The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Dooley v. Luxfer MEL Technologies (In re Fansteel Foundry Corp.), ___ B.R. ___ (8th Cir. BAP, No. 20-6005, August 7, 2020) (“Fansteel”), the United States Bankruptcy Appellate Panel for the Eighth Circuit (the “BAP”) remanded a preference case to the bankruptcy court to explain why it adopted 47 days as the ordinary course payment, an apparently random deviation from the ordinary course of business payment practices between the parties established by a lengthy base line period which ended about a year before the 90 preference period began. The BAP devoted some of the opinion to discussing what it comprehended as the state of the ordinary course of business defense.
The Fansteel opinion can be found here.
A bankruptcy trustee sued Fansteel to avoid and recover preferential transfers under Bankruptcy Code (the “Code”) section 547(b). The defendant raised the ordinary course of business (“OCB”) and new value affirmative defenses under Code sections 547(c)(2)(A) and (c)(4), respectively. The defendant also raised the affirmative defense of Code section 547(c)(2)(B) that the payment was made on a debt incurred on ordinary business terms (until recently, (c)(2)(A) and (c)(2)(B) used to be conjuncts so that a defendant had to show both were present, but they are now disjuncts, so that a defendant can win by showing one or the other).
After trial, the trustee stipulated to a credit amount for the new value defense. On the OCB defense, the bankruptcy court used the four-year period ending just over a year before the bankruptcy petition date as the “base line” period to determine the interval for the OCB payments, rejecting as conceptually unworkable the defendant’s proposed period because it straddled about half the 90-day preference period. The average days to payment during the baseline period was 43. The average days to payment increased by 40% from 43 during the baseline to 60 during the preference period. Without explaining why, the bankruptcy court adopted the trustee’s test that payments made after more than 47 days during the preference period were not ordinary course. Using that figure, the bankruptcy court determined that just over $680,000 in preference period payments (the sum left after credit for the new value defense) was avoidable as falling outside the 47-day criterion. It entered a judgment avoiding those transfers.
The defendant appealed to the BAP. The BAP remanded, requiring the bankruptcy court to explain why it adopted the 47-day ordinary course yardstick.
The BAP spent a fair amount of the opinion in a short refresher course on its view of the OCB defense generally. Quoting Lovett v. St. Johnsbury Trucking, 931 F.2d 494, 497 (8th Cir.1991), the BAP explained that at the heart of the OCB defense is “some consistency with other business transactions between the debtor and the creditor.” Other authority, the Court added, teaches that although other considerations such as pressure by the creditor or a different payment method may bear on the OCB, in the absence of such facts the basic test for “consistency” is the mathematics of the timing of payments. Indeed, the mathematics may override other considerations even if they are present to some degree. The BAP further noted that the base line period should end at the latest when the debtor began to suffer financial distress. Though the opinion does not say so, that is probably why the bankruptcy court adopted a baseline period that ended more than a year before the bankruptcy.
In reviewing applicable law on the OCB defense, the BAP focused on Eighth Circuit authority. One point it made in this discussion is that the so-called “four factor” test adopted by some courts that adds three issues other than timing to assess an OCB defense, authority raised by the defendant, has not been adopted in by the Eighth Circuit. In any event, citing Concast Canada, Inc. v. Laclede Steel Co. (In re Laclede Steel Co.), 271 B.R. 127, 131-132 (B.A.P. 8th Cir. 2002) (emphasis in original), aff’d 47 Fed. Appx. 784 (8th Cir. 2002) (per curiam) (unpublished)), the BAP said that any factor that is seriously inconsistent with ordinary course governs the case. Here, the defendant’s claim that the parties changed terms to permit longer payment intervals explained the timing issues was undermined by the fact that those new terms arose before the preference period and had to do with creditworthiness. Hence, the test of payment timing remained far and away the dominant factor for the OCB analysis.
