Section 547(c)(2)(B) of the Bankruptcy Code was the former subjective component of the three-pronged test set forth in Section 547(c)(2) of the Bankruptcy Code and involves the question of whether the transfer was “made in the ordinary course of business or financial affairs of the debtor and the transferee.” This inquiry is done on a case-by-case basis and, in doing so, the factors that courts consider in determining whether the preferential transfer at issue was made in the ordinary course of business include: (1) the prior course dealing between the parties; (2) the amount of the payments; (3) the timing of the payments; and (4) the circumstances surrounding the payments.
Where the debtor and the creditor do not share a pre-preference course of dealing, some courts have held that the ordinary course of business exception is unavailable as an affirmative defense. See e.g., In re Brown Transport Truckload, 152 B.R. 690, 691 (Bankr. N.D.Ga. 1992) (“If there is no prior course of dealings between the parties, the transferee cannot satisfy [Section 547(c)(2)(B)], then the transfer may be avoided.”); In re Winters, 182 B.R. 26, 29 (Bankr. E.D.Ky. 1995) (“It is clear that Section 547(c)(2) applies if the Debtor and the transferee have an ongoing, recurring business relationship. It does not apply to single, isolated transactions, such as the one between the Debtor and the Defendants herein.” While Winters stands for the proposition that a “prior course of dealing” is required for a Section 547(c)(2) defense, the circumstances of the case are such that the decision is less than instructive. In particular, the transfer in Winter was a garnishment by a judgment creditor, which the court held by its nature was not part of a recurring business relationship.); and In re Crystal Medical Products, Inc., 240 B.R. 290, 299 (Bankr. N.D.Ill. 1999) (Stating without analysis that “[t]he transfer could not be ordinary in relation to past practices between CMP and P&H because there was no past practices.”)
An opposite conclusion was reached in Kleven v. Household Bank F.S.B., 334 F.3d 638 (7th Cir. 2003). This decision and others cited herein, focused on the terms of the parties actual written agreement. The court held that although a history of dealing between parties is certainly the strongest factor supporting a determination that the business between a debtor and an alleged preference creditor is ordinary, it was not absolutely necessary. Id. at 642-43.
In some instances, and this is one, the ordinary course of business may be established by the terms of the parties’ agreement, until that agreement is somehow or other modified by actual performance. In the absence of modifying behavior, we see no reason why we should not look to the terms of the parties’ agreement in order to determine their ordinary course of business.
Id. at 643.
In re Russell Cave Co., Inc., 259 B.R. 879 (Bankr. E.D.Ky. 2001) also found that the existence of a prior course of dealing was not a prerequisite to a Section 547(c)(2) defense. But because the subjective prong requires proof that the transaction between the debtor and the transferee was ordinary as between the parties, without a historical prospective the ability to prove the transfer was made in the ordinary course may be difficult if not impossible. The court stated that when no historical relationship exists demonstrating the parties disregard of the payment terms set out on the invoices, the court must give weight to the terms the parties agreed to as reflected by their invoices and purchase orders. Id. at 884.
In Warsco v. Household Bank F.S.B., 272 B.R. 246 (Bankr. N.D.Ind. 2002), the court held that an isolated one-time transaction may be in the ordinary course of business or financial affairs of the debtor and the transferee. The court admitted that although prior course of dealing between the parties would aid the court’s determination concerning the ordinary course of business between the debtor and the preference defendant, it was not an absolute necessity to the defense. Rather, the court stated that the ordinary course of business may be established by the terms of the parties’ agreement. The court noted the following:
The parties have the opportunity to define the terms of their world, and, at least initially, they do so via their agreement. Over time, however, their actual performance of those contractual commitments may differ from what was originally agreed upon and, if it does, the course of conduct demonstrated by the historical performance will supersede the terms of the agreement. (See 2-202(a) and 2-208(1) (a course of conduct may explain or supplement the terms of an agreement). Then – apparently based on the proposition that actions speak louder than words – history rather than the terms of the parties’ agreement, will determine the ordinary course of business between them. Nonetheless, in the absence of such a history, there seems to be no good reason not to look to the terms of the parties’ agreement in order to determine their ordinary course of business.
Id. at 251.
In In re Conex Holdings, LLC, 518 B.R. 269 (Bankr. D.Del. 2014), the court stated that in those situations where only one or a few transactions exist between the parties, the court would not import an “industry practice” analysis found in Section 547(c)(2)(B) to establish ordinary course under Section 547(c)(2)(A), a practice that was allegedly followed by some courts pre-BAPCPA. In particular, the court cited to In re Molded Acoustical Products, Inc., 18 F.3d 217, 224-26 (3rd. Cir. 1994). The court noted that since the amendment found in BAPCPA, the elements of Sections 547(c)(2)(A) & (B) are independent. “To require a defendant to show that transfers were made under industry norms to establish that the transfers were made in the ordinary course of the parties’ relationship would be to rewrite the statute to its pre-2005 terms.” Id. at 282.
