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Short History of Dealings? No More Gap Filling for Ordinary Course of Business Defense

Stanziale, Jr. v. Southern Steel & Supply, L.L.C. (In re Conex Holdings, LLC), Adv. No. 12-51211 (CSS), 2014 WL 5139240 (Bankr. D. Del. Oct. 14, 2014)

In this recent Opinion from the Honorable Christopher S. Sontchi, the Court was presented with cross-motions for summary judgment, both seeking a determination that six preferential transfers paid to the defendant by the debtor qualified for the ordinary course of business defense under section 547(c)(2) of the Bankruptcy Code.  Importantly, the transfers constituted the totality of the parties’ relationship.  In rendering His Honor’s Opinion denying both summary judgment requests, the Court made it clear that only the parties’ short relationship could be considered when determining whether the transfers at issue were made in the ordinary course of business of the debtor and the defendant pursuant to the subjective test of section 547(c)(2)(A) of the Bankruptcy Code.  Such holding is significant as it departs from the developed case law requiring preference defendants to fill the gap by referencing industry standards when asserting that first-time transactions between itself and a debtor qualify as ordinary course transactions under section 547(c)(2)(A).

Under section 547(c)(2) of the Bankruptcy Code, avoidance of a preferential transfer may not occur if the transferee proves that “such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was – (A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms.”  The test under section 547(c)(2)(A) is commonly known as the “subjective test” and requires courts to consider the ordinariness of preferential transfers as between the debtor and transferee.  On the other hand, the test under section 547(c)(2)(B), known as the “objective test,” requires courts to compare the transactions between the debtor and transferee to others in the industry.

Until BAPCPA, both the subjective and objective prongs of section 547(c)(2) were required to be fulfilled for a transaction to be considered made in the ordinary course of business.  When Congress revised the Bankruptcy Code in 2005, it was re-written in the disjunctive and now, only requires one prong to be satisfied – either the subjective or the objective.  As the Court highlights in this decision, parties with a long history of dealing may rely entirely upon their prior dealings when seeking a determination under the subjective test.  However, despite the change in the Bankruptcy Code, those with a limited history of dealing (e.g., one or two transactions, some or all of which occurred during the preference period) have been required to fill the gap by referencing “more extensive and exacting analysis of industry standards.”  The problem with this approach, according to Judge Sontchi, is that it “rewrite[s] the statute to its pre-2005 terms,” returning the ordinary course of business defense to a two-prong approach.  The more appropriate practice rather is for the Court to “do the best it can with the evidence before it as to the parties’ relationship” and not “import the industry practice into its review[.]”