Unsecured Trade Creditors Committee

Volume 3, Number 2 / March 2005

In This Issue:

• New Delaware Bankruptcy Court Preference Decisions
• Committee Meeting at 2005 Annual Spring Meeting

• Committee Officers
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• Editor: David Wheeler
  Moore & Van Allen PLLC

New Delaware Bankruptcy Court Preference Decisions

by Deborah L. Thorne, Barnes & Thornburg LLP

Two recent decisions in the United States Bankruptcy Court for the District of Delaware provide insight into both the ordinary course and new value defenses to unsecured creditors faced with preference liability.

Background of Hechinger Investment Company of Delaware

In 1999, Hechinger Investment Company filed a chapter 11 petition that rapidly became a liquidating chapter 11 case. Hechinger had operated a retail chain of “do-it-yourself” stores, including Builders Square. Hechinger remained in possession and in control of the liquidation. In 2001, Hechinger filed hundreds of complaints seeking to avoid alleged preferential transfers, including one against Universal Forest Products (“UFP”) and one against James Austin Company (“JAC”).

Hechinger Investment Company of Delaware v. Universal Forest Products, Inc.

In Hechinger Investment Company of Delaware v. Universal Forest Products, Inc. (In re Hechinger Investment Company of Delaware, Inc.), 2004 WL 3113718 (Bankr. D. Del. 2004), Judge Paul B. Lindsey was faced with a Motion for Summary Judgment asserting ordinary course of business, contemporaneous exchange for new value and new value defenses. Finding that both the ordinary course and contemporaneous exchange defenses left too many issues of material fact for summary judgment, he turned to the new value defense.

Section 547(c)(4) New Value Defense

UFP argued that the facts of this case were distinguishable from New York City Shoes1 in that UFP received 34 allegedly preferential transfers during the preference period. UFP argued that because it had rolling new value it was much closer to the fact situation presented in Check Reporting Services.2 In Check Reporting Services the court held that the new value amounts need not “remain unpaid.” UFP continued to argue that the summary judgement of policy reasons of the Bankruptcy Code and the overwhelming trend of courts to reject the “remain unpaid” rule was appropriate.

Hechinger, on the other hand, argued that UFP was not entitled to the new value defense as no amounts “remain unpaid.” Hechinger further argued that the Third Circuit had previously held in New York City Shoes that new value must remain unpaid to be used as a credit in a new value defense and that therefore UFP was not entitled to the defense.

In examining the undisputed facts, Judge Lindsey found that the UFP situation was much more similar to the Check Reporting case than to that of New York City Shoes, in that UFP had a running account with Hechinger. In the case of New York City Shoes there was only one transfer at issue in the preference period. For this reason, Judge Lindsey found that New York City Shoes was distinguishable on its facts and adopted the reasoning of Check Reporting Services. New value on a rolling basis need not be unpaid to be used as a credit against the alleged preferences so long as the payments on account of the “new value” were not made by non-avoidable transfers. Based upon this reasoning, the court was “inclined” to enter summary judgment for UFP on the new value defense. This could not be done until there was a waiver of the other defenses of ordinary course and contemporaneous exchange, as the new value defense can only be used in the event there has been a prior application of any other transfers that are “otherwise avoidable.”

Hechinger Liquidation Trust v. James Austin Company

In a second decision coming out of the Hechinger case, Judge Lindsey held that JAC satisfied the burden of showing that challenged payments were made “according to ordinary business terms.” Hechinger Liquidation Trust v. James Austin Company (In re Hechinger Investment Company of Delaware, Inc.) 320 B.R. 541 (Bankr. D. Del. 2004). JAC was a supplier of bleach and ammonia products to Hechinger. The payment terms between the parties were at all relevant times “2% 30 days, net 31 days.” The president of JAC, Mr. Austin, testified that approximately 10 percent of JAC’s accounts were paid within invoice terms, 50 percent within 60 days, 25 percent within 90 days and 10 percent within 120 days or thereafter. He also testified that JAC’s chief competitors were national firms such as Procter & Gamble, Lever and Clorox and a small number of regional companies. He also testified that he believed that those entities generally used the same or substantially similar payment terms. He testified that JAC had not done business with Hechinger prior to 1998 and that it sold to Hechinger when it received purchase orders, which was usually on a seasonal basis. The entire business relationship had existed for 10 months. The usual invoice amount was between $3,000 and $4,000, and Hechinger, along with all of JAC’s customers, preferred to accumulate a number of invoices and pay them in a single payment. Mr. Austin stated that his company took no collection action on accounts receivable until they reached the 120-day past-due stage. With Hechinger, there was no collection action of any kind, no attempt to change billing or collection practices or procedures and no effort to change credit terms.

