On April 17, 2014, the United States Bankruptcy Judge Sean H. Lane issued an opinion in the Waterford Wedgwood bankruptcy discussing at length one of the defenses available to preference defendants. The opinion turns upon the scope of “ordinary business terms,” the objective prong of the ordinary course of business defense.
The case involved almost $1 million in payments made to United Parcel Service of America Inc. (“UPS”) and its affiliates in the 90 days prior to the debtor’s bankruptcy filing. UPS did not dispute that the Trustee had a prima facie case for avoidance under Section 547(b) of the Bankruptcy Code, but relied on the various defenses available to defendants, including Section 547(c)(2), which protects (i) transfers “made in the ordinary course of business or financial affairs of the debtor and the transferee” or (ii) transfers “made according to ordinary business terms.” Together, these concepts are often referred to as the “ordinary course defense.” Prior to 2005, a defendant needed to prove both elements to succeed in its defense, but current law only requires a defendant to prove either element by a preponderance of the evidence. The first element is often referred to as the “subjective” test and involves an analysis of the payment history between the debtor and transferee to determine whether it was ordinary as between the parties. The second element is often referred to as the “objective” test and involves an analysis of the general practices in the industry of the creditor, and was the primary subject of this opinion.
UPS did not present outside expert testimony regarding the industry standard. Rather, it presented evidence of the payments and invoice records with the debtor as well as the testimony of an experienced credit manager who utilized a Credit Risk Monitor database to compare the range of payments made in the shipping industry to conclude that all of the payments made were within “a reasonable deviation from the industry norm considering market conditions and the size of the Debtors.”
The Trustee argued that the Debtors accelerated payments to UPS during the preference period, but the Court concluded this was irrelevant in considering ordinary business terms and that the Trustee was conflating the subjective and objective tests. The Court noted that each transfer must be analyzed to determine whether it was “within the outer limits of normal industry practice.” The Court also rejected the Trustee’s argument that any payments outside of the stated terms for payment would not satisfy the objective test as inconsistent with prior Second Circuit authority which allows certain payments under a debt restructuring agreement to satisfy the standard.
The Court next addressed the method for evaluating whether the actual transactions comported with industry standards and found that it was appropriate to compare each payment to the “timing of payments in the industry as a whole.” In connection with this analysis, the Court criticized the testimony of UPS’s credit manager stating that his range of permissible payments was too broad and did not appropriately account for outliers by condoning the payment practices of 90% of the industry. In making this determination, the Court noted that the witness had relied only on his own judgment, had no input from counsel and did not review any other expert testimony or opinions. The Court adopted the Trustee’s use of a one standard deviation from the mean to establish payments that would be within ordinary business terms.
Judge Lane’s opinion should serve as a reminder to preference defendants to press the objective ordinary course defense. While the data available to calculate the subjective ordinary course defense is often more readily available, defendants should consider whether they have an employee with the requisite knowledge to opine on the industry standard or alternatively, seek the advice of an expert. Moreover, all parties should be cognizant of the standard deviation approach in litigating both the objective and subjective ordinary course defenses.