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Ordinary Course Of Business

“…you can make a preference claim into a better situation by knowing the options and keeping and reviewing your invoicing and payment records.”

Bankruptcy! It is a word that elicits fear, disgust, and even embarrassment to most business owners. Bankruptcy court is the last place the business owner wants to be, but what about the owner that gets unwillingly drawn into another business owner’s bankruptcy proceeding? It is especially troublesome if the last few payments were received prior to the other business owner’s filing for bankruptcy and the invoices were for valid goods or services and were due and owing. It just wouldn’t be right to make a business owner give back money that was paid to him in the “ordinary course of business.” Would it?

Why would I have to give up those payments?

That is usually the first question a business creditor’s attorney is asked by a client. The owner provided supplies, materials or services to the now bankrupt business owner, and as usual, had sent out the normal invoices for payment. The invoices were paid, albeit a little late; however, late payments were customary for that bankrupt business. The owner would immediately inquire, “Why do I have to give my money back?” The answer to that question lies in the murky area of “preferences” under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

What is a preference?

The first concept for the creditor business to understand is the circumstance when a preference arises. The most common example usually begins with a simple business owner (the “creditor business”) providing goods or services to a regular client that fails financially and files for bankruptcy (the “bankrupt business”).

Sometimes the creditor business has not received any payments, and if it has been some time, may have even started its own proceedings in state court to collect the unpaid amounts. More often however, the creditor business had a long term relationship with the bankrupt business and received some payments, if not all, for its outstanding invoices just prior to the bankrupt business filing for bankruptcy.

These final payments are what the bankruptcy trustee questions. The trustee, in an effort to collect as much money to satisfy all the bankrupt business’ creditors, will contact and attempt to recoup payments made shortly before the filing. The trustee views those creditor businesses that received those final payments as being “preferred” over the creditor businesses that were not paid. And, in the spirit of fairness, the Bankruptcy Code allows the trustee to avoid certain payments.

What preferred payments can be avoided?

Subject to certain exceptions, the bankruptcy trustee has broad powers to avoid preferences. The bankruptcy trustee, except as discussed later, “may avoid any transfer of an interest of the debtor in property…made (A) on or within 90 days before the date of the filing of the petition; or (B) between 90 days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider.” Because most standard business creditors are not considered insider creditors, the real focus for the trustee is those payments made in the 90 days preceding the bankruptcy filing. A creditor business that received any payment from the bankrupt business in the last 90 days will likely be contacted by the bankruptcy trustee who will demand the return of all payments received during that time period.

What can I do to protect my money?

After receiving a demand letter from a bankruptcy trustee, the creditor business owner usually panics. He may feel he did something wrong, or should have known better than to deal with that other business. He knew the business was struggling and yet allowed late payments to slide for a few days, weeks and sometimes even for more than he normally would. He always got paid, so it never occurred to him to stop working with the other business. It was what he would do in the “ordinary course of business.” That phrase, creditor business owner, is the key to keeping money out of the bankruptcy trustee’s pockets and more importantly, in your own. And, why should that money go to someone else since it is money you are owed? It is YOUR money!

Despite the criticisms Congress takes — and often times it is well deserved criticism — the elected officials in Washington have given small business owners a new and more powerful tool to protect themselves from preference payment claims in bankruptcy. The Bankruptcy Code has recognized that small businesses have to continue working and dealing with other businesses that may be struggling. A small business owner cannot predict which struggling business will push through the tough times and become successful again or which will continue to struggle and eventually collapse into bankruptcy. Congress wants to encourage the small business owner to continue to deal with each client as they ordinarily would, and as a result, a defense to the bankruptcy trustees avoiding powers was created –the “ordinary course of business” defense.

Although the bankruptcy trustee is given broad powers to avoid payments made within 90 days before the bankruptcy filing, the Bankruptcy Code provides certain exceptions. One of the most powerful defenses provides that the bankruptcy trustee “may not avoid…a transfer…to the extent that such a 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.” In essence, those payments made to the creditor business (i.e. the “transferee”) within the ninety day period that are either in the ordinary course of business between those two companies ordinary business terms for the type of business they are in, may not be avoided by the bankruptcy trustee.

How do I prove my payments were in the ordinary course of business?

Using the ordinary course of business defense in a bankruptcy proceeding will take the right facts, and most assuredly, the skill and zealous representation only an attorney can provide a business owner. But, you can help yourself. Prior to the recent changes by BAPCPA to the Bankruptcy Code, a successful creditor’s attorney had to prove both that the payments made within the 90 day preference period were in the ordinary course of business between the two companies in question and were ordinary for the type of business the parties were transacting in. Before the creditor business had a difficult time producing records, invoices, and payment histories that were consistent between themselves and the now bankrupt business (a subjective test) and that were also acceptable by industry standards (an objective test) to satisfy the “ordinary course of business” requirements. Now, however, because a creditor business can prove either of the above standards, they stand a better chance of making an argument that those final payments cannot be avoided by the bankruptcy trustee.

Proving that your company’s specific payments were received in the ordinary course of business is always a fact determination. And because there has been limited litigation and commentary regarding this defense, there is little information to determine if any specific fact pattern will be determinative. There are, however, certain business practices that can help you make a better case that the “ordinary course of business defense” applies to you:

  • Keep detailed records.
  • Periodically cross reference the time from invoice to receipt of payment for any particular client to watch for payments that begin to fall outside your ordinary course of business with that particular client.
  • Follow your industry’s standards for ordinary business terms and debt collection practices when invoicing and collecting payments from clients.
  • If you are faced with a preference payment claim from a bankruptcy trustee, consult an attorney familiar with bankruptcy preference practices and defenses.

There is never a good bankruptcy situation, but you can make a preference claim into a better situation by knowing the options and keeping and reviewing your invoicing and payment records. With good, ordinary course of business practices and a good attorney, you can keep more money in your business and yourself out of bankruptcy court.