Is payment on the first time shipment within the ordinary course of business?
By Bradley D. Blakeley

Your company has just received a first-time order from a company you know is having financial difficulty. As a credit manager, do you agree to take the order and extend credit? The Pennsylvania bankruptcy court's decision in In re Forman Enterprises, Inc. encourages you to do so.

In In re Forman Enterprises, Inc., the debtor, a retailer of casual clothing, placed an order with Golden Knitting Mills, Inc. for sweaters valued at $115,200. It was the first transaction between the parties, with stated invoice terms of "NET 30". The Debtor failed to pay within terms, and several calls were placed by Golden in an attempt to collect the past due amount. Golden went so far as to re-send the invoice to the Debtor's Chief Financial Officer, and finally spoke with the CFO concerning the delinquent payment. The Debtor agreed to pay the full amount owing, and, in return, Golden shipped additional goods to the Debtor. A week later, 19 days after the due date, the Debtor paid Golden $115,200.

The trustee filed a preference action against Golden seeking to recover the full $115,200. At trial, the court acknowledged that several courts in other jurisdictions have adopted a per se rule that first-time transactions between a debtor and creditor can never qualify as an ordinary-course transaction. The Forman Enterprises court rejected this position, however, and asserted such a rule would discourage rather than encourage first-time creditors from doing business with a struggling debtor. The court found that the transfer was not made outside of the ordinary course of business, and found in favor of Golden.

It is important to note that the court underscored the importance of the second shipment made by Golden. With an interesting interpretation on the communications between the parties, the court found that the communications leading up to payment were a "prelude to [the debtor] ultimately agreeing to ship the second order of sweaters," and rejected the trustee's argument that the tactics employed by Golden placed undue pressure on the Debtor to make the transfer.

In its decision, the Forman Enterprises court recognizes the difficulties encountered by debtors to find new suppliers willing to give credit in troubled times, and the importance of encouraging creditors to do so. The decision is a step in the right direction toward giving creditors the assurance they need before extending credit to a firsttime customer.

Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP Fall 03