Defining Ordinary: Judge Walrath (Bankr. D. Del.) Surveys Ordinary Course of Business Methodologies in In re Powerwave Technologies

  Thankfully, Judge Walrath recently issued a very helpful opinion, Stanziale v. Superior Technical Resources, Inc. (In re Powerwave Technologies, Inc.), Adv. No. 15-50085 (MFW) (Bankr. D. Del. Apr. 13, 2017), which touches upon all of those issues.  While the decision’s ultimate utility may be limited by the fact that the judge was merely addressing a summary judgment motion (the “Motion”) and found factual disputes precluded a decision on the merits, the opinion should still prove useful.

Background

The Powerwave cases began in January 2013 and the instant adversary proceeding was initiated approximately two years later.  Defendant in the adversary proceeding provided workforce solutions to the Debtors pursuant to an agreement, and during the Preference Period, received approximately $383,336.55 in transfers (the “Transfers”).  During the Preference Period, Defendant sent the Debtors correspondences about the Debtors’ aging accounts and ultimately changed payment terms from net 45 to net 7.  Defendant further demanded payment in full during this time.

The Parties’ Positions

            While Defendant did not contest that the predicate elements of the Transfers had been met, it argued the defenses under 11 U.S.C. §§ 547(c)(2) and (4) abrogated or eliminated its exposure.  It based these defenses on several assertions:

  • All of the Transfers were protected from avoidance by the subjective and objective OCOB defenses
    • For 547(c)(2)(A) purposes, Defendant argued in favor of using the “Range” and “Batch” Methods
  • Any portion not protected by OCOB were subject to reduction by applying the subsequent new value defense under 547(c)(4)

Plaintiff-Trustee disagreed, of course, and argued instead:

  • Defendant’s method for determining which Transfers were OCOB created factual disputes
    • Specifically, Plaintiff-Trustee argued Defendant used a Historical Period (“Historical Period”) that was almost 50% narrower than the one espoused by the Plaintiff-Trustee
    • Moreover, Plaintiff-Trustee argued the “Range” and “Batch” Methods for determining ordinariness are inappropriate, favoring instead the “Days Sales Outstanding” (“DSO”), “Inter-quartile”, and “Standard Deviation” methods.
  • Defendant engaged in unusual collection activity during the preference period
  • Subsequent new value defense cannot be decided before the Court determines OCOB applicability

The Court’s Decision

In denying Defendant’s Motion, the Court addressed each of the foregoing arguments and counterarguments in turn, but in sum, Judge Walrath found too many facts in dispute to render a decision at the summary judgment stage.  Nevertheless, her opinion is instructive.

The Proper Historical Period

The Court noted the Parties’ dispute over the proper Historical Period – specifically, whether Defendant’s proposed Historical Period captured enough of its history with the Debtors.  Noting that that “the Historical Period should encompass the time period when the debtor was financially healthy,” the Court found that Defendant did “not include a sustained period when the Debtor was financially sound.”  As such, a factual dispute existed.

Subjective OCOB Methodologies

Judge Walrath addressed the following five OCOB methodologies, although the lack of agreement on the Historical Period prevented her from applying any of them at this time:

  • Range
    • The Court noted that without the proper historical baseline, the Range method (in which a defendant asserts that if a given preferential transfer fell within the days to pay range seen in the Historical Period, it should be excluded from avoidance) could inappropriately include outlier payments that do not accurately reflect the Parties’ OCOB. The judge noted that simply citing to other cases that use the range method isn’t sufficient, and Defendant’s citations were factually much narrower in any event (comparing the 34-371 historical range here to other cases with ranges of 7-67 days, 35-73 days, 0-33 days, 65-168 days, 0-31 days, 28-76 days).
  • Batch
    • The Court found the Batch method (which derives a standard deviation range by taking the average age of invoices paid in each batch) likewise inappropriate, as the number of invoices paid per batch ranged from 1-133, with higher amounts paid during the Preference Period than in the Historical Period.
  • DSO
    • The DSO Method involves multiplying the total amount of an invoice by the number of days that it took to be paid. That number is then divided by the total amount of the invoices in that batch.  Defendant argued that even if the DSO method results in the 23-day spread between the historical and preference periods alleged by Plaintiff-Trustee, 23 days is not out of the ordinary between the Parties.  Again, the absence of a proper Historical Period foreclosed this method’s application.
  • Inter-quartile
    • The Plaintiff-Trustee’s proposed Inter-quartile range found that 50% of invoices were paid within a 15-day spread, with anything falling outside of that range allegedly not OCOB. Defendant objected that the Inter-quartile method has no precedent in Delaware, but the Court dismissed “lack of acceptance” of a given method as a means for precluding its use.  Judge Walrath noted that “courts may consider a variety of mathematical formulas when deciding the consistency among payments.”
  • Standard Deviation
    • The Plaintiff-Trustee’s Standard Deviation analysis resulted in a range of approximately 75 days (roughly 37 days on either side of the Historical Period average). Defendant did not address the argument, and as with the other methodologies, factual issues precluded application at this time.

