Burtch v. Revchem Composites, Inc., f/n/a Revchem Plastics, Inc. (In re Sierra Concrete Design, Inc.), Adv. Case No. 10-52667 (CSS) (Bankr. D. Del., Jan. 4, 2012), read opinion here.
Tara Lattomus of Eckert Seamans prepared this summary.
Whether a creditor sued in a preference action was entitled to summary judgment based upon the ordinary course of business and subsequent new value defenses?
The defendant’s motion for summary judgment was denied in part and granted in part. The defendant failed to establish a sufficient course of business to establish the ordinary course of business defense. However, invoices issued after the preference payments entitled the defendant to some credit for the new value defense.
This opinion did not contain many details about the underlying dispute. Instead, Judge Sontchi took the opportunity to explain the theories behind bankruptcy law, in general, and preference law, specifically. He began with the concept that outside of the bankruptcy context creditor recoveries are based on the principle of “first come, first served.” However, in the bankruptcy context, this principle may be harmful to creditors as a whole. The bankruptcy proceeding ends the individual collection efforts of specific creditors in favor of maximizing the return to all similarly situated creditors. Preference law supports the theory behind bankruptcy because it allows a debtor to recover any payments made to its creditors in the 90 days prior to the filing of the bankruptcy case. So, in other words, preference law is meant to deal with those creditors who see a bankruptcy filing on the horizon and step up their collection efforts in order to receive full payment on their claims before the case is filed.
Because not all creditors who receive payments in the 90 days prior to bankruptcy are pursuing a debtor with this motivation, there are certain defenses to a preference action that are very fact specific. The two most common defenses are the ordinary course of business and new value defenses.
The ordinary course of business defense protects payments “that are made in ordinary course on debts incurred in ordinary course according to ordinary business terms.” The ordinary course of business defense can be established either by reference to the course of dealing between the two parties or by the industry standard. Specifically, a creditor must prove that the payments received during the preference period were consistent with payments it received prior to the preference period or that the payments it received were consistent with the industry standard.
The subsequent new value defense “protects creditors who provide new credit [to the debtor] after an old invoice is paid off.” In order to establish the subsequent new value defense a creditor must establish two elements: (1) after receiving the transfer the creditor must have advanced new value to the debtor on an unsecured basis; and (2) the debtor must not have fully compensated the creditor for the new value as of the bankruptcy filing. The judge explained that in order to undertake this analysis one must consider the net result after looking at the new value the creditor extended to the debtor after the preference payments but that any credit for new value should not be in excess of the preference exposure.
In this case, Judge Sontchi ruled that the creditor and the debtor had an insufficient pre-preference period relationship to establish an ordinary course of business. The pre-preference period consisted of 17 checks covering approximately 68 invoices over an 11 month period. The Court ruled that this was insufficient evidence to establish an ordinary course of business. The creditor also failed to present sufficient evidence to establish an industry standard. However, the judge did find that the creditor was entitled to certain credits for new value thereby reducing its preference exposure. As a result, the motion for summary judgment was denied in part and granted in part.