Preference Relief Is on the Way
by David B. Wheeler
Not usually the source of good news, it appears that Congress has provided some very good news for prospective preference defendants wishing to assert the ordinary-course-of-business defense.
Under the current law, §547(c)(2), a preference defendant may escape liability to the extent it can establish:
…that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; made in the ordinary course of business or financial affairs of the debtor and the transferee; and made according to ordinary business terms (emphasis provided).
To a great extent, the courts have construed this provision to require the defendant to establish not only that the payment was typical or in the ordinary course of business between the parties but was ordinary or typical in the related industry at large.
When it becomes effective on Oct. 17, 2005, the ordinary course of business defense will be modified to provide:
To the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee and such transfer was made in the ordinary course of business or financial affairs of the debtor and the transferee or made according to ordinary business terms. (emphasis added)
The big distinction between the current and respective statutory provision is the substitution of the word “or” for the word “and.” While a seemingly minor modification, it will allow preference defendants to more actively utilize or assert this defense. For example, under the existing statute, many jurisdictions require expert testimony to establish the ordinary or typical business terms between such parties in the business or industry at large. The related expense of retaining an expert—even if the parties can determine the proper identity of the business or industry at large—often deterred defendants from aggressively asserting this defense. As modified, a defendant will be able to establish that the manner of payment between the parties was typical for the parties, which should not necessitate the use of expert witnesses. Alternatively, if there is little or no history between the debtor and transferee to be cited in support of the assertion that the payments were ordinary or typical, the defendant may still have an “out” by establishing how the payments between the parties were typical for the industry at large. Presumably, this latter showing will still require the use of expert witnesses in many cases.
It would have been helpful if Congress had gone one step further and modified the statute to provide that in any situation in which payment was received within invoice terms, it would be presumed that the payment qualified for the ordinary-course-of-business defense. Nonetheless, the changes Congress did choose to make to this provision will be very helpful to defendants from a practical perspective in that they will now be able to more actively and aggressively assert this defense, which is applicable in the vast majority of preference claims.