When it was enacted, most publicity regarding the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) focused on consumer bankruptcy reforms. However, commercial creditors faced with the vexing problem of a preference action in bankruptcy also received some relief. The three most significant changes were touted at the time to offer the following benefits: (1) ease the creditor’s burden to establish the ordinary course of business defense; (2) preclude a commercial debtor from suing to recover transfers under $5,000.00; and (3) require lawsuits seeking less than $10,000.00 total to be brought in the creditor’s home court, rather than the sometimes-remote bankruptcy court where the original petition was filed. In practice, since these reforms were put in place, the changes have offered some relief, but not all that creditors had hoped for at the time.
Preference Claims and the Ordinary Course of Business Defense
Creditors that have suffered through a customer’s bankruptcy filing know that a double whammy can be involved: First, the customer files its bankruptcy petition leaving a large unpaid balance, resulting in an unsecured claim worth pennies on the dollar. Second, often years after the original bankruptcy filing, the debtor or the trustee sues the creditor to recover all payments that the debtor made in the 90 days before the bankruptcy filing—the dreaded preference claim.
The threshold to assert the preference claim is very low. Debtors tend to sue every company that received a payment within the 90 day preference period. The burden then falls to the creditor to establish some defense. Two more common defenses were not altered by BAPCPA; the subsequent new value defense and the contemporaneous exchange defense were unchanged by the law, and remain powerful tools for defending preference claims. Unfortunately, these defenses rarely provide a complete shield for all payments—usually the creditor must resort to the ordinary course of business defense to protect a portion of the payments received in the preference period. One change in BAPCPA expanded this defense.
Specifically, prior to BAPCPA, the ordinary course of business defense had three parts, all of which the creditor had to establish: (1) The payment must have been for a debt incurred in the ordinary course of business; and (2) The payment must have been made in the ordinary course of business of the debtor and the creditor; and (3) The payment must have been made according to ordinary business terms. The first requirement (fortunately) is rarely disputed. The second element involves comparing the debtor’s payment history for the 90-day preference period with the period of time prior to the preference period—if the payment histories for the two periods are generally alike, this is a good indication that this test will be satisfied (although other factors can also come into play, such as held orders, a switch from checks to wire transfers or other collection efforts). The third element—ordinary business terms—required evidence that the payments fell within a “range of ordinariness” within the relevant industry.
Most courts required proof of “ordinariness” in the relevant industry to be established by expert testimony – a time consuming and expensive proposition. Debtors often exploited this requirement by resisting the ordinary course of business defense, even in the face of a consistent payment history between the parties, and Court decisions regularly ruled against creditors that failed to establish this required third element.
A Simple Change: “and” Became “or,” Resulting in a Broader Ordinary Course Defense
BAPCPA changed the wording of the defense: the word “and” in the statute between elements two and three was changed to “or,” so that the creditor can protect a payment with the ordinary course of business defense by establishing the first element and then either the second element or the third element. In other words, the ordinary course of business defense now succeeds if a payment was either (a) consistent with the pre-preference period payment history; or (b) made according to ordinary business terms, i.e., ordinary within industry standards.
Over the last 12 years, this change has significantly improved the hand of the preference defendant and has also reduced somewhat the cost of defending a preference claim. Where the preference period payment history does not vary significantly from the prior payment history, debtors cannot insist on expert testimony to establish the third element. On the other hand, if the preference period payment history varies significantly from the prior payment history (which would have been a defense-killer under the old law) the creditor can still come forward with expert testimony to set forth industry standards and still protect the payments.
The $5,000 Minimum for Preference Claims—Now $6,825
BAPCPA also added a new, seemingly bright-line defense to the recovery of individual transfers of less than $5,000.00, which has now increased to a minimum of $6,825 under CPI adjustments built into the law every three years. Unfortunately, this change has not worked out as creditors might have hoped. Even though as written, the language seems to protect individual payments (now) of less than $6,825.00 from preference attack, courts have generally allowed recovery of smaller payments, as long as the total of all payments during the 90 day period exceeded the minimum. There is still the occasional case where the total a creditor received in the 90 day period is less than $6,825.00, in which case the defense does knock out these claims, but the original hope back in 2005 when the minimum claim was established has not panned out in practice.
The Venue Provision – Where a Debtor can Sue
Under the old, pre-BAPCPA bankruptcy law, debtors or trustees filed all preference lawsuits in the bankruptcy court where the bankruptcy petition was filed. That practice subjected creditors to the prospect of defending even small preference actions in far distant states such as New York, Delaware, or any other, debtor-friendly bankruptcy court around the country.
BAPCPA, however, included a change that appeared to require a debtor or trustee files a preference suit for less than $10,000.00 (now up to $13,650.00 under every-three-year CPI adjustments), to sue the creditor in the creditor’s home-town federal bankruptcy court. In other words, even if the debtor or trustee files its bankruptcy case in debtor-friendly Delaware, BAPCPA seems to require a preference suit against a Wisconsin creditor for less than $13,650.00, to be filed in one of the federal courts in Wisconsin.
Again, however, this has not worked out as creditors would have hoped. Many courts (including those in debtor-friendly Delaware) have held that BAPCPA’s change to the venue statute did not go far enough to expressly apply to preference claims, whatever Congress’s intent might have been. Therefore debtors and trustees continue to bring small preference cases in the local court where the bankruptcy was filed, where it is convenient for the debtor, but not the creditor. And, unfortunately, because this issue only comes up in cases where the amounts at issue are relatively small, it usually behooves a creditor to negotiate a resolution based on the standard preference defenses (e.g., new value, ordinary course), rather than spending more hard-earned creditor money on procedural arguments that might, or might not, succeed.
Even though all the anticipated benefits of the preference changes in BAPCPA have not played out as hoped, the change in the ordinary course of business defense has still provided a material benefit to preference defendants. Expert witness reports and testimony are no longer a required part of all preference defenses, but they remain a valuable tool in the event the specific debtor-creditor course of business strays out of the ordinary. The other two defenses have not helped as much, but the three-year CPI adjustments keep the minimums creeping up, and in the right case, they still are another point of leverage in the ongoing battle between the forces of Good (Creditors, of course) and the Evil preference claim.
If you have any questions regarding this article or other bankruptcy-related matters, please contact attorney Matthew P. Gerdisch (firstname.lastname@example.org) or attorney Samuel C. Wisotzkey (email@example.com) at (414) 962-5110.
NOTE: This article was originally posted on April 4, 2017. It has been updated to reflect the three year CPI adjustments that took effect April 1, 2019 (See Doc. 2019-01903 Published 2-12-19).
Kohner, Mann & Kailas, S.C. (KMK) is a value-driven law firm with a global reputation for success and a rich tradition of results. When you need unsurpassed legal expertise in business and financial services, business litigation, or commercial collections, let our seasoned attorneys help you achieve your most important objectives. Founded in Milwaukee in 1937, KMK enjoys a local, national, and international reputation, recognized by U.S. News & World Report as one of the nation’s Best Law Firms. For more information, visit www.kmksc.com