As to Plaintiff-Trustee’s assertion that Defendant’s Preference Period collection activity (i.e. calling/emailing about late payments, change of payment terms, etc.) was unusual, the Court found there was a factual dispute as to whether such behavior was in fact normal between the Parties.

Objective OCOB Approaches

Defendant also asserted a defense under section 547(c)(2)(B), arguing it was classified as an employment agency in the administrative and waste management services industry; Plaintiff-Trustee countered that its classification was unclear, and thus the proper “industry” for 547(c)(2)(B) purposes was in dispute.  The Court found that while “a creditor has “considerable latitude in defining what the relevant industry is” and “expert testimony is not required”, a “sufficiently detailed basis is needed to establish the relevant industry.”  Given the classification dispute, the Court found summary judgment inappropriate.

The Sequencing of 547(c) Defenses

Lastly, Defendant argued that its subsequent new value defense under 547(c)(4) eliminated any remaining exposure it may still have from the Transfers.  Plaintiff-Trustee argued, however, that analysis under 547(c)(4) is premature until the 547(c)(2) OCOB review is confirmed.  The Court sided with Plaintiff-Trustee, finding Defendant’s

new value calculations were based on the remaining Transfers being “otherwise unavoidable” according to its calculations under the ordinary course of business defense. However, the Court has found that there are disputes as to material facts regarding the ordinary course of business defense. Therefore, the Court must deny the Defendant’s Motion for Summary Judgment as to the new value defense until the ordinary course of business defense is determined.

In sum, the Motion was denied.

Conclusion

Even without any application of the various OCOB methodologies discussed above, this opinion provides preference practitioners (on either side) with a section 547(c)(2) road map.  Moreover, the decision reaffirms that a viable “Historical Period” should capture an ample ‘healthy period’ of a debtor’s history, though what constitutes “healthy”, of course, should remain subject to intense dispute.  In addition, the Court advises – on these facts, at least – that subsequent new value should not be applied before resolution of what constitutes OCOB.

A copy of the Opinion can be found here.

Are Customer Funds Held by Debtor Logistics Company Property of the Debtor’s Estate? Chief Judge Ferguson (D.N.J.) Addresses Multiple Avoidance Issues in TransVantage Solutions

  Chief Judge Ferguson (Bankr. D.N.J.) recently tackled some of these issues at the motion to dismiss stage in her opinion for Giuliano v. Delta Air Lines, Inc. (In re TransVantage Solutions, Inc.), Adv. No. 15-1882, 2016 WL 5854197 (Bankr. D.N.J. Oct. 6, 2016).  In denying the motion to dismiss (hereafter, the “Motion”), the Court provides a detailed analysis of the 547(b) preference elements that may prove influential as these cases arise in the future, notwithstanding the non-binding nature of the opinion.

Background

The TransVantage cases were initiated under Chapter 7 of the Bankruptcy Code on May 3, 2013 (“Petition Date”), following which Alfred Giuliano was appointed Chapter 7 Trustee (“Trustee”).  In April 2015, the Trustee filed hundreds of preference and fraudulent transfer complaints against various defendants.  Per one of the complaints (which may differ from defendant to defendant), the Debtors were

in the business of providing freight audit and payment services on behalf of its customers (the “Customers”) to help ensure that the auditing and payment of freight invoices were done accurately and timely. TransVantage Solutions would receive freight invoices from the Customers’ common carriers/shippers . . . and then audit and determine whether those invoices were accurate and in compliance with the Customers’ agreements with the carriers/shippers, tariffs and/or regulations.  TransVantage Solutions would then remit the funds received from the Customers to the applicable carriers/shippers. The transfers that are the subject of this Complaint are the transfers described in the preceding sentence that were received by the [Carrier].