Rather, the court stated that it needed to do the best it could with the evidence before it as to the parties’ relationship. The court then noted that because the relationship between the parties began within the preference period, it was obviously impossible for the court to compare the transfers that occurred to any transfers in a pre-preference or historical period. Yet, the court noted there did not appear to have been any unusual action by the defendant or the debtor to collect on or to pay the debt, respectively, with the exception of the last payment, which was large. Notwithstanding this fact, given the payments were not made within invoice terms, the court ruled that the defendant did not establish that the payments were made in the ordinary course of business stating the following:
Ultimately, the requirements of section 547(c)(2)(A) have not been met. While there does not appear to be any unusual action by Southern Steel or the Debtor to collect on or pay the debt (with the exception of perhaps the last large payment), nor were there allegations of any advantage gained by Southern Steel in light of the Debtor’s impending insolvency, these two factors alone are not enough to show that the payments occurred within the ordinary course of business between the Debtor and Southern Steel. Indeed, Southern Steel has failed to establish that there was any ordinary course of business between the parties. At the very least, Southern Steel has not established that it was in the ordinary course of the parties’ business for invoices to be paid late. As the bulk of the payments by number and by amount were made late, they are presumed not to have been made in the ordinary course of business. Southern Steel, as the movant, has not sustained its burden in proving that the transfers were made in the ordinary course of business of the debtor and the transferee.
Id. at 285.
In re Specialty’s Café and Bakery, Inc., 2022 WL 318637 (Bankr. N.D.Cal. Feb. 2, 2022) dealt with the recission and return of a Paycheck Protection Program loan of $8.1 million. Here, the debtor signed and then submitted an application for a PPP Loan on April 24, 2020. The Loan Application included required certifications made by the debtor, as required by 13 C.F.R. §120.100-001. On May 5, 2020, the debtor signed the note evidencing the loan. On May 7, 2020, the debtor received the loan by wire transfer. On May 7, 2020, Debtor’s CFO wrote to the loan broker stating, “in light of recent evolution of the PPP guidelines we may decide to return the funds we received this morning * * * please let us know asap how we should proceed should we decide to do so.” On May 12, 2020, Debtor’s board of directors confirmed that decision. At the time of this transaction, the Program had a “safe harbor” deadline of May 14, 2020, under which a PPP loan could be canceled by a borrower with no liability for false or misleading certifications made in the loan application process and the borrower would be deemed by the SBA to have made the required certifications in good faith. The safe harbor was “necessary and appropriate to ensure a borrower’s prompt repayment of a loan obtained based on a misunderstanding or misapplication of required certification standard.”
The debtor’s Chapter 7 trustee sued the SBA seeking recovery of the repaid $8.1 loan as a preference. The SBA raised an affirmative defense under Section 547(c)(2)(A). In determining whether the ordinary course of business defense under the subjective prong could be met in this one-time transaction, the court recognized that this element typically involves an analysis of the payment history between a debtor and a creditor. But the absence of such a history does not preclude the defense. Rather the court stated that in that situation, it looks at transactions between similarly situated parties not sliding into bankruptcy. In this regard, and given the safe harbor rules that permitted Debtor to do exactly what it did, the court concluded that “[a]ny similarly situated party could have done the same thing.” Id. at *8. Thus, this made the transfer one that fits the definition of one made in the ordinary course of business or financial affairs of Debtor and Defendants.
In In re Morren Meat & Poultry Co., 192 B.R. 737 (W.D.Mich. 1998), the court, suggesting a third approach, focused more broadly on conduct which would suggest that debtor’s delayed payment was outside the scope of their agreement. In this case, the debtor purchased meat from a creditor only once with an order that totaled $41,580.00. The pre-printed invoice set forth the terms of the order as follows: “TERMS-NET CASH IN SEVEN DAYS * * * service charge of one and one-half percent per month may be computed on all balances outstanding over thirty days. Annual percentage rate 18%.” The creditor received one check for half of the amount of the invoice thirty-one days after the invoice date and twenty-one days after receipt of the goods. A second check for the remaining balance was received forty days after the date of invoice and thirty-six days after delivery of the goods.
