On September 1, 2010, Judge Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware issued a decision finding that the payment practices between a creditor and debtor satisfied the ordinary course of business defense. Judge Sontchi’s decision is worth review as it provides a current look at one of the most common defenses to a preference action. Better still, motions for summary judgment based on ordinary course of business often fail due to fact intensive nature of the defense. It is helpful, then, to understand the reasons for the court granting summary judgment and the facts the court found significant.
Archway Cookies (“Archway”) filed for chapter 11 bankruptcy protection on October 6, 2008. Approximately three months after filing for bankruptcy, the company converted to a chapter 7 liquidation and a chapter 7 trustee (the “Trustee”) was appointed. The Trustee commenced several avoidance actions, one of which was against Detroit Forming, Inc. (“DFI”). DFI manufactures plastic trays which it sold to Archway for approximately two years prior to the petition date. Pursuant to the parties agreement, DFI shipped goods to Archway on net 20 day payment terms. Opinion at *3.
Section 547(c)(2)(A) of the Bankruptcy Code permits a recipient of an otherwise avoidable transfer to keep the transfer if it was made “in the ordinary course of business or financial affairs of the debtor and the transferee.” 11 U.S.C. Sec. 547(c)(2)(A). The party relying on the defense carries the burden of proof by a preponderance of the evidence. Opinion at *9.
The court in Archway considered two time periods in deciding whether the payments made to DFI fell within the ordinary course of business safe harbor. From October 6, 2206 to July 7, 2008, Archway paid DFI’s invoices between 21 and 177 days after invoice (the “Historical Period”). Further, from July 8, 2008 to October 6, 2008 (the “Preference Period”), Archway paid DFI’s invoices between 33 and 64 days after invoice. Opinion at *3-4.
There are two ways to prove the ordinary course of business defense: the “subjective test” and the “objective test”. The subjective test looks to whether the transfers between the parties were made in the ordinary course of business. The objective test, on the other hand, looks to whether the transfers were made according to “ordinary business terms.” In Archway Cookies, DFI argued that the payments it received from Archway were protected under the “subjective test” (i.e. the payments were ordinary as between Archway and DFI).
In deciding whether to apply the ordinary course of business defense using the subjective analysis, the Court looked at factors such as (1) the length of time the parties engaged in the type of dealing at issue; (2) whether the transfers were in an amount greater than what was usually paid; (3) whether the payments at issue were made in a manner different from prior payments; (4) whether there was unusual collection activity; and (5) whether the creditor did anything to gain an advantage over the debtor. Opinion at *11-12.
The court first considered the length of the parties’ relationship. This is significant because in deciding whether to apply the ordinary course of business defense, the court had to determine whether the parties’ relationship was of “recent origin” or one that is “cemented long before the onset of insolvency.” Opinion at 12-13, citing In re Molded Acoustical Products, Inc., 18 F.3d 217, 219 (3d Cir. 1994). Archway and DFI had a two-year relationship during which there were 117 transactions between the parties. Opinion at *13. Based on this time period and the number of transactions, the court found that the relationship was of “sufficient length to establish an ordinary course of dealing between the parties.”
Next, the court looked at the similarity of transactions in the Historical Period and the Preference Period. Based on the facts before it, the court found there was no evidence that the payments were inconsistent with the practices between the parties. By this, payments during the Historical Period ran from 21 to 177 days, averaging 42.3 days. During the Preference Period, payments ranged from 41 to 64 days, averaging 47.2 days to pay. Opinion at *15. This difference, the court found, was not material. Further, the Trustee presented no evidence of differing payment practices between the parties. Id. Based upon these findings, the court found that the practices between the parties were consistent with their historical dealings and summary judgment was appropriate. Opinion at 17.
Preference actions are fact senstive proceedings that often center around the course of dealings between the parties. The Archway decision reminds readers that creditors can, in some instances, establish a solid ordinary course relationship in a relatively short amount of time – two years. Further, Archway shows that the range of payments may vary, yet still remain within the protections of the ordinary course of business defense. A copy of the court’s decision in Archwary is available here.