First-Instance Transaction May Qualify For 'Ordinary Course Of Business' Preference Defense

Section 547(c)(2) of the Bankruptcy Code excepts from the trustee's power to avoid preferential transfers any transaction in which the debtor transfers property to a creditor in the "ordinary course of business." Exactly what constitutes "ordinary course of business," however, is not a settled question of law. In Jubber v. SMC Electrical Products (In re C.W. Mining Co.), 798 F.3d 983 (10th Cir. 2015), the U.S. Court of Appeals for the Tenth Circuit considered whether a first-time transaction between a debtor and a creditor can satisfy the ordinary course exception. The Tenth Circuit held that a first-instance transaction can qualify if: (i) the debt was ordinary in accordance with the past practices of the debtor and the creditor when dealing with other, similarly situated parties; and (ii) the payment was made in the ordinary course of business of the debtor and the transferee. The court accordingly affirmed rulings below that a two-day-early installment payment on a first-instance equipment purchase could not be avoided by a bankruptcy trustee as a preference.

The Law

Section 547(b) of the Bankruptcy Code empowers a bankruptcy trustee to avoid transfers made by an insolvent debtor to creditors within 90 days of a bankruptcy filing if, as a consequence of the transfer, the creditor received a greater amount with respect to its claim than it would in a chapter 7 liquidation. Certain otherwise preferential transfers, however, are excepted from the trustee's avoidance powers. Among these—as specified in section 547(c)(2)—are transfers in payment of a debt incurred by the debtor in the ordinary course of business, which payments were "(A) made in the ordinary course of business . . . or (B) made according to ordinary business terms."

These exceptions enable a financially distressed company to continue operating its business in the ordinary course, prior to filing for bankruptcy, ultimately preserving the value of the assets of the estate as well as staving off the proverbial "race to the courthouse" by creditors. At the same time, by leaving undisturbed only the normal financial relations of debtors and creditors, this exception does not extend to unusual and risky behaviors, which could adversely affect the interests of creditors and the estate. See Union Bank v. Wolas, 502 U.S. 151 (1991).

Prior to 2005, many courts construed section 547(c)(2) to require that both subsections (A) and (B) must be satisfied to insulate a transfer from avoidance under the ordinary course of business exceptioni.e., that a transfer was made in the ordinary course and that it was made according to ordinary business terms. See 5 Collier on Bankruptcy § 547.04[2] (16th ed...