Many defendants in the case settled, but ten did not (those ten hereafter referred to as the “Defendants”) and sought to go forward with the Motion.

The Preference Counts

The Defendants based their Motion upon, inter alia, an assertion that the Trustee failed to sufficiently plead the predicate elements of section 547(b) of the Bankruptcy Code.  These points are summarized as follows:

  1. “Interest of the debtor in property”

The Defendants first contended that because the Trustee referred to the funds advanced to the Debtors by the Customers as being held in trust, there could be no property of the estate involved.  The Court, however, would not dismiss the Complaint solely because of the Trustee’s use of the word “trust”; to contrary, the Court found the usage to be conclusory at best, as “[d]etermining whether something is a true trust for bankruptcy purposes is a legal determination for the court to make, it should not be done on a motion to dismiss.” The Court found this especially true considering the early stage of the proceedings, which warrants freely permitting amendment to cure pleading deficiencies.

Having dismissed the Defendants’ “trust” language argument, the Court found that the Debtors at least had a possessory interest in the funds in its own account, which account received the transferred funds from its Customers.

  1. “To or for the benefit of a creditor”

The Court next determined that payments made to the Carriers were for the benefit of the Customers who owed the freight bills.  Customers, in the Court’s view, met the definition of “creditors” under the Bankruptcy Code, as they would have had a claim against the Debtors by virtue of the Customers advancing funds to the Debtors for payment to the Carriers.

  1. “For or on account of an antecedent debt owed by the debtor”

One of the Defendants argued that the Trustee’s failure to allege an antecedent debt owed by the Debtors to the Defendant was dispositive because its business relationship was with the Debtors’ Customers, not the Debtors.  Nevertheless, the Court found that section 547(b)(2) “does not state that the antecedent debt must be owed by the debtor to the defendant, it merely states that it must be ‘owed by the debtor’”; as such, a payment to the Defendant would have been for the benefit of a Customer (a creditor).

  1. “Made while the debtor was insolvent”

The Court found this element met by virtue of the presumption of insolvency under section 547(f) as well as the allegation of a $40 million shortfall as of the Petition Date.

  1. “Made on or within 90 days before the date of the filing of the petition”

The Court found the Complaint clearly pled that pertinent transfers were made within 90 days of the Petition Date.

  1. “Transfer enabled the creditor to receive more than it would have in a Chapter 7 but for the transfer”

The Trustee argued that the Debtors’ liabilities exceeded their assets such that all of the Debtors’ unsecured creditors would not receive full payment – i.e., the Customers whose freight carriers received either full or partial payment made out much better than those Customers whose Carriers received no payment.  The Court appeared to find this allegation sufficient.

In light of the foregoing, the Court concluded the predicate preference elements were sufficiently pled to survive dismissal.  Interestingly, one of the Defendants also raised an ordinary course of business defense under section 547(c)(2), which the Court questioned both on procedural and substantive grounds.  To the latter, “[t]aking the factual allegations in the complaint as true . . . the payments were neither made in the ordinary course of business nor made according to ordinary business terms.”  Further, “the method of payment deviated from the ordinary course of business which was supposed to have been that the funds paid by the Customers were held specifically to pay the freight bills of that Customer and only that Customer.”

The Fraudulent Transfer Counts Under State and Federal Law

The Complaint also contains fraudulent transfer allegations under sections 544 (using New Jersey law) and 548.  The Defendants attacked these counts on multiple fronts, arguing that the Trustee failed to identify “an actual creditor holding an allowed unsecured claim who could avoid the challenged transfers.”  Nevertheless, the Court found that “[w]hen analyzing the sufficiency of a complaint for purposes of Rule 12(b)(6), courts do not generally require a trustee to plead the existence of an unsecured creditor by name, although the trustee must ultimately prove such a creditor exists.”

