Outside of bankruptcy law, it is perfectly acceptable for a debtor to prefer one creditor over another. For example, in any given month a consumer holding two credit cards may very well choose to pay off one credit card in its entirety while making only the minimum payment on the other. Bankruptcy law, on the other hand, purports to promote fairness and equality amongst similarly situated creditors. To this end, section 547 of the United States Bankruptcy Code provides for a cause of action against certain creditors who receive payments from a debtor during the 90 day period (or 1 year for insiders) prior to the debtor’s bankruptcy filing (the “preference period”). This section 547 claim is referred to as a preference action.
A successful preference action results in a creditor being required to return funds received from the debtor, during the preference period, to the debtor’s estate. A creditor-defendant, however, can defeat an otherwise viable preference action by proving that the preference payments received fell under one of the defenses enumerated in section 547(c).
In a recent decision decided by Judge Sontchi of the Bankruptcy Court housed in the District of Delaware, In re American Home Mortgage Holdings, Inc. v. Vector Consulting, Inc., the defendant, Vector Consulting, Inc., sought to defeat a preference action primarily by raising the “ordinary course of business” defense. 2012 WL 2046829 (Bankr. D. Del. June 5, 2012) (notably, the defendant also raised the new value defense, however, the court’s holding with respect to this defense was not as significant as its holding regarding the ordinary course of business defense). As its name implies, a creditor-defendant advancing the ordinary course of business defense is essentially claiming that the debtor was simply making payments to the creditor in the ordinary course of business; therefore, the debtor did not prefer the defendant over other creditors. To successfully raise the ordinary course of business defense, a defendant-creditor, as a threshold matter, must prove that the alleged payments were for a debt incurred by the debtor in the debtor’s ordinary course of business. Next, the court determines whether the preference period transfers were either (a) made in the ordinary course of business between the debtor and the creditor, or (b) made according to “ordinary business terms.”
To determine whether preference payments were made within the ordinary course of business between parties to a bankruptcy dispute, courts examine certain hallmarks, including: “(1) the length of time the parties engaged in the type of dealing at issue; (2) whether the subject transfers were in an amount more than usually paid; (3) whether the payments at issue were tendered in a manner different from previous payments; (4) whether there appears to have been an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor’s deteriorating financial condition.” In re Am. Home Mortg. Holdings, Inc. v. Vector Consulting, Inc., 2012 WL 2046829 (Bankr. D. Del. June 5, 2012).
Turning to these hallmarks, the Court in American Home Mortgage Holdings held that, although the IT staffing contract between the debtor and creditor only extended for eight months, the average contract in the IT staffing industry was roughly six months. Accordingly, the parties’ relatively short relationship fell well within the industry standard. Therefore, the first hallmark was deemed satisfied. In the same vein, Judge Sontchi swiftly held that (1) all payments at issue were tendered in the same manner as previous payments; (2) there was no appearance of any unusual collection or payment activity; and (3) the creditor did nothing to gain an advantage in light of the debtor’s impending bankruptcy.
At the heart of the Court’s decision was determining whether the preference payments at issue were in an amount more than usually paid. To resolve this issue, the Court compared the payments made by the debtor during the preference period to those made prior to the preference period (i.e., the “historical period”). The parties to this dispute, however, took divergent views with respect to the manner in which the Court was to compare the preference period payments with the historical period payments. The plaintiff, for example, asserted that when comparing the historical period payments with the preference period payments the court should calculate the average days between the date of each invoice and the date that each check cleared. To this end, the plaintiff claimed that the average number of days between the invoice date and the check clear date was 24.7 days during the historical period compared to 57.4 days during the preference period.
The Court, however, rejected the plaintiff’s approach. Instead, when analyzing the timing of the payments, the Court looked at a “payment after invoice range.” The Court noted that a range of payments, as opposed to an average, more accurately portrays the business relationship between the parties. Notably, the Court’s decision to examine a range of payments represents a departure from the use of an average payment and, consequently, evidences a radical shift in the way preference actions will henceforth be analyzed by Judge Sontchi. This shift is favorable to preference defendants.
Further, Judge Sontchi held that the date each check was received by the creditor, as opposed to the date each check cleared, was controlling. To this effect, the court found that the debtor’s historical period payments were received by the creditor between 7 and 67 days after the invoice date. Accordingly, the court held the checks received during the preference period, which were received between 34 and 62 days after the invoice date, fell squarely within the historical period range.
The Court’s decision to calculate a range of payments, as opposed to an average, and to use the check receipt date rather than the check clear date, results in a more accurate representation of parties’ business relationships. Additionally, the Court’s holding provides parties to a preference action with greater clarity when the ordinary course of business defense is raised.
Peter I. Tsoflias, Law Clerk
Ferry Joseph, P.A.
