-preference period/new ownership timeframe can override or take precedence over a course of business evidenced by older business dealings. It is interesting to consider how the analysis would change if the Preference Period dealings in Sterry had been consistent with the older business dealings (i.e. before the Prior Period), but inconsistent with the Prior Period.
The opinion is also important for its suggestion that payments coming later in the preference period are less indicative of preferential status than the contrary. The Court also recognized that certain practices that may appear coercive in normal circumstances (such as personally collecting an invoice payment or changing terms to “Due upon receipt”) may not be in the particular context of the parties’ course of dealings.
A copy of the Sterry Opinion can be found here.