The Court next rejected the Defendants’ argument that the Complaint is deficient with respect to Federal Rule of Civil Procedure 9(b); the Defendants asserted that the Debtors’ intent to hinder, delay or defraud creditors did not meet the rule’s heightened pleading standards. The Court, however, found that Rule 9(b) permits fraudulent intent to be alleged generally.  As such, the Court found sufficient the Complaint’s allegations that the Debtors’ insiders “were not segregating the funds in the Freight Payment Plan Account, but instead using them to pay personal and business expenses, the complaint adequately pleads actual intent to hinder, delay or defraud.”

The Defendants also argued that the Complaint fails to allege a cause of action for constructive fraud under section 548(a)(1)(B) and N.J.S.A. 25:2-27 because the Debtors received reasonably equivalent value in exchange for each alleged transfer.  In other words, each transfer “was a ‘wash’ because each payment made to the Carriers reduced a corresponding liability owed to them by [the Debtors] (on behalf of the Customers) on a dollar for dollar basis.”  While not rejecting this contention, the Court found that it was inappropriate to find as much at the motion to dismiss stage, noting how highly fact-sensitive such a determination would be.

The Court likewise found that, despite the Defendants’ assertions to the contrary, the Complaint did sufficiently allege insolvency based upon statements that the Debtors’ debts were greater than their assets and that they could operate only in reliance upon new Customer funds.

Is the Bankruptcy Code Preempted by the Federal Aviation Administration Authorization Act?

The Defendants’ last argument relied upon the Federal Aviation Administration Authorization Act, which they averred should limit any remaining fraudulent transfer claims to 18 months prior to the bankruptcy filing.  The FAAAA is designed to preempt any law “related to a price, route or service of any motor carrier, … broker, or freight forwarder with respect to the transportation of property.”  Nevertheless, the Court rejected this argument for multiple reasons: (1) the Defendants cite no supporting case law in which the Bankruptcy Code or New Jersey’s fraudulent transfer statutes were preempted by the FAAAA; (2) the state law claims are derivative of the Trustee’s federal powers in any event, making it not a purely state law issue; and (3) two federal statutes should be harmonized instead of preempting one in favor of another.  To the last point, the Court found that the statutes could be so harmonized, as “the Bankruptcy Code’s goal of equality of distribution through allowing avoidance actions in no meaningful way interferes with the goal of increased competition in interstate transportation.”  Even if it did, however, the Court found that the FAAAA should yield to Bankruptcy Code, citing to a 1994 bankruptcy decision from the Northern District of California (In re Medicar Ambulance Co.).

Conclusion

It bears repeating that the Court has designated the instant opinion as “Not for Publication”.  Nevertheless, given the relative dearth of opinions in the logistics debtors space, parties representing any party in the affected trifecta (customer, debtor/trustee, carrier) should take note of this opinion.  The issues and questions in such cases are invariably quite similar – chief among them being the determination of the trifecta’s rights as to any alleged asset of the estate.

Moreover, it obviously remains to be seen what the final outcome will be in these cases once the parties have had an opportunity to flesh their arguments out with discovery.  Until then, this will be a docket to keep an eye on, barring settlement.

A copy of the Opinion can be found here.

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.

Does a Recent Change of Ownership Impact a Preference Defendant’s Ordinary Course of Business Defense? Judge Davis (Bankr. W.D. Tex.) Provides an Answer in In re Sterry Industries, Inc.

  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

Preference 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.

Conclusion

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.

Decision by the Bankruptcy Appellate Panel for the First Circuit Provides a Cautionary Tale for Preference Defendants

  The principal adversary proceeding among those ruled upon, Wiscovitch–Rentas v. Villa Blanca VB Plaza LLC (In re PMC Marketing Corp.), 2016 WL 234963 (B.A.P. 1st Cir. Jan. 19, 2016), provided a helpful survey of the First Circuit’s preference action jurisprudence, including the different analytical frameworks for assessing the “ordinariness” of a given transaction.  In so doing, the Panel provided a cautionary tale to preference defendants as to the level of proof they must offer in utilizing the defenses of 11 U.S.C. § 547(c).

