The Seventh Circuit expanded the “ordinary course" defense of creditors who have been sued for the avoidance of preferential payments under Section 547 of the Bankruptcy Code. In re Creditors Comm. of Sparrer Sausage Company, Inc. v. Jason’s Foods, Inc.^[1] The court provided a roadmap for preference defendants and expanded the range of “ordinary course” historical payment experience that provides the benchmark for insulating alleged preferential transfers made during the 90 days preceding bankruptcy. After applying the broader standard as well as the "subsequent new value" defense, the creditor’s liability dropped from $306,310 to zero. The court offered some other interesting tactical advice to preference defendants seeking protection from a preference lawsuit.

Jason’s Foods received $587,000 in payments during the 90-day preference period which ranged between 14 and 38 days after invoice date. The bankruptcy court concluded that $310,000 were avoidable preferences by (i) ending the historical period seven months before the preference period began and (ii) defining “ordinary course” to be the 22 day average payment period – plus or minus 6 days so that only payments made between 16 and 28 days after invoice were protected.

The Seventh Circuit first considered the historical period that can be used to establish whether payments made outside stated payment terms were nevertheless protected by the parties’ looser “ordinary course” of actual transactions. Decisions vary widely regarding the beginning and ending dates of the historical period and whether averages, weighted averages or median pay delay periods should be compared.^[2] In Jason's Foods, the Seventh Circuit favored a variation of the average approach, first finding that the bankruptcy court did not abuse its discretion by shortening the historical period during which “the norm [is] established by the debtor and the creditor in the period before, preferably well before, the preference period”.^[3] An earlier cutoff seven months before the beginning of the preference period was justified because the share of payments that were past due (over 30 days after the invoice date) thereafter jumped from 6% to 46% of all payments.^[4]

However, it reversed as “arbitrary and excessively narrow” the bankruptcy court’s formula that treated only 64% of the payments during the historical period as “ordinary course”. It found that the precedent^[5] required increasing the spread above and below the average to eight days so that 88% of the payments from the historical period established the parties’ “ordinary course”. The resulting insulation of payments made between 14 to 30 days after invoice date protected all but two remaining payments that were made 37 and 38 days after invoice date and totaled $60,700. Because the debtor had not paid Jason’s Foods for $63,500 in goods that were shipped after making these two payments, the “subsequent new value” defense completely insulated the creditor. The court cited its own precedent holding that the bankruptcy estate had been replenished because creditors received the benefit of additional unsecured credit that remained unpaid.^[6]

Jason’s Foods offers several lessons for the creditor facing a preference demand beyond the holding that assessment of the “ordinary course” established in the historical period must be broad enough to capture the vast majority (here, nearly 90%) of payments made during the period. Analysis of a spreadsheet of all payments is essential to drawing the boundaries broadly enough to only exclude true outlying payments to establish an appropriate benchmark.

First, there is considerable flexibility in settling the claim based or persuading the bankruptcy court, who has considerable discretion in defining and applying the "ordinary course" defense. The case focused on the actual pattern of payments between the parties (the “subjective” ordinary course) which often is looser than the stated terms. This is not always the case, however, where actual payments may be made more promptly than required. Hence, the stated terms may actually protect more payments under the alternative, “objective” ordinary course approach.

Second, the Seventh Circuit views all of the parties’ dealings prior to the beginning of the 90-day preference period as an appropriate historical period (the “total range” methodology), provided there is no marked deterioration in past due payments.^[7] Although the historical period should end before the debtor begins to experience financial difficulties that affect its payment practices, the Seventh Circuit’s prior ideal of reaching reach back “well before the preference period”,^[8] its directive did not “require truncating the historical period ‘well before’ the beginning of the preference period but simply under-scores that the baseline should reflect payment practices that the companies established before the onset of any financial distress associated with the debtor’s impending bankruptcy”.^[9]

Third, the court said that the “bucket” approach is one appropriate method to defining the ordinary course based a spread of days from the average payment period, but did not make it mandatory. Hence, the range of all payments during the historical period may be considered ordinary course if they are tightly distributed without substantial outliers.

Fourth, while it is a good tactic to stipulate on the historical period, the bankruptcy court is within its discretion to reject that stipulation based on its own analysis. Hence, if the parties do reach such a stipulation, they probably should not provide a detailed transaction history that could support such a rejection.

Finally, preference defenses are cumulative.^[10]Jason’s Foods applied ordinary course first, then applied a credit for subsequent new value^[11], using the particular methodology that required that the invoices for subsequent shipments remain unpaid. Defendants should be aware, that other circuits use a more relaxed standard.^[12] Other defenses also may be applied, such as contemporaneous exchange^[13] if the defendant shipped additional goods with the intention of simultaneously receiving payment of old invoices and substantially did so. In a global spreadsheet analysis, this defense typically is applied after ordinary course and before subsequent new value.

