Did You Know? Bankruptcy and Collection Tips

publications full of ideas

Whose Business is Ordinary?

08.01.2006

Lisa P. Sumner

You may recall that when a trustee seeks to recover a preferential transfer or payment made to a creditor within the 90-day period prior to the bankruptcy petition date, even if the trustee proves all of the “elements” required to recover the payment from the creditor, the creditor still may prevail (and keep the money) if the creditor proves the payment was made in the “ordinary course of business.”

Prior to the changes made to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), a creditor had to prove three elements to mount a successful ordinary course of business (“OCB”) defense:

The payment was on a debt incurred by the debtor in the OCB of the debtor and the creditor;
The payment was made in the OCB between the debtor and creditor (subjective prong); and
The payment was made according to ordinary business terms (objective or industry standard prong).

However, for more recent bankruptcy cases to which BAPCPA applies, a creditor need only prove the first element and either the second or third element of the OCB defense (subjective prong or industry standard prong), but not all three.

While not many courts have issued opinions yet applying the revised version of the OCB defense, the Bankruptcy Court in Raleigh for the Eastern District of North Carolina just did. In the case of Hutson v. BB&T (In re National Gas Distr., Case No. 06-00166-8-ATS), AP No. S-06-00029-8-AP (Bankr. E.D.N.C. July 31, 2006), Judge Thomas Small focused on how to apply the third, industry standard prong of the defense now that a creditor can rely on it without also having to prove the second, subjective prong. Judge Small noted that in earlier cases, where the debtor and creditor were in different industries, the courts in our area looked to what is ordinary in the creditor’s industry in order to determine whether the creditor proved the industry standard prong of OCB defense. This made sense in cases where proof of the second, subjective prong of the defense also was required, because the subjective prong forces the court to give some consideration to the debtor’s business practices. In cases where the new version of the Code applies, though, focusing solely on the creditor’s industry when applying the industry standard prong of the defense could result in an unbalanced view of the facts, with no consideration or scrutiny of the debtor’s behavior. Instead, the court explained that some consideration of the debtor’s industry standards also is needed to provide a check of the debtor’s conduct and discourage the parties from engaging in unusual actions during the debtor’s slide into bankruptcy.

The moral of the story for creditors? Don’t assume that just because you behaved within the bounds of what is normal collection practice in your industry, you can avoid any liability exposure in preference actions. Proof of the OCB defense may have become somewhat easier for creditors under BAPCPA, but the courts will continue to examine the implications of the new law, and creditors must continue to use caution and good preference avoidance planning when dealing with financially unstable parties.

Physical Address: 301 Fayetteville Street, Suite 1900, Raleigh, NC 27601

related information

08.01.2006