Bankruptcy Court Broadly Interprets the "Ordinary Course of Business Defense" in Preference Action

BANKRUPTCY COURT BROADLY INTERPRETS THE "ORDINARY COURSE OF BUSINESS DEFENSE" IN PREFERENCE ACTION

As most of you have defended your company against a debtor's or trustee's preference claims, you may already be familiar with the "ordinary course of business" defense in an action to recover "preferential transfers." Nevertheless, to refresh your memory, a preferential transfer is generally a transfer made by the debtor (i) to or for the benefit of an unsecured creditor, (ii) for or on account of an antecedent (i.e., existing) debt, (iii) while insolvent, and (iv) within the preference period (90-days prior to the debtor's filing of its bankruptcy petition). Among the defenses that a creditor may assert to a preference claim is the three-pronged "ordinary course of business" defense. Specifically, Section 547(c)(2) of the Bankruptcy Code provides that a debtor or trustee may not avoid a transfer that was "(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; (B) made in the ordinary course of business or financial affairs of the debtor and the transferee [the 'subjective prong']; and (C) made according to ordinary business terms [the 'objective prong' ]."

In determining whether a transfer falls within the "ordinary course of business" defense, most of the litigation has centered on whether particular transfers satisfy the subjective prong (Section 547(c)(2)(B)) and the objective prong (Section 547(c)(2)(C)) of that defense. The subjective prong concerns the consistency of the parties' course of dealing, and the objective prong concerns the relationship between the parties' course of dealing and industry norms.