Hechinger’s witness, its former V.P. of Merchandise Administration, testified that Hechinger received letters from JAC disputing the pricing of certain shipments and characterized these letters as “collection activity” by JAC. Mr. Austin testified that these were simply routine inquiries and that they were not dunning or any other type of collection activity. Hechinger’s witness introduced its “ordinary course” analysis, which used a “weighted average” to determine the number of days late any particular invoice was paid. He testified that weighted average was important because it was common for there to be shortages, damaged goods and the like in connection with shipments and that invoices issued pursuant to such shipments would be disputed, resulting in the invoices being paid later than would otherwise be the case. He testified that the weighted average took into account the adjustments required by such circumstances and normalized the payment history. The court noted that it appreciated that a weighted average might be important in the business world for statistical purposes, but doubted that a weighted average served any useful purpose in determining ordinary course for preference defense purposes.

Section 547(c)(2)(B) Ordinary Course between JAC and Hechinger Defense

In analyzing the evidence presented, the court lamented the fact that Congress had not spelled out precisely what it meant by “ordinary course.” Relying upon the J.P. Fyfe3 case, which addressed §547(c)(2)(B), the court observed that “the purpose of the exception was to leave undisturbed normal financing relations, because it does not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor’s slide into bankruptcy.” (891 F.2d at 70). The liquidating trustee argued that more than $324,000 was paid in only four checks in a one-month duration during the preference period and asserted that this was an unusually large amount. The court noted that during the early portion of the relationship between the parties, the debtor paid a total of 100 invoices in a single $78,000 check. The court seemed particularly influenced by the evidence showing that during the business relationship between the parties:

• there was no change in the credit terms
• there were no letters, telephone calls or any attempts by JAC to apply pressure on the debtor to encourage more prompt payment
• there were no attempts by JAC to change credit, delivery or other terms or conditions of the relationship
• there were no threats or intimidation by JAC, direct or indirect
• there was no indication of any intention on the part of JAC to institute legal action or collect amounts owed to it.

In fact, the only support the court found for the trustee’s position with regard to §547(c)(2)(B) was the fact that invoices were paid later during the preference period than during the pre-preference period. The court did not believe that the difference put the case outside the normal range of activity between the parties as 20 percent of debtor’s pre-preference period payments were more than 60 days late, as compared to only 8 percent of the payments during the preference period. In fact, according to Mr. Austin’s testimony, no payment by the debtor was as late as the payment of some 35 percent of JAC’s other customers. Thus, the court found that JAC met its burden under §547(c)(2)(B).

Section 547(c)(2)(C) Ordinary Course in the Industry Defense

In determining whether the payments were “so idiosyncratic” as to fall outside that broad range of ordinary business terms, the court examined the testimony of the JAC’s president, Mr. Austin. It seems to rely upon the fact that Mr. Austin had been employed by JAC in various capacities since 1979 and had been president since 1999. He was very familiar with its books, records and procedures. He testified to the credit terms and procedures employed by JAC and as to his knowledge and belief that JAC’s terms were representative of those employed throughout the bleach industry. Mr. Austin’s testimony was the only evidence presented with regard to what constituted “ordinary business terms” in JAC’s industry, the bleach business. The court cited several other cases in which 3rd Circuit Courts had found that an employee of the preference defendant could testify as to the industry standard for §547(c)(2)(C).4 The court found Mr. Austin to be credible and believed his experience in the bleach industry to be both significant and relevant. Furthermore, the plaintiff offered neither evidence nor argument to contradict his testimony. Thus, the court found that JAC had met its burden under §547(c)(2)(C) to establish that the payments in question were made according to ordinary business terms.