Review of Late Payments for Ordinary Defense | Nelson Mullins Riley & Scarborough LLP

You have a contract with the company Slow Pay/No Pay. You provide Slow Pay/No Pay Company with goods, and Slow Pay/No Pay Company pays you for those goods. Over the past year, you notice that the company Slow Pay/No Pay has become increasingly slow in paying its bills. You then receive a notice that the Slow Pay/No Pay company has filed for Chapter 7 bankruptcy. You are not surprised by this. However, you are surprised when you receive a letter from a Chapter 7 trustee stating that the payments you received from the Slow Pay/No Pay company 90 days before the bankruptcy are “preferential payments” that you must return to the trustee. of Chapter 7. You have done nothing wrong and, in fact, you have done exactly what is contractually required between you and the Slow Pay/No Pay Company. The Slow Pay/No Pay company simply paid you according to the terms of your contract. Sound familiar?

Section 547(b) of the Bankruptcy Code gives the Chapter 7 trustee statutory authority to attempt to collect “preferential payments” and states the following:

[T]The trustee may…avoid any transfer of a debtor’s interest in the property—
(1) to or for the benefit of a creditor;
(2) for or in respect of a prior indebtedness owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) fact—
(A) no later than 90 days before the filing date of the petition; or
(B) between ninety days and one year before the date of filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) which enables that creditor to receive more than he would receive if—
(A) the matter was a matter referred to in Chapter 7 of this title;
(B) the transfer has not been completed; and
(C) such creditor has received payment of such debt to the extent provided by the provisions of this title.

Does this mean that simply receiving payment from the Slow Pay/No Pay company automatically obliges you to return the payment to the Chapter 7 Trustee? Section 547(c) of the Bankruptcy Code provides defenses against possible preferential liability. In particular, Section 547(c)(2) of the Bankruptcy Code provides the following:

The trustee cannot avoid under this article a transfer:
(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of the business or financial affairs of the debtor and the assignee, and
such a transfer was—
(A) made in the ordinary course of the debtor’s and the assignee’s business or financial affairs; or
(B) made on normal trade terms

This is commonly referred to as the “ordinary course” defense to preferential liability, which protects payments made in the ordinary course of business between parties. However, it can be difficult to prove the defense in the normal course of business, especially when payments have not been made in accordance with the terms required by the invoices.

In the recent case of Miller v. Exist, Inc. (In re J&M Sales Inc.), no. 18-11801 (JTD), Adv. proc. No. 20-50223 (JTD), 2022 WL 610780 (Bankr. D. Del. Mar. 1, 2022), the Chapter 7 trustee sought to recover alleged preferential payments in the amount of $131,184. However, the defendant argued that a comparison between the history of past payments (“historic period”) and the history of payments during the period of preference (“period of preference”) between him and the debtors provided a defense in the normal course of events.

In particular, during the historical period, debtors paid 12 invoices, which ranged from 100 to 430 days after the invoice date (the invoicing terms being either Net 60 or Net 180 days). However, the only invoice paid during the preference period (made by three separate transfers) was paid between 354 and 389 days after the invoice date. Thus, the Chapter 7 trustee argued that by using a “weighted average” analysis,[1] the weighted average number of days between invoice date and payment date increased from 276 days in the historical period to 371 days in the preference period, which the Chapter 7 Trustee said would rule out an in-the-moment defense normal of things.

The bankruptcy court disagreed. In particular, the bankruptcy court held that “late payments do not prevent [an ordinary course defense] when there is a tendency for late payments in both the historical period and the preferential period” and that “consistency between payments made is all that is required”. While the Chapter 7 trustee only argued that the “weighted average” analysis should be used to examine preference liability, the bankruptcy court felt that it could use a number of analyzes to determine whether the payments satisfied the ordinary course defense, including the range, averages, and weighted percentages of time between invoice date and payment date.

Here, the bankruptcy court applied pure range analysis to determine that the number of days between invoice and payment during the preference period (between 354 and 389) fell within the range of days between invoice and payment. payment during the historical period (between 100 and 430 ). Thus, the bankruptcy court denied the Chapter 7 trustee’s motion for summary judgment[2].

The analysis of the ordinary course defense (or other defenses) against preferential liability can be very technical and nuanced.

[1] A weighted average is a statistical calculation that recognizes that some numbers are more important than others. For example, a weighted average analysis to determine the preference obligation could be based on all invoices and after excluding outlying invoices (such as the top/bottom 10%).

[2] In its complaint, the trustee also included a cause of action to avoid transfers under 11 USC § 548(a)(1)(B). The trustee did not seek summary judgment on this issue, so presumably this issue will go to trial.

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