Decision in Sierra Concrete Design, Inc. Provides a Thorough Explanation of the Principles Behind Bankruptcy's Preference Laws
In an opinion issued January 4, 2012, Judge Sontchi of the Delaware Bankruptcy Court provided an easy to follow primer in preference law in the course of granting in part and denying in part a preference defendant’s motion for summary judgment. Judge Sontchi’s opinion is available here (the “Opinion”). The Opinion provides an excellent framework for all preference defendants to understand why preference laws are in place and the reasoning behind their existence. The first half of the Opinion would make a fantastic introduction to any discussion of two of the most common preference defenses, the “ordinary course of business” and “new value” defenses. Please bear in mind, however, that the Opinion was issued in response to a motion for summary judgment, which applies different standards than an opinion written following a complete trial. The below blog posts address other opinions written in response to motions for summary judgment:
In 2008, Sierra Concrete Design, Inc. and Trevi Architectural, Inc. (the “Debtors”) filed for bankruptcy in the District of Delaware. As a part of their bankruptcy proceedings, the Trustee who was appointed to handle their bankruptcy proceedings, Jeoffrey L. Burtch, filed a number of preference actions against entities which had been paid by the Debtors within the ninety-day period prior to the Debtors’ bankruptcy filings. In one of these preference cases, Revchem Composites, Inc. was a named defendant. Revchem eventually filed a motion for summary judgment, arguing that the payments made to it were protected from recovery by exceptions built into the Bankruptcy Code – the “ordinary course of business” and “subsequent new value” defenses. Opinion at *4.
Judge Sontchi’s Opinion
Judge Sontchi begins the Opinion by asking, “Why is there a preference law?” Opinion at *1. He then spends the next several pages explaining what would happen in the absence of preference laws and how the ensuing strong-arm tactics and efforts by creditors to collect payment would harm businesses in general.
The two preference defenses discussed in the Opinion are (1) the ordinary course of business defense and (2) the subsequent new value defense. The ordinary course of business defense has two ways in which in can be applied. First, did you treat the Debtor the same way you always did, and did the Debtor pay you the same way they always did? If you can answer this two-part question yes, and you have a history of working with this company, you are likely protected. In this case, Judge Sontchi opines that “17 checks covering approximately 68 invoices over an 11 month period” is “insufficient evidence….” Opinion at *7. The second way in which the ordinary course of business defense can apply, is if your interactions with the Debtor were ordinary for your industry. This requires a defendant to present evidence relating to standard industry practice. This evidence will normally be provided by an expert witness who has studied the preference defendant’s industry and who testifies in court, under oath, that the interactions were ordinary. Take note, however, that “a one-paragraph, conclusory allegation” is insufficient evidence to uphold the ordinary course of business defense. Opinion at *7.
The new value defense allows a creditor to limit their preference exposure before a bankruptcy occurs. If, for example, a debtor has a line of credit for $1,000 that it maxes out and repays four times in the ninety-day period before declaring bankruptcy, it would make no sense for the creditor to be liable for $4,000 of preferences. On page 9 of the Opinion, Judge Sontchi provides an example of how the new value defense is applied, and I have recreated the chart here:
|Date||Preference Payment||New Value||
|1/15/2010||--||$2,000||$0 (not -$1,000)|
As illustrated by the chart, any value provided after a payment will reduce (or eliminate) the preference exposure. However, this defense only tracks new value, so any new value provided will not be applied to later payments. Applying the new value analysis is an exercise based entirely on the record of payments to the preference defendant and the record of goods/services provided to the debtor by the preference defendant. In the Opinion, Judge Sontchi applied this analysis to limit the maximum preference liability of the defendant. Opinion at *10. Thus, this motion for summary judgment was allowed in part and denied in part.
The preference discussion in the Opinion is comparatively easy to follow, and I highly recommend anyone with an interest in preference actions review this decision. Not only is it an explanation suited to attorneys, but its marked lack of technical jargon makes this an opinion accessible to those who would consider themselves legal novices. Ultimately, it comes down to this – If you do business and get paid the same way you always have, you may not have to repay the preference. Or, if you provide the Debtor with some value after you get paid, you may not have to repay all of the preference. Just remember, every situation is different, and getting a professional’s help early in a preference case may save you money in the end.