Preference cases are rarely litigated, so Jason’s Foods demonstrates the need for careful analytics and good advocacy. The lessons learned also can shape successful settlement negotiations that can avoid costly trials and appeals, which only are cost effective in the largest claims.

^{[1] __ F.3d __, 2016 WL 3213096 (No. 15-2356, June 3, 2016).}

^{[2]  Compare Cox v. Momar, Inc. (In re Affiliated Foods Southwest, Inc.), 750 F.3d 714, 781 (8th Cir. 2014) (expands historical period from one to two years to better capture transactions before debtor’s financial distress and upholds the ordinary course defense because the payment delay of the alleged preferential transfer was less than the historical average payment delay and within the historical range of payment delay) with Davis v. Clarklift West, Inc. (In re Quebecor World (USA), Inc.), 518 B.R. 757 (Bankr. S.D.N.Y. 2014) (rejects ordinary course defense based on the shorter weighted average of payment delay during preference period that the weighted average payment delay during the two-year historical period).}

^{[3]  Id. at *3, quoting In re Tolona Pizza Prods. Corp., 3 F.3d 1029, 1032 (7th Cir. 1993).}

^{[4] Even though the debtor did not experience a marked “liquidity crisis” or other marked change in payment practices, the bankruptcy court offered a reasoned basis for truncating the historical period before the start of the preference period because the debtor’s financial difficulties had already substantially altered its dealings with the creditor.  Slip Op. at 9, citing In re Circuit City Stores, Inc., 479 B.R. 703, 710 (Bankr. E.D. Va. 2012); In re H.L. Hansen Lumber Co. of Galesburg, Inc., 270 B.R. 273, 278-279 (Bankr. C.D. Ill. 2001).}

^{[5]  In re Quebecor World (USA), Inc., 491 B.R. 379, 387 (Bankr. S.D.N.Y. 2013), the leading case establishing the “bucketing” approach of adding an “ordinary course” bracket to the average historical payment period, captured 88% of the historical period payments in the bucket it established.}

^{[6] 2016 WL 3213096 at *5, citing In re Prescott, 805 F.2d 719, 727 (7th Cir. 1986); In re Globe Bldg. Materials, Inc., 484 F.3d 946, 950 (7th Cir. 2007).}

^{[7] 2016 WL 3213096 at *3.}

^{[8]  Tolona Pizza, supra, 3 F3d at 1032.}

^{[9] 2016 WL 3213096 at *3, citing In re Affiliated Foods Sw. Inc., 750 F.3d 714, 720 (8th Cir. 2014) (“To make a sound comparison, ‘[n]umerous decisions support the view that the historical baseline should be based on a time frame when the debtor was financially healthy.’” quoting Quebecor World, supra, 491 B.R. at 387).}

^{[10] 2016 WL 3213096 at *5, citing 5 COLLIER ON BANKRUPTCY ¶ 547.04[4][e] at 565–69 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2015) (noting that § 547(c) defenses may be used cumulatively).}

^{[11] 11 U.S.C. § 547(c)(4).}

^{[12] Prescott and older cases interpreting this defense required the subsequent new value to be “unpaid”.  See, e.g., Kroh Bros. Dev. Co. v. Continental Construction Engineering (In re Kroh Bros. Dev. Co.), 930 F.2d 648, 652 (8th Cir. 1991); New York City Shoes, Inc. v. Bentley lnt'l, Inc. (In re New York City Shoes, Inc.), 880 F.2d 679, 680 (3d Cir. 1989); Charisma Inv. Co., N.V. v. Airport Systems, Inc. (In re Jet Florida System, Inc.), 841 F.2d 1082, 1083 (11th Cir. 1988).  Newer decisions reject the notion that the new value must remain unpaid so long as the repayment is itself voidable (or would have been avoidable but for the trustee’s failure to prosecute or a defense arising from still later subsequent new value that itself is unrepaid).  See. e.g., Hall v. Chrysler Credit Corp. (In re JKJ Chevrolet Inc.), 412 F.3d 545, 552 (4th Cir. 2005) (allows defense because the subsequent new value was repaid by an avoidable transfer that trustee elected not to pursue); Jones Truck Lines, Inc. v. Central States, Southeast & Southwest Areas Pension Fund (In re Jones Truck Lines. Inc.), 130 F.3d 323, 329 (8th Cir. 1998) (allows defense because repayments of subsequent new value are themselves avoidable); Mosier v. Ever-Fresh Food Company (In re IRFM, Inc.), 52 F3d 228, 231-32 (9th Cir. 1995)(same); Laker v. Vallette (In re Toyota of Jefferson, Inc.), 14 F.3d 1088, 1092-93 (5th Cir. 1994)(same); Wiscovitch-Rentas v. PDCM Assocs., S.E. (In re PMC Mktg. Corp.), 518 B.R. 150, 159 (B.A.P. 1st Cir. 2014)(same, collecting cases).}

^{[13] 11 U.S.C. § 547(c)(1).}