In Faulkner v. Broadway Festivals, Inc. (In re Reagor-Dykes Motors, L.P.), ___ B.R. ___, 2022 WL 120199 (No. 20-0503) (Bank. N.D. Tex. January 12, 2022) (“Reagor-Dykes”), in a thoughtful decision on various aspects of preference law under Bankruptcy Code (the “Code”) § 547, the Bankruptcy Court for the Northern District of Texas (the “Court”) denied the plaintiff’s motion for summary judgment against defendant Broadway Festivals, Inc. (“Broadway”) on a preference claim by finding that Broadway established an ordinary course defense based on a single similar transaction with the debtor, even though the timing of the payments at issue in the two transactions was substantially different.
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Broadway Festivals, Inc. (“Broadway”), a nonprofit, produced an annual Fourth of July festival in Lubbock, Texas. It raised money for the festivals by providing various kinds of publicity for contributors in connection with the festival. In 2017, Reagor-Dykes Motors, L.P. (the “Debtor”) and Broadway entered into an agreement under which Broadway would provide publicity for the Debtor in connection with the July 4 festival in return for $20,000 payment by the Debtor. Broadway invoiced the Debtor for $20,000 in February and the Debtor paid the invoice in May, long before July 4. The parties reprised their arrangement for the 2018 festival. This time Broadway invoiced the Debtor in May and the Debtor made its $25,000 payment to Broadway nine days after the July 4 event. Within 90 days of that payment, the Debtor (and some affiliates) filed Chapter 11 cases. Evidently a plan has been confirmed that created a creditor trust, of which Faulkner was made the trustee (the “Trustee”).
The Trustee sued Broadway to avoid the $25,000 payment as a preference under § 547. Presently, the Trustee moved for summary judgment. In response, Broadway raised two defenses: that the payment was not made on account of an antecedent debt, an element of a preference claim; and the statutory affirmative defense that the payment was made in the ordinary course of business under Code § 547(c)(2). The Court rejected the several theories Broadway urged for why the subject debt was not antecedent, but it found for Broadway on the ordinary course defense even though the payment in 2017 preceded the festival and the payment in 2018 occurred some days after. (Though it does not appear in the opinion, the Court entered judgment for Broadway because Broadway had established its ordinary course defense in defending against the Trustee’s summary judgment motion.)
Antecedent Debt. The Court explained that a debt arises when the debtor becomes obligated to pay it (not, e.g., when the creditor invoices the debtor), and [for contracts] the obligation to pay occurs when the consideration has passed to the debtor or when the creditor has performed. Broadway contended that because the Debtor had received some additional benefits for which it contracted after July 4, the debt had not yet been incurred, even though the festival, with most of the Debtor’s advertisements and publicity supplied by Broadway had taken place. The Court rejected this theory because the addition of some “incidental” benefits under the contract after the main services on July 4 did not eliminate July 4 as the date the debt was incurred. In any case, Broadway itself admitted in a filing that the debt arose on July 4.
The Court also dismissed Broadway’s argument that the payment was not on account of an antecedent debt because it was substantially contemporaneous with transfer of the consideration. This, the Court observed, mistakenly imported a slice of the affirmative defense under Code § 547(c)(1) (discussed next) into the issue of whether the payment was for an antecedent debt, one of the elements of a preference under § 547(b).
Broadway also claimed that its provision of the consideration and the Debtor’s payment met the requirements of the Code § 547(c)(1) affirmative defense that any transfer that is intended to be and was in fact substantially contemporaneous is not avoidable even if it is otherwise a preference. Noting that Broadway has the burden of proof for affirmative defenses, the Court still rejected intent element of this defense because the evidence provided on this issue pointed to an expectation that payment would occur sometime after full performance by Broadway rather than substantially contemporaneously with it. The Court also denied Broadway’s claim that the transfer was in fact substantially contemporaneous for § 547(c)(1) purposes. Although the nine-day interval at issue could be substantially contemporaneous under the right circumstances, in Reagor-Dykes the delay was not the result of some unforeseen or uncontrollable development that prevented the payment from occurring in the normal course. In other words, a nine-day delay might satisfy § 547(c)(1) only if a sooner payment was intended but unaccountably held up.
Ordinary Course. The affirmative defense on which Broadway won was that the payment occurred in the ordinary course of business under Code § 547(c)(2) even though it was not a common transaction between the parties, being but the second one. The Court referred to the two tests for ordinary course. One is the “objective” test (sometimes also called the “horizontal” test) that considers what is ordinary in the industry. The other is the “subjective” test (sometimes called the “vertical” test) that focuses on what the past practices between the parties have been.
In considering the subjective test, the Court referred to the line of cases that says that what is “ordinary” need not be common or repetitive. The Court recognized that various lower court cases in its Circuit require that there have been a number of prior transactions between the parties to establish an ordinary “baseline,” but based on decisions of the Circuit Courts in four Circuits (including the Ninth Circuit in Wood v. Stratos Prod. Dev, LLC (In re Ahaza Sys., Inc.), 482 F.3d 1118, 1125 (9th Cir. 2007)) it rejected that approach. It pointed out that the statute does not specifically require ordinary course between the debtor and the creditor. Considering that the purpose of preference law is to promote equality of distribution (while encouraging creditors to continue to deal with a distressed party to help it avoid bankruptcy through certain of the affirmative defenses), it homed in on the underlying issue of what is ordinary rather than unusual in the larger industry environment. (In a sense, the Court is importing the horizontal test into the subjective test.) The presence of the unusual conduct suggests acts by either the debtor or the creditor designed to confer a special advantage on the creditor. Of course prior frequency may be relevant in any particular case, but it is not necessarily determinative.
In Reagor-Dykes, the Court pointed out, there was no indication of anything unusual about the payment even if it was only for the second ever transaction between the parties. There was no evidence of pressure, threats or other factors that extracted or induced the payment (that is, no unfavorable vertical evidence). Furthermore, the horizontal evidence showed that in general Broadway’s customers paid over a wide variety of time, often some months after Broadway performed its part on July 4, as was the case with the 2018 payment by the Debtor to Broadway. Thus, looking at the entire record, and with no contrary ordinary course evidence other than that the timing of the Debtor’s second payment differed from that of the first in terms both of days and temporal relationship to the festival, the Court was comfortable concluding that that payment at issue was ordinary course. It therefore sustained Broadway’s § 547(c)(2) affirmative defense.
Reagor-Dykes is notable for several reasons. First, it is a well-written, informative tour through the law it applies: the standards for summary judgment, who has the burden of proof, and the elements of the provisions of Code § 547 it applies.
On the merits, it reaches the correct conclusion in each instance. It rejects the historic slavish resort to counting days between payments as virtually dispositive for the ordinary course issue reflected in lower court decisions in its Circuit in favor of the more contemporary policy-driven approach of the four Circuit decision to which it refers. That approach produced essentially uncontradicted evidence that there was nothing significant about the later second payment in light of the conduct of the parties and the general practices in Broadway’s slice of the industry. This last point reminds us to be sure to introduce all relevant evidence on any vital issue; it may be that the Trustee lost his own summary judgment motion to Broadway’s ordinary course defense because he did not see the risk that failure to counter Broadway’s evidence might do more beyond just denial of his motion: it might (and did) lead the Court to enter judgment against the Trustee in the action.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, 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.