ORDINARY COURSE OF BUSINESS: WHEN IT PAYS TO BE ORDINARY
Perhaps the most frequent claim litigated in bankruptcy court is the preference. In an earlier post, my partner James Angell discussed the basics of preference claims and their defenses. This post delves deeper into the most popular (or unpopular depending on your perspective) of defenses: ordinary course of business.
What is a Preference?
A preference in simple terms is the payment of a debt by the debtor during the 90-day period preceding its bankruptcy filing. A bankrupt debtor or bankruptcy trustee can recover a preference, under the theory that the debtor should not prefer some creditors over others at a time when it is struggling financially. Those doing business may not even be aware of a problem until they receive a demand letter or notice of lawsuit in the mail, sometimes a few years after the payment occurs.
The Ordinary Course of Business Defense
The “OCB” defense works like this: Any payments you received during the 90-day preference period are protected if made in a manner consistent with your historical course of dealing with the debtor or in accordance with industry standards.
Simple enough, so why so much litigation?
Over the years courts have wrestled with the interpretation of “ordinary course of business,” developing fact-intensive tests to determine what is and is not ordinary. Ultimately, a defendant’s success will depend on the facts and circumstances of the business relationship. However, you can bet the court will consider one or more of the following tests:
- Average Days to Payment
Courts in the Fourth Circuit (including North Carolina) typically will compare the average lateness of payments both before and during the 90-day preference period. For example, if invoices were historically paid about 30 days after invoice date, and the preference payment was paid 32 days after invoice date, you have a very good argument for keeping the payment. On the other hand, if the debtor paid an invoice 3 months late when it typically paid within 30 days, the ordinary course defense probably will not help you.
- Amount and Number of Invoices
It helps if the preference payments were similar in amount both before and during the preference period. On the other hand, preference payments that differ substantially from the parties’ history of dealings, whether by amount, method, or the number of invoices paid by each payment, could be deemed abnormal.
- Changes in Behavior
Courts are interested to know whether your relationship with the debtor changed during the preference period. If unusual steps were taken to encourage the debtor to make payments, such as by changing payment terms or threatening legal action, the court is less likely to find payments to be ordinary.
- Standard Deviation
Some attorneys have argued that payments within a standard deviation of the historical norm are ordinary. The standard deviation method takes the Average Days analysis a step further by defining an ordinary range. This requires a statistical analysis (luckily, one that Microsoft Excel or a calculator can help you with) to identify an acceptable variance from the average. Under this theory, if the debtor paid invoices on average within 30 days, and the standard deviation during the historical period is 10, then any preference payments paid within 20 and 40 days after invoice would conceivably be protected.
- Total Range
Under this analysis, any preference payments paid within the range of days common to the pre-preference period would arguably be protected. If payments were historically paid as early as 2 days after invoice and as late as 60 days after invoice, only preference payments beyond the 2 – 60 day range would be recoverable. Because of its potentially broad and sweeping application, most courts do not give great weight to this method.
The ordinary course of business defense is often your best hope for side-stepping a preference claim. However, its success requires a fact-intensive analysis, an understanding of the court’s approach in your district, and some good old-fashioned arithmetic. The above are just a few of the more common examples for establishing ordinary course of business. If you receive a preference demand, consider consulting with a bankruptcy attorney to understand your rights and just how ordinary your dealings with the debtor may have been.