Preference Actions in Bankruptcy
For a simple explanation of what a preference action in bankruptcy is, click here. A preference action is undertaken by the trustee or debtor in possession in either chapter 7 or chapter 11 bankruptcy. In some ways, it is similar to a fraudulent transfer or fraudulent conveyance proceeding in that it is an adversary proceeding intended to claw-back payments made by the debtor prior to filing the bankruptcy petition in order to maximize the value of the debtor’s estate. A creditor is incentivized to fight to keep the previous transfer with any and all applicable defenses available allowing them to keep the transfer. This blog post discusses one of the two most heavily litigated creditor defenses to a preference action in bankruptcy. For a discussion of the other most heavily litigated defense to a preference action, click here.
Debt Incurred in the Ordinary Course of Business Defense in Preference Actions in Bankruptcy
Section 11 U.S.C. 547(c)(2) provides preference defendants with an affirmative defense to uphold transactions made in the ordinary course of the debtor’s business. The defense realizes that payments made by a debtor in the ordinary course of business should not be avoided as a preference. “[T]he purpose of this [defense] is to leave undisturbed normal financial relations because it does not detract from general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor’s slide into bankruptcy.” Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com), 504 F.3d 775, 789 (9th Cir. 2007). The debt incurred in the ordinary course of business defense applies to both transfers made in the ordinary course of business of the debtor and the transferee and to transfers made according to ordinary business terms.
Transfers in the Ordinary course of Business Between Debtor and Transferee Defense in Preference Actions
The Ninth Circuit has weighed in on this issue, recently holding that:
In determining whether transfers are ordinary in relation to past practices under § 547(c)(2)(A), courts consider the following factors:1) the length of time the parties were engaged in the transactions at issue;2) whether the amount or form of tender differed from past practices;3) whether the debtor or creditor engaged in any unusual collection or payment activity; and,4) whether the creditor took advantage of the debtor’s deteriorating financial condition.
to assess what is “ordinary” among parties who have interacted repeatedly, the Court must “inquire into the pattern of interactions between the actual creditor and the actual debtor in question, not about what transactions would have been ‘ordinary’ for either party with other debtors or creditors.” [Edmund J. Wood v. Stratos Product Development, LLC (In re Ahaza Sys., Inc.), 482 F.3d 1118, 1124 (9th Cir. 2007).] Conducting this inquiry requires the Court to first identify a baseline historical period reflecting the parties’ typical payment practices. [Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com), 504 F.3d 775, 790 (9th Cir. 2007).] The allegedly preferential transfers can then be compared to this historical baseline period to determine whether the § 547(c)(2) defenses apply. Id.
Transfers Made According to Ordinary Business Terms Defense in Preference Actions
The Ninth Circuit recently held that in order to establish that a payment was made according to ordinary business terms, a creditor defending the transaction must show:
First the creditor must establish the “broad range” of business terms employed by similarly situated debtors and creditors, including those in financial distress, during the relevant period. In re Jan Weilert RV, Inc., 315 F.3d 1192, 1197–98 (9th Cir. 2003). Second, the creditor must show that the relevant payments were “ordinary in relation to [these] prevailing business terms.” See In re Kaypro, 218 F.3d 1070, 1074 (9th Cir. 2009). In general, § 547(c)(2)(C) should not pose a particularly high burden for creditors. See In re Jan Weilert RV, Inc., 315 F.3d at 1198 (holding only payments which are so unusual as to be “aberration[s] in the relevant industry” do not satisfy [§ 547(c)(2)(B) ] ).
Contact an Experienced Preference Defense Bankruptcy Attorney in Los Angeles, Orange County, San Diego, Riverside, Palm Springs, San Bernardino, & Silicon Valley
Please note that this article only discusses two of the nine affirmative defenses available in a preference action. This is a very complex area of law shown by the breadth of this article discussing less than 25% of the defenses available to creditors being pursued by a bankruptcy trustee. As such, if a trustee has filed an adversary complaint alleging that a bankruptcy creditor has received a preferential transfer, contact a skilled bankruptcy lawyer to determined whether defenses are available.