Preference Avoidance Actions: When Late is Ordinary

A recent case shows how even late payments can be used to satisfy the ordinary course of business defense in a preference avoidance action.  Baumgart v. Savani Props Ltd. (In re Murphy), Case No. 20-11873, Adv. Pro. No. 20-1070, 2021 Bankr. LEXIS 1035 (Bankr. N.D. Ohio Apr. 19, 2021).

The defendant owned an apartment building where the debtor was a tenant.  Rent was due on the first of each month, with a five-day grace period before a late charge was imposed.  About 20 months after the lease began, the tenant filed for chapter 7.  Two monthly payments were made on time.  The other payments were late, ranging from 6 to 29 days after the due date.

The chapter 7 trustee sued the landlord, alleging the rent payments were avoidable as preferential transfers under Bankruptcy Code section 547.  The defendant’s answer asserted two affirmative defenses under section 547(c): (i) contemporaneous exchange for new value, and (ii) ordinary course of business.  The defendant later moved for summary judgment, citing the ordinary course of business defense.

Transfers can be avoided when they’re made to or for the benefit of a creditor; for or on account of an antecedent debt; while the debtor was insolvent; within 90 days of the bankruptcy filing date, or one year for payments made to insiders; and when the transferee receives more than it would in a chapter 7 liquidation.  11 U.S.C. § 547(b).

The defendant argued that even if these elements were satisfied, the ordinary course of business defense entitled him to summary judgment.  The defense applies when a transfer was in payment of a debt incurred in the ordinary course of business or financial affairs of the debtor and the transfer and either: was made in the ordinary course of business or financial affairs of the debtor and the transferee, or made according to ordinary business terms.

The key word in that test is “or.”  Before the 2005 amendments to section 547(c)(2) under the Bankruptcy Abuse Prevention and Consumer Protection Act, a defendant asserting the ordinary course of business defense had to satisfy both prongs:  the transfer had to be both in the ordinary course of business or financial affairs of the debtor and the transferee and made according to ordinary business terms.

The 2005 amendments changed the defense such that just one prong must be satisfied.  Thus, payments made to a defendant within the ordinary course of business or financial affairs of the debtor and the transferee can satisfy the test even if those payments aren’t made according to industry standards.

Therefore, “even if the debtor’s business transactions were irregular, they may be considered ‘ordinary’ for purposes of 547(c)(2) if those transactions were consistent with the course of dealings between the particular parties.”  Yurika Foods Corp. v. United Parcel Serv. (In re Yurika Foods Corp.),888 F.2d 42, 45 (6th Cir. 1989).

As noted above, in Baumgart, 18 of the 20 monthly payments were late.  But the court observed that “[a] 29-day range is not so extraordinary to make the rent payments fall outside the ordinary course of business between the parties.”  2021 Bankr. LEXIS at *8-9.  Late payments within 29 days of the due date were “ordinary” in these circumstances.  Thus, the court granted the defendant’s motion for summary judgment.