Much has been made of the amendments to the
“ordinary course of business” defense to preferences in the Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005 (“BAPCPA”).
The revision eliminated the traditional
3-pronged defense which required all 3 prongs to be proven to satisfy the
general ordinary course of business defense. Creditors in post-BAPCPA cases
now have two different “ordinary” defenses available to them:
The first defense, “ordinary course of
business,” evaluates the course of dealing between the debtor and creditor
by comparing the preferential transfer to the history of payments between
the parties for a significant period prior to the preferential transfers.
The second “ordinary business terms” defense
typically has looked at the course of dealing in the “industry” to determine
whether the preferential transfer was ordinary within the industry.
Historically, the analysis of what was ordinary in the industry turned on an
analysis of practices in the creditor’s industry with a fairly loose
standard being applied. Many preference defendants provided their own
“expert” testimony about what is normal in their industry. When the new law
was unveiled, the creditor body felt that this amendment would significantly
ease their defense of preference attacks. Apparently, that is not to be the
case.
Prior to BAPCPA, a creditor needed to prove
both the “ordinary course of business” and the “ordinary business terms”
defenses to prevail in an ordinary course defense. Under the old law, the
“ordinary business terms” defense was most critical when there was not
sufficient prepetition conduct between the debtor and creditor to establish
a course of dealing between the parties. When a course of dealing was
lacking, industry standards were to supply the ordinary course benchmark.
However, when the course of dealing between the parties was sufficient to
establish the defense, the testimony on the terms of dealing in the industry
was covered with perfunctory testimony.
Judge Thomas Small of the United States
Bankruptcy Court in the Eastern District of North Carolina is a highly
regarded bankruptcy jurist. He issued an opinion in the National Gas
Distributors (In Re National Gas Distributors, 346 BR. 394 (Bank.
E.D.N.C. 2006) case that promises to make the “ordinary business terms”
defense much more difficult. As Judge Small put it, the amendment and
reconfiguration of the ordinary course defense by BAPCPA has changed the
defense dramatically, and after the BAPCPA amendments, 547(c)(2)(B) is a new
statute and, as with any new statute, its interpretation starts with the
statute’s plain meaning.
The bad news is that the legislative history
regarding this change provides absolutely no insight on how the
reconstructed statute is to be interpreted. Clearly, we now have two
separate defenses as outlined above.
The good news is that under the new law we can
use the “ordinary business terms” defense even if the history of dealing
between the creditor and debtor would not provide a good “ordinary course of
business defense.” Said another way, the preferential transfer may be far
outside of the ordinary course of dealing between the parties, yet conform
to the industry standard and therefore provide a complete defense to the
preference attack.
WHICH INDUSTRY? The first question to
be answered, and the first significant deviation from old law, is the issue
of identification of the relevant industry. Under the old law, the general
understanding was that the industry standard to be applied when examining
“ordinary business terms” was that of the creditor’s industry. The
main case on this point came out of the Fourth Circuit Court of Appeals,
which includes the states of South Carolina, North Carolina, Virginia, West
Virginia and Maryland. There were other courts – notably the Eighth Circuit
–that required the preference recipient to demonstrate that the debtor made
the transfer according to the “ordinary business terms” prevailing within
the debtor’s industry. Judge Small’s decision confirms that the new
law requires an examination of more than the standards in the
creditor’s industry. As Judge Small pointed out, if this defense only
required examination of the creditor’s industry standards, there would be no
review or check on the debtor’s conduct. Therefore, the standard in the
debtor’s industry is also critical.
To further complicate the defense, Judge Small
believes that one also must evaluate general business standards common to
all business transactions in all industries. In other words, if
a payment simply does not make good sense, then it does not meet the
industry standard. Additionally, a creditor may not simply provide general
characterizations regarding the industry norm, but must be specific
to satisfy the requirements of the defense. In the Natural Gas case,
the bank which was the preference target made a general statement that the
payment met banking standards. The court found that this was a virtually
meaningless and insufficient general statement. Industry standards must be
applied to the factual circumstances of the transfer, and must be consistent
with sound business practice in general.
In the Natural Gas case, it made no
difference to the court that the bank which received the payment did nothing
out of the ordinary, had no knowledge that the debtor was having any
financial difficulties, took no action to pursue collection against the
debtor and merely received payment on its loans when those loans became due
after several standard extensions. The kicker in the National Gas case was
that the bank received two preferential payments totaling more than $3.2
million on two outstanding obligations. The payments were made shortly
before the due dates at a time when the debtor was in serious financial
difficulty (a circumstance unknown to the bank). The obligations to the
bank were guaranteed by the husband and wife principals of the debtor and
were secured by the wife’s personal assets. The court looked at all of
these facts and found that the “ordinary business terms” defense could not
be used, even though the bank showed that the credit lines were typical of
those normally extended to similar businesses, that it was customary within
the bank to extend maturity dates, that it was typical for a customer to pay
a note in full on or shortly before the maturity date, and that all payments
were made consistent with the terms of the notes and within standard terms
and practice at that bank and in the banking industry in general.
When viewed from the eyes of the unsecured
creditors in the case, it looks like the decision was a good one as it
resulted in a significant recovery for the estate. But it also raises
significant issues regarding the effort that will be needed by creditors in
the future to successfully prove the “ordinary business terms” defense.
Judy
Thompson and her colleagues at Poyner & Spruill defend preference
lawsuits brought in bankruptcy cases nationwide and offer substantial
additional information about preferences on the firm website,
www.poynerspruill.com. You may
reach Judy at 704.342.5299 or jthompson@poynerspruill.com.
