Are Invoice Terms Alone Sufficient to Establish Contemporaneous Exchange for New Value or Ordinary Course of Business Defenses? In Cousins Fish Market, Second Circuit Offers Guidance

 Defendant offered no testimony or contractual terms in support of its section 547(c)(1) defense, nor did it provide sufficient pre-Preference Period evidence to establish a defense under section 547(c)(2).  The Second Circuit’s ruling is in the form of a summary order, so certain facts are pulled from the District Court’s opinion, available at 539 B.R. 205 and here.

Lower Court Activity

This action was initiated in October 2011.  Pertinent to this post, Defendant offered 44 invoices and checks in support of its affirmative defenses under section 547(c)(1) and (2).  To the latter, the bankruptcy court found – and the District Court affirmed – that the invoices and checks were primarily from within the Preference Period, meaning no “baseline of dealings” could reasonably be discerned.  Moreover, there was no evidence to establish when payments were due under any of the invoices or whether the Debtor typically paid them early or late, although Defendant argued that the invoice term “COD Check” implied otherwise.  The District Court noted that notwithstanding the “COD” term, it was readily apparent – even by the limited evidence offered – that the Debtor did not pay the invoices COD.  That fact, combined with the absence of any context for the timing of payments, rendered it impossible to determine what was ordinary between the parties.

As to the contemporaneous exchange for new value defense under section 547(c)(1), the bankruptcy court found that the documents alone could not show the subjective intent required.  The District Court found that the bankruptcy court’s findings in this regard were not clear error, adding that intent can be established through testimony or through surrounding circumstances, but could not be established in this case simply by the invoices and checks alone.  This amounted to mere innuendo, according to the District Court.

The Second Circuit Appeal

The Second Circuit affirmed the Lower Courts in all respects.  As to section 547(c)(1), the court found that Defendant produced no testimony or contractual terms governing the transfers, and “although reasonable inferences of intent can be drawn from the invoices and corresponding checks between the parties, we cannot say in these circumstances that the Bankruptcy Court’s finding that [Defendant] failed to prove intent was clearly erroneous.”

As to section 547(c)(2), the Second Circuit agreed with the Lower Courts, finding that although Defendant “had submitted 44 invoices, . . . 37 of these were dated within the preference period . . . and the remaining 7 were dated within the week before the preference period; and that only 2 of the checks tendered by [the Debtor] were dated before the preference period.”  This “paucity of evidence”, combined with the lack of any indication as to when payments were due during the pre-Preference Period, led the Second Circuit to affirm the Lower Courts.

Conclusion

Not discussed in this post are some of the reasons why Defendant failed to provide sufficient evidence in support of its section 547(c) defenses, which were also subject to a portion of the appeals.  Both the Second Circuit and Lower Courts suggest that had Defendant been in position to offer such evidence, the outcome here may have been different.

Nevertheless, the Second Circuit’s Summary Order is useful in delineating what is inadequate for purposes of evidence in support of a section 547(c)(1) or (2) defense: subjective intent can likely not be shown based on invoices and checks alone, nor can the terms of the invoice establish what constituted “ordinariness” between a debtor and a preference defendant – even with the introduction of 7 pre-Preference Period invoices and 2 pre-Preference Period checks as guidance.  The distinguishing factor as to the relevance of the pre-Preference Period invoices appears to be their nearness in time to the Preference Period.

A copy of the District Court and Second Circuit rulings can be found here and here, respectively.

Judge Sontchi Rules Preferential Transactions Were Made in the Ordinary Course of Business Notwithstanding Earlier Ruling Adverse to Defendant at Summary Judgment Stage

  The Court made this decision notwithstanding an earlier adverse ruling on Defendant’s summary judgment motion which sought dismissal, inter alia, on OCOB Defense grounds.

On August 29, 2008 (the “Petition Date”), Trevi Architectural Inc. along with its parent company, Sierra Concrete Design, Inc. (the “Debtors”), filed voluntary chapter 7 petitions for relief.  Prior to the Petition Date, Defendant provided plastic composites to the Debtors under a credit limit and on the following invoice terms: from February 2004 to April 2007, net 30 days, from April 2007 through August 2008, net 60 days, with variation in the time of payment a routine occurrence.  On August 19, 2010, the Chapter 7 Trustee (the “Trustee”) appointed in the Debtors’ cases filed a complaint (the “Complaint”) seeking to avoid and to recover 27 preferential transfers – totaling $612,879.94 – from Defendant.  In a January 2012 opinion, the Court granted, in part, and denied, in part, Defendant’s summary judgment motion on the basis that Defendant established a limitation of liability under Bankruptcy Code section 547(c)(4) but didnot establish the OCOB Defense.  On the latter issue, the Court found that the parties’ pre-preference relationship as presented to the Court – which consisted of 17 checks covering approximately 68 invoices over an 11 month period – was insufficient to establish the existence of an ordinary course of business; moreover, the Court found that Defendant’s behavior during the preference period was of the type that “the preference law is intended to thwart.”

In September 2014, the trial on the Complaint went forward on the question of whether seven transfers in the amount of $172,932.14 were protected by the OCOB Defense or the “contemporaneous exchange of new value” defense under Bankruptcy Code section 547(c)(1).  The Court first analyzed the OCOB Defense, noting that the defense was divided into subjective and objective components, with Defendant needing only to satisfy one of the two.  As to the former, the Court found that the parties’ relationship was established over a 4.5 year period, during which time there were approximately 610 transactions between them, and other than letting the Debtors know that they were at or near their credit limit, Defendant never pressured the Debtors to pay outstanding invoices at a faster rate than usual; the Court noted that the evidence submitted at trial was vastly more extensive than that put before the Court at the earlier summary judgment stage, and as such, easily established an ordinary course of dealing.  Compared to the preference period, the Court found no evidence that the amounts paid or method of payment were unusual, nor did Defendant take any steps to pressure the Debtors.

With respect to the days-to-pay comparison – 55.22 days during the historical period versus 27.3 in the preference period – the Court found that this facially significant deviation was distinguishable from cases like In re Archway Cookies for several reasons – one, the parties changed their payment terms during their relationship; two, the Debtors were engaged in a construction project during the Preference Period that required product and invoicing at a faster rate; and three, the parties operated under a credit limit which was not strictly enforced by Defendant during either the historical period or preference period.  The Court found that the Trustee offered no evidence to rebut these points.

In its analysis of the objective OCOB Defense prong, the Court found that the trial testimony of Defendant’s CEO was insufficient to establish the “industry” standard requirement under Bankruptcy Code section 547(c)(2)(B), notwithstanding his 40 years of experience and assertion that Defendant’s contracts were in line with the industry.  The Court agreed with the Trustee that Defendant’s CEO provided no objective data or reports on the “industry standard”.

In analyzing Defendant’s contemporaneous exchange of new value defense provided for in Bankruptcy Code section 547(c)(1), the Court found that there was no evidence in the record to indicate that the parties intended at any time during the Preference Period for the transfers to be contemporaneous.  To the contrary, the Court found that the Debtors routinely paid outstanding invoices within either net 30 or net 60 days, averaging 52.8 days to pay; checks sent by the Debtors often referenced old invoices; and finally, Defendant admittedly applied payments to old invoices, a hallmark of a party’s lack of intent to commit contemporaneous exchanges.

Notwithstanding Defendant’s failure under Bankruptcy Code sections 547(c)(2)(B) and 547(c)(1), the Court found that Defendant established a complete defense under section 547(c)(2)(A), and thus entered judgment in Defendant’s favor under Federal Rule of Bankruptcy Procedure 7058.

A copy of the opinion can be found here.