The BAP did not quarrel with the bankruptcy court’s baseline period. But it did question the bankruptcy court’s 47-day ordinary course period. That period, it observed, was hardly longer than the baseline period, thus it appeared to be a meaningless adjustment. And it was much shorter than the 63-day average for the 90-day preference period. Though the BAP did not say so, these facts might have produced an ordinary course period more favorable to the defendant. Therefore, the BAP remanded to the bankruptcy court to explain its ordinary course period conclusions (or re-think them).
Finally, the BAP rejected the defendant’s contention that the bankruptcy court did not rule on the ordinary business terms defense. According to the BAP, the defendant did not properly present that issue on appeal because it only discussed it in a footnote in its opening brief and in its reply to the trustee’s response. Evidently, the defendant failed to identify the issue in its statement of the issues on appeal, though the opinion is silent on that point.
The BAP’s remand to the bankruptcy court on the question of how the latter arrived at the 47-days ordinary course period was appropriate only if the defendant had properly raised it on appeal. This is a bit of nagging question because the opinion does not expressly attribute the issue to the defendant. For if the BAP raised it sua sponte, it was exceeding its proper role as an appellate court, especially on a question of fact.
Of greater interest is the BAP’s apparent adherence to the notion that the mathematics of payments is at least first among equals as a factor in determining the OCB defense. If that is what the BAP has in mind, it is, the author submits, out of step with the development of preference jurisprudence. The OCB defense has been liberalized in recent years.
In years past courts tended to look slavishly at the timing of payments in the pre-preference period vs. the preference period to decide whether a payment satisfied the ordinary course defense. No more, however. In assessing the ordinary course defense, courts increasingly are looking at whether anything unusual happened as the ultimate test of the defense, interval-to-payment statistics being only one factor in evaluating that question. See, e.g., Miller v. Florida Mining and Materials (In re A.W. & Assocs., Inc.), 136 F.3d 1439, 1442-43 (11th Cir. 1998) (recognizing the broad scope of what can be ordinary course). Hence, for example, the courts even are noting that payments by a financially distressed party as part of a regime for dealing with its distress can be ordinary course. See, e.g., Lawson v. Ford Motor Co. (In re Roblin Indus., Inc.), 78 F.3d 30, 41 (2d Cir. 1998); Schoenmann v. BCCI Construction Co. (In re Northpoint Communications Group, Inc.), 361 B.R. 149 (Bankr. N.D. Cal. 2007). Indeed, as the BAP notes, the “four factor” test has been adopted elsewhere, as the BAP acknowledges, E.g., Sulmeyer v. Pacific Suzuki (In re Grand Chevrolet), 25 F.3d 728, 732 (9th Cir. 1994); see also Cocolat, Inc. v. Fisher Dev. Inc. (In re Cocolat, Inc.), 176 B.R. 540, 550 (Bankr. N.D. Cal. 1995) (recognizing late payments as the norm where alleged-preferential payment was only second transaction). Indeed, even a “one-time” transaction can include a revision of a past relationship between the debtor and creditor. Wood v. Stratos Product Development (In re Ahaza Systems, Inc.), 482 F.3d 1118, 1125-1128 (9th Cir. 2007).
As these cases recognize, the ultimate issue is whether the payments at issue result from special pressure by the recipient or special efforts to pay that particular creditor by the debtor. See Ganis Credit Corp. v. Anderson (In re Jan Weilert RV, Inc.), 315 F.3d 1192, 1197 (9th Cir. 2003), citing, Fiber-Lite Corp. v. Molded Acoustical Prods., Inc. (In re Molded Acoustical Prods., Inc.), 18 F.3d 217, 224-25 (3d Cir. 1994). The BAP in Fansteel might have done well to adopt the four factor test and treat those factors as of equal dignity to the ultimate questions of special pressure or efforts to pay even if the Eighth Circuit has not yet done so. While that analysis might not have changed the outcome of the case on appeal, it might have set a different tone in the Eighth Circuit until the Circuit itself either affirms or rejects the modern approach.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.