Question: Under what circumstances might a debtor or trustee in bankruptcy seek the return of previous payments made to non-insider, creditors?
Answer: Under the Bankruptcy Code, the debtor in bankruptcy or the trustee of a bankrupt debtor can seek the return of payments to non-insider, creditors made during the 90 days preceding the filing of the debtor’s bankruptcy case (preference period) if the transfers are "preferential."
The Bankruptcy Code provides various defenses a creditor may assert to recover preferential transfers. A commonly asserted defense to the recovery of preferential transfers is the "ordinary course" of business exception. For this defense to apply, the transfer must be in payment of a debt that was incurred by the debtor in the ordinary course of business and the payments must be: (1) made in the ordinary course of business or financial affairs of the debtor and the creditor, or (2) made according to ordinary business terms in the applicable industry.
Question: How does the court determine "whether payments were made in the ordinary" course of business or financial affairs of the debtor and the creditor?
Answer: The following are some key factors courts often use to determine whether payments are "ordinary" as compared to prior dealings between the parties:
Changes in the Timing of Payments. Timing of the payment is critical. If a preferential payment is made more quickly or slowly — as compared to the timing of past payments — the ordinary course defense may be rejected by the court. To help protect this defense, a creditor should be aware of the time it typically takes a debtor to pay. If the timing of payments deviate from the norm, the creditor should determine the reason why the timing of these payments do not comport with the prior payment history. If the change relates to the debtor’s financial difficulties, a court might ultimately reject an attempt by the creditor to rely on the ordinary course defense.
Different Methods of Payments. Whether or not the payment is made by the same method as previous payments is another way courts determine if a payment is ordinary as compared to prior payments between the parties. For instance, if a debtor typically makes payments by wire transfer, but the preference payments are by check, the ordinary course defense may be rejected. For this reason, creditors should take careful note of any change in the debtor’s method of payment. If the change in payment does not relate to the debtor’s deteriorating financial condition, the ordinary course defense may be viable.
Partial Payments vs. Payment in Full. Additional factors courts consider are changes in whether payments are payments in full or partial payments. If a debtor typically pays invoices in full, but, during the 90 days before the bankruptcy filing makes partial payments, the ordinary course defense might fail. A creditor should note whether a debtor typically pays invoices in full or in part. If the change signals financial difficulties, a court might ultimately reject the ordinary course defense.
Requests to Change Payment Terms. A request for a change in payment terms can also be a warning sign to the creditor (and, eventually, to a court) that the debtor is experiencing financial distress. If the debtor is fiscally healthy, a change in the terms may not be problematic. For instance, if a debtor requests a change from payment in net 30 days to net 45 days, and the reason for the request for the change does not relate to financial problems, there might be enough time between the change in terms and any future bankruptcy filing to allow the new terms to become the ordinary course between the parties.
Be Mindful of Collection Efforts. Courts also consider whether the payments are made in response to "unusual" debt collection activities by the creditor. In order to make this determination, courts often