- The bankruptcy code provides business creditors with defenses to stop the return of money received by a debtor during the 90-day preference period, with the goal of encouraging business entities to continue to transact business with financially distressed customers.
- This articles discusses the ordinary “course of business defense” to the compulsory return of payments received from a bankrupt customer.
The Bankruptcy code gives a bankruptcy trustee and debtors the right to sue for and recover payments made by the debtor business within 90 days before it files for bankruptcy. Creditors who previously had large unpaid receivables paid by a debtor find out months after they have been paid that they are being sued to recover what they have been paid by the debtor in the days and months leading up to its Bankruptcy filing. Businesses should understand that they have legal arguments to defend against these actions.
These defenses are:
- The ‘ordinary course’ defense
- The ‘new value’ defense
- The ‘contemporaneous exchange’ defense
The Bankruptcy Code & the Law of Preferences
Preference law is found in the bankruptcy code. It permits the recovery of certain payments and transfers made by a debtor prior to its bankruptcy. To be deemed a preference, a payment or transfer must meet the following criteria:
- The payment or transfer relates to an existing debt;
- The payment or transfer occurs within 90 days prior to the bankruptcy filing (180 days for insiders of the debtor);
- The payment or transfer occurs while the debtor is insolvent;
- The payment or transfer allows the creditor to receive more than it would have otherwise received in a Chapter 7 Bankruptcy case.
The vast majority of preference cases involve the payment of money by way of a check or wire transfer, but preference(s) can also take many other forms, including, but not limited to, the creation of a security interest or the leasing of property.
Understanding the Ordinary Course of Business Defense
The ordinary course of business defense protects transactions between a debtor and a creditor that can be described as being within the ordinary course of dealings between the parties (or within the industry). The defense is often claimed by vendors, utilities, and other entities providing goods or services to the debtor in the ordinary course of its business.
In order to avail itself of the defense, a creditor must show that the payments it received during the preference period were:
- Made because of debts incurred by the debtor in their general, everyday course of business between of the debtor and the creditor, and
- Were under taken according to ordinary business terms rather than a unique and/or unusual manner.
If the challenged transactions are similar to how business was conducted between the creditor and debtor prior to the 90-day preference period. These payments may be deemed to have been made in the ordinary course and protected from recovery by the bankruptcy trustee or debtor-in-possession.
In determining whether payments were made in the ordinary course of business between the debtor and the creditor. The courts have considered factors such as whether:
- the creditor engaged in unusual collection practices,
- whether the amount or form of payment differed from historical practice between the parties, and
- Whether the payments made by the creditor during the 90-day preference period were usual between the parties.
This last factor, examines the time between invoicing and payment if the payments made during the 90-days preference period as compared to the ‘historical’ lag times of payments made prior to that period.
Can a creditor protecting itself from preference claims do anything to avoid potential exposure while receiving payments from a financially distressed debtor-customer? The answer is yes. You can demand that any future orders or services be paid for C.O.D. Creditors should be careful about imposing other demands.
Cash-on-delivery transactions that are true exchanges of equal value should be protected from a preference claim; however, if a creditor refuses to do business unless a payment is made upon delivery but the creditor applies the payment to a previous invoice instead of the current shipment, a court may determine that the required intent of the parties that the transaction be a contemporaneous exchange of new value is lacking.
To discuss your NJ Business and Corporation Law matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at firstname.lastname@example.org. Please ask us about our video conferencing consultations if you are unable to come to our office.
By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Business and Corporation Law Attorney