The Bankruptcy and Adversary Cases

The Debtor’s case began under Chapter 11 in March 2009, but by May 2010, it had been converted to Chapter 7.  In March 2012, the appointed Chapter 7 trustee (the “Trustee”) filed a complaint against Villa Blanca VB Plaza LLC (“Defendant”) seeking “turnover of preferential transfers pursuant to § 547.”  The transfers at issue (the “Transfers” or “Transfer”) were two rent payments from the Debtor to Defendant on December 16, 2008 and January 13, 2009; rent was typically due on the first day of each month per the terms of the operative lease agreement.

In the subsequent summary judgment motions that were filed in the Bankruptcy Court, Defendant argued, inter alia, that the Transfers were made in the ordinary course of business “by a tenant to the landlord” pursuant to section 547(c)(2)(A) and (B).  Defendant further argued that the Transfer* (*Defendant alleged only one of the Transfers was actually within the preference period, which the Trustee ultimately conceded) was late, and as such could be considered ordinary because it was within the pattern of payments between the parties.  In support of this contention, Defendant attached a payment ledger covering the period from May 1997 through July 2011.

The Trustee filed a cross-motion for summary judgment, by which she challenged Defendant’s 547(c)(2)(B) defense on the basis that Defendant neither alleged nor demonstrated that the Transfer was made in accordance with the ordinary business terms of the industry.  As to section 547(c)(2)(A), the Trustee alleged that the Transfer was inconsistent with the contract terms, and therefore did not satisfy the ordinary course of business exception.  Further, the Trustee argued that reviewing the pre-preference period history showed no set payment pattern – in some months, the Debtor made no payments, while in others it made two, etc.  The Trustee later amended these arguments (by way of an amended cross-motion for summary judgment, the “Amended Cross-Motion”) by striking the objective argument while bolstering the subjective argument by supplying an analysis of the degree of lateness of the Debtor’s payments pre-preference period and during the preference period.  The latter analysis showed that the “average lateness during the pre-preference period was 64.3 days and the median was 59 days, while the preference period the average lateness and the median were both 105 days.”

The Bankruptcy Court entered an order striking the Amended Cross-Motion for being filed without leave of court and timeliness reasons.  As to the merits of Defendant’s 547(c) defense, the Bankruptcy Court found that the ledger “revealed an inconsistent payment date and thus demonstrated that the lessor/lessee payment relationship . . . seemed to be a rather flexible one. . . [Defendant] has met the burden for both § 547(c)(2) and § 547(c)(2)(A).”  In so finding, the Bankruptcy Court found no genuine issue of material fact and granted summary judgment in favor of Defendant.

The Trustee immediately filed a motion for reconsideration, arguing that “allowing late payments to be considered ordinary where there is no established pattern of payment would be tantamount to allowing the exception to swallow the rule.” This motion too was denied, prompting the instant appeal.

The Parties’ Arguments on Appeal

The Trustee’s contentions on appeal were largely the same as those contained in his summary judgment arguments, while adding that the Amended Cross-Motion shouldn’t have been struck, as it simply provided the analysis that Defendant should have furnished.  In response, Defendant relied upon its assertion that the Transfer was late, thus fitting within the pattern of payments the Debtor and Defendant had established; Defendant did not, however, provide an analysis of that pattern, choosing to rely instead on the Bankruptcy Court’s characterization of the relationship as “a flexible one”.  In fact, Defendant rejected the notion that it was required to establish a baseline of dealings at all, arguing that the Debtor’s ledgers and the lease agreement were sufficient.

The BAP’s Analytical Framework

The Panel began by noting that there is “no precise legal test to determine whether a preferential transfer was made in the ordinary course of business between the debtor and the creditor”, and as such, it noted that ordinary course of business defenses can rarely be determined at the summary judgment stage.  Referring repeatedly to the seminal First Circuit decision in In re Healthco Int’l, Inc., 132 F.3d 104 (1st Cir. 1997), the Panel stated that “[w]here there were virtually no significant similarities between the challenged payment and the antecedent course of dealings between the parties,” courts should refuse to apply the § 547(c)(2) defense.  This “consistency analysis” requires the preference defendant to establish a “baseline of dealing” between the parties during the historical period.  Per Healthco, the First Circuit instructs that the factors that “bear upon whether a particular transfer warrants protection under [§] 547(c)(2) … include the amount transferred, the timing of the payment, the historic course of dealings between the debtor and the transferee, and the circumstances under which the transfer was effected.”