1521 Concord Pike
Case study: Defenses in Bankruptcy Preference Actions
Outside of bankruptcy law, it is perfectly acceptable for a debtor to prefer one creditor over another. For example, in any given month a consumer holding two credit cards may very well choose to pay off one credit card in its entirety while making only the minimum payment on the other. Bankruptcy law, on the other hand, purports to promote fairness and equality amongst similarly situated creditors. To this end, section 547 of the United States Bankruptcy Code provides for a cause of action against certain creditors who receive payments from a debtor during the 90 day period (or 1 year for insiders) prior to the debtor’s bankruptcy filing (the “preference period”). This section 547 claim is referred to as a preference action.
A successful preference action results in a creditor being required to return funds received from the debtor, during the preference period, to the debtor’s estate. A creditor-defendant, however, can defeat an otherwise viable preference action by proving that the preference payments received fell under one of the defenses enumerated in section 547(c).
In a recent decision decided by Judge Sontchi of the Bankruptcy Court housed in the District of Delaware, In re American Home Mortgage Holdings, Inc. v. Vector Consulting, Inc., the defendant, Vector Consulting, Inc., sought to defeat a preference action primarily by raising the “ordinary course of business” defense. 2012 WL 2046829 (Bankr. D. Del. June 5, 2012) (notably, the defendant also raised the new value defense, however, the court’s holding with respect to this defense was not as significant as its holding regarding the ordinary course of business defense). As its name implies, a creditor-defendant advancing the ordinary course of business defense is essentially claiming that the debtor was simply making payments to the creditor in the ordinary course of business; therefore, the debtor did not prefer the defendant over other creditors. To successfully raise the ordinary course of business defense, a defendant-creditor, as a threshold matter, must prove that the alleged payments were for a debt incurred by the debtor in the debtor’s ordinary course of business. Next, the court determines whether the preference period transfers were either (a) made in the ordinary course of business between the debtor and the creditor, or (b) made according to “ordinary business terms.”
To determine whether preference payments were made within the ordinary course of business between parties to a bankruptcy dispute, courts examine certain hallmarks, including: “(1) the length of time the parties engaged in the type of dealing at issue; (2) whether the subject transfers were in an amount more than usually paid; (3) whether the payments at issue were tendered in a manner different from previous payments; (4) whether there appears to have been an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor’s deteriorating financial condition.” In re Am. Home Mortg. Holdings, Inc. v. Vector Consulting, Inc., 2012 WL 2046829 (Bankr. D. Del. June 5, 2012).
Turning to these hallmarks, the Court in American Home Mortgage Holdings held that, although the IT staffing contract between the debtor and creditor only extended for eight months, the average contract in the IT staffing industry was roughly six months. Accordingly, the parties’ relatively short relationship fell well within the industry standard. Therefore, the first hallmark was deemed satisfied. In the same vein, Judge Sontchi swiftly held that (1) all payments at issue were tendered in the same manner as previous payments; (2) there was no appearance of any unusual collection or payment activity; and (3) the creditor did nothing to gain an advantage in light of the debtor’s impending bankruptcy.
At the heart of the Court’s decision was determining whether the preference payments at issue were in an amount more than usually paid. To resolve this issue, the Court compared the payments made by the debtor during the preference period to those made prior to the preference period (i.e., the “historical period”). The parties to this dispute, however, took divergent views with respect to the manner in which the Court was to compare the preference period payments with the historical period payments. The plaintiff, for example, asserted that when comparing the historical period payments with the preference period payments the court should calculate the average days between the date of each invoice and the date that each check cleared. To this end, the plaintiff claimed that the average number of days between the invoice date and the check clear date was 24.7 days during the historical period compared to 57.4 days during the preference period.
The Court, however, rejected the plaintiff’s approach. Instead, when analyzing the timing of the payments, the Court looked at a “payment after invoice range.” The Court noted that a range of payments, as opposed to an average, more accurately portrays the business relationship between the parties. Notably, the Court’s decision to examine a range of payments represents a departure from the use of an average payment and, consequently, evidences a radical shift in the way preference actions will henceforth be analyzed by Judge Sontchi. This shift is favorable to preference defendants.
Further, Judge Sontchi held that the date each check was received by the creditor, as opposed to the date each check cleared, was controlling. To this effect, the court found that the debtor’s historical period payments were received by the creditor between 7 and 67 days after the invoice date. Accordingly, the court held the checks received during the preference period, which were received between 34 and 62 days after the invoice date, fell squarely within the historical period range.
The Court’s decision to calculate a range of payments, as opposed to an average, and to use the check receipt date rather than the check clear date, results in a more accurate representation of parties’ business relationships. Additionally, the Court’s holding provides parties to a preference action with greater clarity when the ordinary course of business defense is raised.
Peter I. Tsoflias, Law Clerk
Ferry Joseph, P.A.