Bankruptcy Court Clarifies the Ordinary Course of Business
Preference Defense, and Vendor Prevails
By Bradley D. Blakeley
The recent flurry of chapter 11 filings in the
State of Delaware has resulted in thousands of vendors finding
themselves, like Armenia Coffee Corporation (Armenia), defending
preference actions instituted in The First State. Thanks to Judge
Judith K. Fitzgerald, vendors now have a brighter line to use
in analyzing their ordinary course of business defense. Judge
Fitzgerald ruled in favor of Armenia, finding that Armenia had
an ordinary course of business defense to the preference action
instituted by the debtor, Brothers Gourmet Coffees, Inc. Debtor).
In the preference action, the Debtor sought recovery of eight transfers to
Armenia totaling more than $800,000 made in the 90 days prior to the petition
date. In response, Armenia filed a motion for summary judgment asserting that
seven transfers (one was made by wire transfer and not included in the motion)
were made in the ordinary course of business.
The Preference Action and the Ordinary Course of Business
The Bankruptcy Code vests the debtor (or trustee
if one is appointed) with far-reaching powers to avoid transfers
of assets and monetary transactions prior to a bankruptcy filing.
The power to avoid preferential transfers is one of the most
powerful weapons a trustee has. The Bankruptcy Code defines a
preference expansively to include nearly every transfer by an
insolvent debtor 90 days prior to bankruptcy. The purpose of
the preference provision is two-fold. First, vendors are discouraged
from racing to the courthouse to dismember a debtor, thereby
hastening its slide into bankruptcy. Second, debtors are deterred
from preferring certain unsecured creditors by the requirement
that any unsecured creditor that receives a greater payment than
similarly situated unsecured creditors disgorge the payment so
that like creditors receive an equal distribution of the debtor's
Not all transfers made within the preference period are avoidable. To protect
those transactions which replace value to the bankruptcy estate previously
transferred, the Bankruptcy Code carves out seven exceptions or defenses to
the trustee's recovery powers. The most commonly asserted exception by trade
creditors is the ordinary course of business defense. That defense protects
payments, in all or part, received by an unsecured creditor within 90 days
of the bankruptcy from recovery where the creditor establishes certain elements
detailed below. The policy supporting the ordinary course of business defense
is two-fold: (1) protect customary transactions, and (2) encourage creditors
to continue to extend credit to financially troubled debtors, possibly helping
the debtor avoid bankruptcy.
To qualify for the ordinary course of business defense, a creditor must establish
that the payment is ordinary as between the parties and that the payment is
ordinary in relation to prevailing business standards. The court determines
a debtor's ordinariness of payments through comparison with prevailing business
standards, which includes common terms used by other trade creditors in the
same industry facing similar problems.
Ordinary Course Prevails
In its ruling, the Brothers Gourmet Coffee Court
first examined whether the transfers were made within the ordinary
course of business between the parties (the subjective analysis).
The Debtor argued that Armenia stepped up its collection efforts
during the preference period such that the payments were not
made in the ordinary course of business. The record reflected
that prior to the preference period, Armenia made calls to Debtor
concerning payment related to 50 percent of its orders, but,
during the preference period, called regarding five out of seven
orders. However, the Court found that the change was not material.
Additionally, the Debtor admitted that the average time between invoice due
date and payment date in the pre-preference period was approximately 32.69
days and the average time between invoice due date and payment date in the
preference period was approximately 33.71 days. The Court found that the difference
of one day was not material and the payments during the preference period were
within the range of payments made in the pre-preference period. Accordingly,
the Court found that Armenia met its burden on the issue of the subjective
The Court also found the transactions were made according to ordinary business
terms (the objective analysis). The Debtor contended that Armenia had not provided
any specific data regarding the ordinary business terms in the coffee industry.
However, the Court disagreed. Instead, the Court found that Armenia's declarant
was an expert whose opinion was offered as to the experience of payment for
orders in the coffee industry, and that the transactions between the Debtor
and Armenia were ordinary within the industry. The Court found that the Debtor
produced no evidence to refute the expert's opinion, and summary judgment was
granted on the section 547(c) issues.
As found in Brothers Gourmet Coffee, a small difference between prepreference
period and preference period collection practices and timing of payments may
not still allow you to prevail on the ordinary course of business defense.
The Court provides ammunition for the vendor to negotiate the preference complaint.
Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley
LLP Summer 02