Court Expands Use of Average Lateness Methodology

Two recent decisions from the United States Bankruptcy Court for the Southern District of New York, Quebecor World Litigation Trust v. Clarklift-West, Inc. dba Clarklift Team Power (In re Quebecor World (USA), Inc.), 2014 WL 5292981 (Bankr. S.D.N.Y. Oct. 14, 2014) and Pereira v. United Parcel Service of America, Inc. (In re Waterford Wedgwood USA, Inc.), 508 B.R. 821 (Bankr. S.D.N.Y. 2014) affirmed the use of “average lateness” methodology to examine both the subjective and the objective components of the ordinary course of business defense to preference actions. This has significance in that average lateness methodology may now be employed to assess both independent prongs of the ordinary course of business defense.

Quebecor

In Quebecor World Litigation Trust v. Clarklift-West, Inc. dba Clarklift Team Power, the litigation trustee for the Quebecor World litigation trust sued Clarklift-West under Bankruptcy Code section 547 to avoid and recover payments the debtor made during the preference period. The defendant argued that the payments were not avoidable because they were made in the “ordinary course of business.” Bankruptcy Code section 547(c) states that payments made in the ordinary course of business are immune from avoidance. The trustee filed a motion for summary judgment.

The debtors filed the underlying bankruptcy cases on Jan. 21, 2008. The defendant was in the business of heavy equipment sales, rentals and service, and had conducted business with the debtors since 2005. To establish a baseline of prior dealings between the parties for the purpose of determining whether the preference period payments were made in the ordinary course of business, the plaintiff utilized approximately two years of historical data. The court noted that during the historical period, approximately 83% of payments to defendant were made between 45 and 65 days past the invoice date, while over 70% of payments during the preference period were made between 76 and 85 days past the invoice date. The court also noted that the historical weighted average days to pay was 50.29 days and increased to 77.70 days during the preference period.

The defendant did not dispute the trustee's figures, but argued that a 33% to 50% variance in timeliness of payments should not take the transactions outside the ordinary course of business. The court rejected this argument, noting there was no special seasonal reason to justify the significant shift in payment timing. The defendant also argued that other factors examined in the ordinary course of business analysis ' 1) amount of payment; 2) circumstances of payment; 3) payment pressure; and 4) change in means of payment ' weigh in favor of finding that payments were made in the ordinary course of business. The court also rejected this argument observing that the existence of some favorable ordinary course analysis factors does not compensate for the large shift in mean time of payment. Therefore, the court concluded that the defendant failed to establish an ordinary course of business defense and entered judgment in favor of the trustee on the summary judgment motion.

Pereira

In Pereira v. United Parcel Service of America, Inc., the Chapter 7 trustee for the affiliated debtors sued UPS under Bankruptcy Code section 547 to avoid and recover payments the debtor made during the preference period. The defendant argued, among other things, that the payments were not avoidable because they were made according to “ordinary business terms” within the industry. The court held that some, but not all, preference transfers made to defendant were protected by the ordinary business terms defense.

The debtors were in the business of importing, distributing and selling china, crystal and other similar goods. They utilized the defendant, UPS, to ship their products. In an effort to demonstrate that the payments were protected under the ordinary business terms of the industry defense under Bankruptcy Code section 547(c)(2)(B) ' the “objective test” ' the defendant relied upon the testimony of Thomas Saluric, corporate credit manager at UPS and member of Credit Research Foundation and the National Association of Credit Managers. The trustee did not offer his own rebuttal witness.

Mr. Saluric's trial testimony focused on the time customers took to pay UPS compared with other similarly situated industry players. Mr. Saluric relied primarily on data collected from the Credit Risk Monitor database (CRMZ). The database monitors the average number of days it takes a company to receive payment once a sale is made. Mr. Saluric utilized CRMZ data to compile a list of 40 businesses in the domestic shipping industry, including UPS, FedEx and Ryder, and to calculate the average number of days in which those companies received payment during the relevant time period. He relied on 90% of the data (removing the upper and lower 5% as outliers) and posited that the normal industry range was 16 to 72 days and, since all preference period payments were made within this range, they should be protected by the ordinary business terms defense.