The court found no evidence that the creditor demanded payment within seven days or attempted to collect service charges as indicated by the terms on the invoice and concluded that the transfers fell within the ordinary course of business exception. The court recognized the parties had not established a course of dealing among themselves given the fact that the transfer in question was the only transaction entered into between the debtor and creditor; however, the court took into consideration the two check payments even though they were the only dealings that took place in the preference period and, concluded that:
[T]his Court is convinced that here, in the case of an isolated transaction pre-printed terms on an invoice definitely defined ordinary course of business for purpose of Section 547(c)(2). While the ordinary course of business remains undefined, this Court notes the absence in these two transfers of any indicia suggesting unusual conduct between Morren and ASC removing the transfer out of the ordinary course of business. The transfers were simply payments on an open account with no unusual attempts at collecting on the debt.
Id. at 741.
Similarly, in In re Armstrong, 231 B.R. 723, 731 (Bankr. E.D.Ark. 1999) the court held that the better view is that, although prior transactions are relevant, the lack of any history between the parties is not necessarily determinative. The court stated that when there are no prior transactions with which to compare, the court may analyze other indicia, including whether the transaction is out of the ordinary for a person in the debtor’s position, or whether the debtor complied with the terms of the contractual arrangement, generally looking to the conduct of the parties, or to the parties’ ordinary course of dealing in other business transactions.
In In re Air South Airlines, Inc., 247 B.R. 153 (Bankr. D.S.C. 2000), the court noted that every borrower who does something in the ordinary course of her affairs must, at some point, have done it for the first time. Id. at 162. The court further noted that the general purposes Section 547(b) is to discourage creditors from engaging in unusual collection activities and to prevent unusual payment activities by debtor’s and allow the trustee, in turn, to avoid those unusual transfers for the benefit of the estate. On the other hand, Section 547(c)(2) allows the debtor to continue normal relationships with creditors to allow the debtor, “to kindle the chances of survival without costly detour through, or a humbling ending in, the sticky web of bankruptcy.” Id. at 163.
In In re Forman Enterprises, Inc., 293 B.R. 848 (Bankr. W.D.Pa. 2003), the court also held that “a first-time transaction between a debtor and a creditor in certain circumstances may qualify as an ordinary course transaction for purposes of §547(c)(2)(B).” Citing to Warsco, the court held that the terms of the parties’ agreement obviously was relevant, but not necessarily determinative. The court found this was particularly true under the facts of its instant case, where the invoice was issued some five weeks after the debtor ordered the product and contemporaneously with their shipment. The court stated “there is no basis for concluding that debtor and Golden had agreed then that payment was due no later than 30 days from the date of shipment. It is more likely that no due date for payment had been agreed, either prior to or at the time of shipment.” The court went on to state that the subsequent conduct of the debtor and its creditor was consistent to the conclusion that they were proceeding “by the seat of their pants” and worked out mutually acceptable payment terms along the way. Id. at 858. The court went on to state that even if the invoice was eliminated as to ordinary course, nothing would have prevented the debtor and Golden from agreeing to different payment terms after the goods were shipped and an invoice was issued.
Further, the court examined the conduct of the parties to determine whether either of them did anything unusual or extraordinary with respect to the transfer made in payment of the underlying debt. If nothing unusual or untoward occurred, there is no good reason to conclude the transfer was out of the ordinary.
In In re Tri-Union Development Corp., 349 B.R. 145 (Bankr. S.D.Tex. 2006), the court dealt with the issue of a new event that occurred in an otherwise long relationship. The court stated that simply because an event had never arisen before did not exclude that transaction from the ordinary course of business exception. “In the situation when such an event occurs, a fact intensive evaluation of the event must occur.” Id. at 151. In this case, the well from which the creditor was buying oil was permanently shut-in for the first time in the relationship of the parties. There was an overpayment due to the creditor, which typically would have been credited against future balances. Since there would be no future balances, the debtor returned the overpayment, thereby equalizing the account.
The court found that this transaction, a one-time event, was “ordinary for the sake of §547(c)(2)(B).” Id. In doing so, the court stated that it had to examine the conduct of the parties to determine whether either of them did anything unusual or extraordinary with respect to the transfer. Here, the court stated that the evaluation of any collection activities to be especially important. Id. at 150. Find no unusual conduct, and specifically, no collection activity, it determined that the payment was made in the ordinary course.
