Letters Asking Debtor To Comply With Trade Terms Does Not Invalidate Ordinary Course Defense, But Change In Credit Terms To Payment In Advance Takes Payments Out Of The § 547(c)(2) Safe Harbor
In re Hayes Lemmerz Int'l, Inc. (HLI Creditor Trust v. Metal Techs., Inc., 337 B.R. 49 (Bankr. D. Del. 2006) (Judge Paul B. Lindsey)
The Court presided over a trial in which only the defendant’s § 547(c)(2)(B) and (C) ordinary course of business defenses were at issue.
The Court found that the payments had been made pursuant to ordinary business terms in the defendant’s industry under pre-BAPCPA §547(c)(2)(C) and read the acceptable range of payment aging broadly.
The Court further found that a creditor who insists on a debtor remaining within credit terms established by the parties can do so without taking subsequent payments out of the ordinary course of business under §547 (c)(2)(B). However, if credit terms are altered, such as when shipment is conditioned on advance payment, the ordinary course defense is defeated.
At trial, the parties stipulated to the basic elements of a preference as found in § 547(b) and that the debt had been incurred in the ordinary course of the business between the debtor and Metal Technologies under 547(c)(2)(A). The plaintiff also conceded that $380,367.70 of the alleged preferential transfers was not avoidable.
Only two issues were reviewed by the Court in its opinion. First, the Court reviewed the “objective test” under §547(c)(2)(C) which is whether payments had been made in the ordinary course of business as measured by comparison to the industry in which the creditor participated. The Court then examined the “subjective test” under §547(c)(2)(B) and analyzed whether the payments had been made in the ordinary course of business as measured by the prior dealings between the parties. Specifically the Court analyzed whether communications by the defendant to the plaintiff invalidated the §547(c)(2) safe harbor by putting undue pressure on the plaintiff to change credit terms.
Objective Test Under §547(c)(2)(C)
The objective test examines the range of terms that are the practices in which firms similar to the creditor in question engage. The defendant’s expert witness used various reports which examined the auto parts industry and other more narrowly defined companies that closely resembled the defendant’s business to determine if the transactions in question were made in the ordinary course of business under §547(c)(2)(C), including a Dun and Bradstreet report on credit history for the Grey Ductile Iron Foundries industry. The plaintiff’s expert discounted the more specific information and relied only on information pulled from the Dun and Bradstreet report.
The Court rejected the plaintiff’s expert’s approach as impermissibly strict in light of Third Circuit precedent in Fiber Lite Corp. v. Molded Acoustical Products, Inc. (In re Molded Acoustical Products, Inc.), 18 F.2d 217, 223 (3d Cir. 1994) and found that the credit terms employed by the parties were consistent with ordinary business terms. Molded Acoustical held that ordinary business terms were those within a range of practices by firms similar to the creditor which were not so “idiosyncratic” that they fell outside of that range, rejecting language that had advocated excluding “unusual” payments, which was deemed too broad by the Court.
The Court held that the use of only the Dun and Bradstreet report to the exclusion of the additional industry information was inconsistent with the approach advocated by Molded Acoustical, which was intended to facilitate the examination of an industry which was more comparable to the creditor’s industry. The Court held that Third Circuit precedent advocated a broader and more flexible approach to the §547(c)(2)(C) ordinary course defense and adopted the position of the defendant that the credit terms employed by the parties, net sixty (60) days, prox. weekly, were consistent with ordinary business terms within the industry of the creditor.
Subjective Test under §547(c)(2)(B)
The Court then reviewed whether or not a creditor can insist on a debtor remaining within credit terms or to what extent the creditor can change credit terms established by the parties without affecting the ordinary course defense for all subsequent payments under §547(c)(2)(B).
The plaintiff argued that certain communications between the parties which requested 1) a letter of credit, 2) adherence to invoice terms, 3) and a switch to payment in advance, all amounted to extraordinary pressure from the defendant to receive the alleged transfers. Such pressure would invalidate the ordinary course of business defense as it would have disrupted or altered the established practices between the parties providing a benefit to the creditor at the expense of other unsecured creditors.
The defendant conceded that it had contacted the plaintiff pre-petition and was aware of the plaintiff’s financial difficulties. The defendant also conceded that it had proposed a letter of credit to secure payment by the debtors, but the parties never entered into any such agreement. The defendant also later insisted that the debtors remain within invoice credit terms for all current accounts and that new orders would require payment in advance.
The Court reviewed three letters that encompassed the alleged communications that the plaintiff claimed unduly pressured the plaintiff to make the transfers under examination.
A September 25, 2001 letter indicated that the defendant was concerned with the credit terms at that time because the defendant had been unable to obtain credit insurance on the debtor’s receivables. The September letter provided a copy of a letter of credit and expressed that the defendant desired one, but made no demand for one, which the Court found insufficient to affect the ordinary course of business defense.
An October 24, 2001 letter notes that the defendant could no longer provide credit on historical terms, requested a letter of credit with more specificity than the September letter, offered to share the cost of securing the letter of credit, and requested the letter of credit be provided by October 31, 2001. The Court found that the letter expressed dissatisfaction with existing credit arrangements but did not demand any change in the timing or method of payment of outstanding invoices, which was insufficient to affect the ordinary course of business defense.
The Court also noted that the transfers after the September and October letters showed very little change from the range established under 547(c)(2)(C) confirming that the letters had no practical effect on the payment practices. The Court further held that transfers that departed no more than five days outside the terms were also within the ordinary course of business between the parties.
A November 6, 2001 letter, however, was more problematic. The Court characterized the November letter as one that “literally changed everything about the credit relationship between the parties.” The November letter required that all subsequent shipments were paid in advance. The November letter also resulted in the payment method changing from payment by check to wire transfer and payments were made earlier than payments prior to the letter. The Court held that the November letter had affected the relationship and pushed the transfers after that date out of the safe harbor of §547(c)(2).
Delaware Practice Pointer
As a preliminary matter, the Court reviewed the parties’ trial exhibits, and determined that of the original $1.2 million sought as avoidable transfers $380,367.70 was conceded as not avoidable by the plaintiff, including seven advance payments totaling $182,596.60, $38,958.60 which was paid prior to the pre-petition preference period, and a $158,812.50 payment which was never made at all. The Court further indicated that the defendant had presented $244,889.06 in new value which might have further reduced the preference exposure. The Court noted that the alleged new value, combined with the concessions in the trial exhibits, left less than half the amount originally claimed, which indicated a “less than thorough exercise of due diligence before filing the action” on the part of the Plaintiff.