The trustee made four alternative arguments against the application of the ordinary business terms defense to the preferential transfers. First, the trustee argued that the relationship between the debtors and UPS was not conducted pursuant to ordinary business terms because there were payment fluctuations over time. The court rejected this argument, noting it improperly conflates the subjective (ordinary course of business between the parties) and objective components of Bankruptcy Code section 547(c)(2) and the instant focus was solely on the objective test.

Second, the trustee urged the court to focus purely on variations from the stated payment terms and argued that any payments made outside the stated terms were not made within ordinary business terms. The court rejected this argument because it also improperly imposed subjective requirements on the objective test and was inconsistent with the ordinary business terms standard which encompasses a broad range of terms and practices in the industry.

Third, the trustee argued that UPS received payment in full prior to commencement of the bankruptcy case and, therefore, payments were not made pursuant to ordinary business terms. The court rejected this argument noting that receipt of payment in full is not relevant to the inquiry and does not necessarily constitute treatment outside the ordinary course of business.

Finally, the trustee argued that the appropriate range of payments made according to ordinary business terms should be derived as a deviation off the mean, rather than the full range of industry payment averages excepting only outliars. The court agreed and noted that the “average lateness” methodology, typically utilized to evaluate the subjective ordinary course of business defense, is equally useful in analyzing whether particular payments were made within ordinary business terms. The court found that the range of 30 to 54 days (which represented 68% of the industry data set and one standard deviation off the mean) was the appropriate range for determining whether payments were made within ordinary business terms. Thus, only payments made within 30-54 days of the invoice date were protected by the ordinary business terms defense and, therefore, not recoverable by the trustee.

In light of these two recent cases, practitioners should always separately consider the implications of both the subjective and objective prongs of the ordinary course defense to preference actions. At the same time, statistical analysis and methodology is not limited to either defense prong and should be carefully examined in both instances. The average lateness analysis, already regularly utilized to examine the viability of the subjective ordinary course of business defense is becoming equally useful in effectuating a comparison with industry data for purposes of the ordinary business terms defense.

Edward E. Neiger is a managing partner at ASK LLP in New York. He can be reached at [email protected] or 212-267-7342. Marianna Udem is counsel at the firm. She can be reached at [email protected] or 212-267-7342.

Two recent decisions from the United States Bankruptcy Court for the Southern District of New York, Quebecor World Litigation Trust v. Clarklift-West, Inc. dba Clarklift Team Power (In re Quebecor World (USA), Inc.), 2014 WL 5292981 (Bankr. S.D.N.Y. Oct. 14, 2014) and Pereira v. United Parcel Service of America, Inc . ( In re Waterford Wedgwood USA, Inc. ), 508 B.R. 821 (Bankr. S.D.N.Y. 2014) affirmed the use of “average lateness” methodology to examine both the subjective and the objective components of the ordinary course of business defense to preference actions. This has significance in that average lateness methodology may now be employed to assess both independent prongs of the ordinary course of business defense.

Quebecor

In Quebecor World Litigation Trust v. Clarklift-West, Inc. dba Clarklift Team Power, the litigation trustee for the Quebecor World litigation trust sued Clarklift-West under Bankruptcy Code section 547 to avoid and recover payments the debtor made during the preference period. The defendant argued that the payments were not avoidable because they were made in the “ordinary course of business.” Bankruptcy Code section 547(c) states that payments made in the ordinary course of business are immune from avoidance. The trustee filed a motion for summary judgment.

The debtors filed the underlying bankruptcy cases on Jan. 21, 2008. The defendant was in the business of heavy equipment sales, rentals and service, and had conducted business with the debtors since 2005. To establish a baseline of prior dealings between the parties for the purpose of determining whether the preference period payments were made in the ordinary course of business, the plaintiff utilized approximately two years of historical data. The court noted that during the historical period, approximately 83% of payments to defendant were made between 45 and 65 days past the invoice date, while over 70% of payments during the preference period were made between 76 and 85 days past the invoice date. The court also noted that the historical weighted average days to pay was 50.29 days and increased to 77.70 days during the preference period.

