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Defending Preferential Transfers: The Ordinary Business Terms Defense- Part V: Failures Using the Ordinary Business Terms Defense

Like all other defenses, the defendant/transferee must provide evidence establishing the elements of the ordinary business terms defense.  Much can be learned from the many seeming half-hearted attempts to prove an ordinary business terms defense.  For example, the lack of competence of witnesses (whether expert or non-expert) and failure to identify the relevant industry or industries has resulted in failed attempts to fully utilize the ordinary business terms defense.  Further, changes to credit terms during the preference period might result in a transferee losing protection under both the ordinary course of business and the ordinary business terms defense.  For example, in In re Hechinger Investment Co. of Delaware, Inc., a creditor made substantial, eleventh hour changes to its credit terms.  Despite having a long relationship with the debtor, the court found that such a substantial change cost the creditor its protection under the ordinary business terms defense.

Creditors/defendants often times fail to establish a definitive industry standard.  In In re U.S. Interactive, Inc., a creditor's expert offered no basis or statistical analysis for his conclusion that the industry average was 60 days past invoice date, and failed to state affirmatively that 45, 50, or 60 days was the standard payment term in the industry.

In the In re Globe Manufacturing Corp. case, the court determined a contractor had failed to successfully assert an ordinary business terms defense where the debtor and contractor had no prior history of dealings, and the only evidence of industry practice presented by the contractor was a "bottom line" conclusion by a non-expert witness who admitted he had no real familiarity with industry payment practices.

Similarly, in the In re Just For Feet, Inc. case, the court found that a conclusory affidavit made by a creditor's president asserting that the creditor's business practices were consistent with unspecified billing practices in the industry was insufficient to establish an ordinary business terms defense.  In this case, engagement of an expert certainly would have been more successful.

The timing of the payment received by a creditor, compared to industry standards, is especially important in determining whether a particular transfer was made according to ordinary business terms.  In In re Amarillo Mesquite Grill, Inc., the court held that a creditor's lack of evidence of insurance industry standards regarding late premium payments was fatal to the defendant's ability to successfully assert an ordinary business terms defense.  Similarly, in In re Waccamaw's Home Place, a court found that payments made by a Chapter 11 debtor could be avoided as preferential when those payments during the preference period were on average 34 days after the invoice due date, as compared with an average delay of 10 to 25 days in the relevant industry.

The clear lesson here is that a creditor needs to do his or her homework in (i) framing the relevant industry, (ii) identifying industry standards, and (iii) showing the creditor's general compliance with those industry standards.

Next time:  Part VI – Successful Use of the Ordinary Business Terms, and Conclusion and Practice Pointers.