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Bankruptcy Court Decision Highlights Ordinary Course Defense to Preferential Transfer Claims

Bankruptcy Court Decision Highlights Ordinary Course Defense to Preferential Transfer Claims

A bankruptcy filing creates a complex legal landscape for creditors, particularly those who received payments from the debtor shortly before the bankruptcy. These creditors, already grappling with unpaid amounts due from the debtor, often face demands to return payments they received — known as “claw-back” claims — for equitable distribution among the wider creditor body.

The Bankruptcy Code includes affirmative defenses to these claw-back claims, which protect certain pre-bankruptcy transfers by the debtor to creditors. One such defense is the “ordinary course of business” defense. In a recent decision in In re ASPC Corp., Adv. Pro. No. 20-2077, 2024 WL 1381655 (Bankr. S.D. Ohio Mar. 29, 2024), Judge John E. Hoffman, Jr., of the United States Bankruptcy Court for the Southern District of Ohio, analyzed this defense and confirmed that a creditor can prevail if it satisfies either the objective or subjective test.

The Ordinary Course of Business Defense

The Bankruptcy Code allows a debtor or trustee to recover certain payments made to a creditor within the ninety-day period preceding the bankruptcy filing, or one year for payments to an insider. This period is known as the “Preference Period.” Among the statutory defenses to preference claims is the ordinary course of business defense, which precludes the claw-back of payments made during this period if the payment: (1) was for a debt incurred by the debtor in its ordinary business dealings with the creditor, and (2) was made in the ordinary course of business of the industry in which the debtor participates (the “Objective Test”) or according to the ordinary business terms established between the debtor and the creditor (the “Subjective Test”). The creditor bears the burden of proof to establish this defense.

In re ASPC Corp.

In In re ASPC Corp., Judge Hoffman examined the framework of the ordinary course of business defense and the creditor’s burden of proof to counter a preferential transfer claim.

The adversary proceeding involved a preference action where the liquidating trustee sought to avoid certain transfers received by Sturm Ruger & Company, Inc. (“Ruger”) from the debtor during the Preference Period.

To decide whether to avoid those transfers, the Bankruptcy Court considered the difference between the Objective and Subjective Tests under Bankruptcy Code § 547(c)(2). The Court noted that before the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), § 547(c)(2) required that a preference defendant prove that transfers were made both: (1) in the ordinary course of business or financial affairs of the debtor and the defendant, and (2) according to ordinary business terms. However, BAPCPA revised the statute, replacing “and” with “or” between the Objective and Subjective Tests, meaning a preference defendant now only needs to prove that a transfer meets one of the two tests, not both.

Based on Ruger’s expert report, which concluded that the payments were made within the ordinary course of business in the debtor’s industry (small arms, firearm industry), the Court held that the debtor’s payments to Ruger were made according to ordinary business terms. Despite the liquidating trustee’s arguments that Ruger had modified the debtor’s credit limits, altering their conduct, the Court stated that the change from “and” to “or” in BAPCPA allowed Ruger to satisfy the objective test alone.

Judge Hoffman noted: “This case illustrates the importance of BAPCPA’s change from the conjunctive ‘and’ to the disjunctive ‘or’ between the subjective and objective tests for the ordinary course of business defense. Although the Court need not decide the issue, there appears to have been a change in the manner in which Ruger dealt with [the debtor] before and during the Preference Period as to credit limits. Were § 547(c)(2) still written in the conjunctive, Ruger would likely be unable to satisfy the subjective test, and therefore may have been unable to establish that the transfers were made in the ordinary course of business. But because preference defendants now need only satisfy either the subjective or objective test, Ruger can avail itself of the ordinary course of business defense by satisfying the objective test alone.”

Conclusion

The decision in In re ASPC Corp. highlights the standards applicable to establish the ordinary course of business defense to a preferential transfer claim and the burden of proof. Judge Hoffman’s decision underscores BAPCPA’s restructuring of the defense, confirming that creditors need only satisfy either the Objective or the Subjective Test, not both.

If you are a creditor facing the complexities of preferential transfer claims in a bankruptcy case, understanding the nuances of defenses like the ordinary course of business is crucial. For expert legal guidance and to protect your interests, contact Jeffrey M. Rosenblum, P.C. Our experienced attorneys are ready to help you navigate these challenging situations. Call us today at 866-637-7300 to schedule a consultation and ensure your rights are defended.

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