The defendant did not dispute the trustee's figures, but argued that a 33% to 50% variance in timeliness of payments should not take the transactions outside the ordinary course of business. The court rejected this argument, noting there was no special seasonal reason to justify the significant shift in payment timing. The defendant also argued that other factors examined in the ordinary course of business analysis ' 1) amount of payment; 2) circumstances of payment; 3) payment pressure; and 4) change in means of payment ' weigh in favor of finding that payments were made in the ordinary course of business. The court also rejected this argument observing that the existence of some favorable ordinary course analysis factors does not compensate for the large shift in mean time of payment. Therefore, the court concluded that the defendant failed to establish an ordinary course of business defense and entered judgment in favor of the trustee on the summary judgment motion.

Pereira

In Pereira v. United Parcel Service of America, Inc., the Chapter 7 trustee for the affiliated debtors sued UPS under Bankruptcy Code section 547 to avoid and recover payments the debtor made during the preference period. The defendant argued, among other things, that the payments were not avoidable because they were made according to “ordinary business terms” within the industry. The court held that some, but not all, preference transfers made to defendant were protected by the ordinary business terms defense.

The debtors were in the business of importing, distributing and selling china, crystal and other similar goods. They utilized the defendant, UPS, to ship their products. In an effort to demonstrate that the payments were protected under the ordinary business terms of the industry defense under Bankruptcy Code section 547(c)(2)(B) ' the “objective test” ' the defendant relied upon the testimony of Thomas Saluric, corporate credit manager at UPS and member of Credit Research Foundation and the National Association of Credit Managers. The trustee did not offer his own rebuttal witness.

Mr. Saluric's trial testimony focused on the time customers took to pay UPS compared with other similarly situated industry players. Mr. Saluric relied primarily on data collected from the Credit Risk Monitor database (CRMZ). The database monitors the average number of days it takes a company to receive payment once a sale is made. Mr. Saluric utilized CRMZ data to compile a list of 40 businesses in the domestic shipping industry, including UPS, FedEx and Ryder, and to calculate the average number of days in which those companies received payment during the relevant time period. He relied on 90% of the data (removing the upper and lower 5% as outliers) and posited that the normal industry range was 16 to 72 days and, since all preference period payments were made within this range, they should be protected by the ordinary business terms defense.

The trustee made four alternative arguments against the application of the ordinary business terms defense to the preferential transfers. First, the trustee argued that the relationship between the debtors and UPS was not conducted pursuant to ordinary business terms because there were payment fluctuations over time. The court rejected this argument, noting it improperly conflates the subjective (ordinary course of business between the parties) and objective components of Bankruptcy Code section 547(c)(2) and the instant focus was solely on the objective test.

Second, the trustee urged the court to focus purely on variations from the stated payment terms and argued that any payments made outside the stated terms were not made within ordinary business terms. The court rejected this argument because it also improperly imposed subjective requirements on the objective test and was inconsistent with the ordinary business terms standard which encompasses a broad range of terms and practices in the industry.

Third, the trustee argued that UPS received payment in full prior to commencement of the bankruptcy case and, therefore, payments were not made pursuant to ordinary business terms. The court rejected this argument noting that receipt of payment in full is not relevant to the inquiry and does not necessarily constitute treatment outside the ordinary course of business.

Finally, the trustee argued that the appropriate range of payments made according to ordinary business terms should be derived as a deviation off the mean, rather than the full range of industry payment averages excepting only outliars. The court agreed and noted that the “average lateness” methodology, typically utilized to evaluate the subjective ordinary course of business defense, is equally useful in analyzing whether particular payments were made within ordinary business terms. The court found that the range of 30 to 54 days (which represented 68% of the industry data set and one standard deviation off the mean) was the appropriate range for determining whether payments were made within ordinary business terms. Thus, only payments made within 30-54 days of the invoice date were protected by the ordinary business terms defense and, therefore, not recoverable by the trustee.

In light of these two recent cases, practitioners should always separately consider the implications of both the subjective and objective prongs of the ordinary course defense to preference actions. At the same time, statistical analysis and methodology is not limited to either defense prong and should be carefully examined in both instances. The average lateness analysis, already regularly utilized to examine the viability of the subjective ordinary course of business defense is becoming equally useful in effectuating a comparison with industry data for purposes of the ordinary business terms defense.

Edward E. Neiger is a managing partner at ASK LLP in New York. He can be reached at [email protected] or 212-267-7342. Marianna Udem is counsel at the firm. She can be reached at [email protected] or 212-267-7342.