Help In Defending

The new law significantly eases the requirements for the “ordinary course of business” defense. Preference suits are brought by a Chapter 11 debtor or a trustee in Chapter 7 or 11 to recover monies that were paid to creditors within 90 days prior to the filing of bankruptcy. The Bankruptcy Code provides several defenses to these preference actions, one of which is the defense that payments were received in the ordinary course of business. Under the current law and in most jurisdictions, a party asserting the ordinary course defense must satisfy a 3-prong test. Two of these prongs require that the payments be received by the debtor during the ordinary course of business between this particular creditor and the debtor, and that the payments are made according to ordinary business terms in the creditor’s industry. The industry prong generally requires the creditor to offer expert testimony and therefore can be a difficult standard to meet. 

Under the Act, the Code is changed to allow a party asserting the ordinary course defense to prove that the payment was received in the ordinary course of the debtor’s business or that it was ordinary in the creditor’s industry. The creditor will no longer have to satisfy both requirements. Preference defendants are now able to choose which of these options is the most applicable, advantageous and easiest to prove in order to defeat a preference claim. It should also be noted that the original first prong is still in place: the creditor must show that the transaction was incurred by the debtor in the ordinary course of business or financial affairs of the debtor and creditor.

Protection From Suit In Distant Venue

Another pro-creditor improvement in the Act requires debtors and trustees to bring these preference actions in the district where the creditor is located if the amount in controversy is less than $10,000. Under current law, creditors were dragged into court in the district where the debtor’s bankruptcy case was filed. This will substantially reduce the number of preference actions that are filed in Delaware and other districts where large bankruptcy cases are pending. Additionally, the Act prohibits a trustee or Chapter 11 debtor from filing an action to avoid a transfer as “preferential” if the aggregate value of all property transferred is less than $5,000.00. This last provision applies to commercial debtors only. 

New Administrative Claim

One other area that may impact preferences is the new administrative claim granted for goods sold within 20 days of the bankruptcy filing. Since these goods will now be paid as an administrative priority, those sales may not be eligible to be considered in a “subsequent extension of new value” defense to a preference action. There is currently case law in some jurisdictions that says “paid” subsequent extensions cannot count as new value. It is likely those jurisdictions will also hold that subsequent sales which qualify for the administrative claim protection will not count for the “subsequent extension of new value defense.” Only time will tell as aggressive creditors pursue these preference defenses and courts rule.

Until the new Act takes effect and these new provisions are tested by creditors, it is hard to predict the total impact that the new Act will have on preference recoveries. However, at a minimum, it seems that Congress has made the standard for successfully defending preference actions much easier, and this should spur creditors to test the waters and challenge preference suits by Chapter 11 debtors and trustees. Creditors, prepare to attack!

Deborah Tyson is an Associate practicing in the areas of bankruptcy, banking, commercial law, creditors’ rights and collections. She may be reached at 704.342.5316 or dtyson@poyners.com. 

This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.