The Panel then considered the importance of the “lateness factor”.  Citing to, among other cases, the Delaware Bankruptcy Court’s In re Archway Cookies opinion, the Panel found that “[l]ate payments do not preclude a finding that the payment occurred during the ordinary course of business . . . [and that] a pattern of late payments can establish an ordinary course between the parties.”

The Panel next discussed several theories courts have employed in determining whether a given late payment is “ordinary”:

  • One approach courts have taken is by utilizing the “average lateness” theory – this involves consideration of the average time of payment after the issuance of the invoice during the pre-preference and post-preference periods.
  • Another approach is to consider the “range of lateness”. This method “considers a transfer during the preference period to be ordinary if it is paid within the minimum and maximum days in the range of all payments during the historical period.”
  • Yet another approach is to consider the “median lateness” in addition to the average, as the Fifth Circuit has done.
  • Finally, the Panel noted the decision reached in In re ACP Ameri-Tech Acquisition, LLC, 2012 WL 481582 (Bankr. E.D. Tex. Feb. 14, 2012), which it characterized as rejecting “any mathematical analysis whatsoever”; the Panel found no other case law support for such an approach.

While finding that the First Circuit has yet to weigh in on the appropriate methodology for analyzing data concerning the lateness of the debtor’s payments during the preference and pre-preference period, the Panel found that the weight of authority suggests that some level of analysis concerning the timing of the preferential payment compared to the historical timing of payments prior to the preference period is warranted.

Applying the Standard

In applying the foregoing framework to the instant case, the Panel first found that the Bankruptcy Court’s decision to be “devoid of legal authority and unaccompanied by any analysis of the data concerning the Debtor’s payment pattern, it is at odds with the weight of authority, which favors a more elaborate, multi-factor analysis to assess whether a challenged transaction is consistent with the parties’ course of dealing.”

Next, the Panel found that “nothing in the record suggests that [Defendant] addressed, or that the bankruptcy court even considered, the issue of the appropriate look-back period for this case, nor does the record otherwise disclose sufficient information from which the Panel might discern when the Debtor was financially sound for purposes of that determination.”  As such, Defendant failed to establish a baseline period for comparison, and also neglected to point to and analyze evidence demonstrating that the timing of the Transfer was consistent with, or ordinary in relation to, payment practices during that period. Although it relied on a “lateness” theory, Defendant never disclosed the degree of lateness of the challenged payment.  Instead, “[i]t simply furnished the bankruptcy court with a copy of a 32–page payment ledger, without any analysis” from which the Panel could determine that: the Transfer was consistent with past payments in form, deviated from usual collection or payment activities, or did not take advantage of the Debtor’s deteriorating financial condition.

The Panel ultimately found that under no theory is the conclusory incantation “late payments are ordinary course,” standing alone, sufficient to satisfy § 547(c)(2)(A). Rather, the consistency determination requires a “fine-grained analysis.”  Ergo, the Panel found in favor the Trustee.

Conclusion

The opinion crystallizes the potential dangers in not completing some sort of analysis when making a 547(c)(2) defense, even in a circuit where uncertainty remains as to the precise standard to apply.  Although the data arguably was there to offer an analysis in opposition to the Trustee’s, Defendant here did not do so.  The extent to which a contrary analysis in this case would have helped Defendant is unclear, although the Panel noted in dicta that the Trustee’s calculations showed a “meaningful change in the degree of lateness of payments during the pre- and post-preference period.”

Note that the foregoing opinion (available here) was cited in the Panel’s similar and concurrently issued opinions for its analysis of 547(c)(2)(A). See Wiscovitch–Rentas v. Sur CSM Plaza Inc. (In re PMC Mktg. Corp.), 2016 WL 319515 (B.A.P. 1st Cir. Jan. 19, 2016), and Wiscovitch–Rentas v. Santa Rosa Mall LLC (In re PMC Mktg. Corp.), 2016 WL 319528 (B.A.P. 1st Cir. Jan. 19, 2016).

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.