In In re GS Inc., 352 B.R. 858 (Bankr. E.D.Ark. 2006), the court stated that one particular approach used when there is no history between the parties “is to examine the conduct of the parties to determine whether either of them did anything unusual or extraordinary with respect to the transfer made in payment of the underlying debt.” Id. at 865. If nothing unusual or untoward occurred, there is no good reason to conclude that the transfer was out of the ordinary. Id. (citing to In re Forman Enterprise, Inc., 293 B.R. 848, 857-58 (Bankr. W.D.Pa. 2003)). “The court would expect that if the normal period of time to pay had expired, there would be a notation on the invoice, or at least there would be evidence that Hydro made some collection effort. But there is no such evidence.” Id. at 866; See also, In re Johnston Industries, Inc., 357 B.R. 907, 915 (Bankr. M.D.Ga. 2006) (stating that the subjective “prong can be established even if only one transaction of the type occurred between the parties because ‘this showing is required merely to assure that neither the debtor nor the creditor do anything abnormal to gain an advantage over other creditors[.]’”) and In re Economy Milling Co., Inc., 37 B.R. 914, 922 (D.S.C. 1983)).
In Jubber v. SMC Elec. Prods. (In re C.W. Min. Co.), 798 F.3d 983 (10th Cir. 2015), the court held that the debt and the payment must be in the ordinary course of business of both the debtor and the transferee, as opposed to as between the debtor and the transferee, thereby allowing first-time transfers to be in the ordinary course. The court stated that “a first-time debt must be ordinary in relation to this debtor’s and this creditor’s past practices when dealing with other, similarly situated parties.” Id. at 990. It was noted that this interpretation comports with the purpose of the exception by leaving undisturbed normal financial relations, because the exception 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.
In In re Sheperd, 585 B.R. 864 (Bankr. E.D.Ky. 2018), a bankruptcy trustee brought adversary proceeding to recover, as an alleged preference, a payment made to long-term disability insurer as a reimbursement for insurer’s overpayment on a policy. The case involved a group long-term disability insurance policy which entitled the debtor to certain benefits. His gross benefits were to be reduced by a percentage of amounts received from governmental sources, specifically Social Security Disability or Retirement Benefits.
As a service to covered beneficiaries, the defendant offered to pay the gross amount of benefits to employees covered by the policy while they awaited award and payment of Social Security benefits. The defendant reached an agreement with the debtor that he would receive his gross benefits but would immediately advise the defendant of his award payment of other benefits. The debtor then would repay or have withheld from future benefits the percentage of the Social Security award. The alternative to this approach was to estimate Social Security benefits and withhold them from the beginning.
Upon award and payment of his Social Security benefits, the debtor advised the defendant of the amount and payment of those benefits. The defendant computed the overpayment and provided the calculations to the debtor to review. The defendant having received no response from the debtor, through a recovery agent, sent a letter to the debtor seeking recovery of the long-term disability policy overpayment. On or about January 11, 2001, Shepherd mailed a check to RSI in the amount of $6,454.10.
First, the payment was for a debt incurred in the course of ordinary business dealings between the debtor and the defendant. Both the debtor and the defendant were engaged in their usual business as insured and insurer pursuant to the contract. The debt was incurred according to the specific language of the insurance policy, and payment of the debt was in compliance with that policy. Id. at 867.
Second, the debt and the payment were ordinary in relation to other business dealings between the debtor and creditor. The fact that the payment was a one-time or first time transaction does not automatically exclude it from being in the “ordinary course of business.” Thus, the reimbursement payment made by [the debtor] to [the recovery agent] was “ordinary” despite the fact that it was a first time occurrence. The timing, amount, and manner of payment as well as the circumstances under which it was made all indicate that the transaction was ordinary between the parties. Stated another way, there was nothing unusual about the transaction between [the debtor] and [the defendant] which disqualifies it from the “ordinary course of business” exception to subsection 547(b).
Finally, the “ordinary course of business” test is whether the payment was made according to ordinary business terms. The court stated that to meet this prong, the defendant must show that the transaction “comports with the standard conduct of business in the industry.” Insurers generally do not permit double recovery of any kind, and they routinely recover overpayments pursuant to the terms of their policy. The defendant’s recovery was standard conduct for the insurance industry. On almost identical facts, a similar conclusion was reached in Matter of Walker, 2019 WL 913354 at *6 (M.D.Ga.) where the court stated:
Here, the evidence establishes that the debt between Guardian and Debtor was incurred under circumstances similar to those which would exist between a similarly situated disabled employee and his insurance company, when the employee receives disability payments and is then asked to refund some of those payments upon receiving an overpayment of benefits from another source. Further, the debt was incurred pursuant to the terms of the contract between the parties. There was nothing at all unusual about the transaction when viewed in relation to similarly situated parties. Accordingly, the Court finds that the debt was incurred in the ordinary course of business or financial affairs of Debtor and Guardian.
Matthew T. Gensburg