By Sarah E. Wenrich –
When a business – or a person – falls on difficult times and files for bankruptcy, its creditors or vendors may find themselves defending lawsuits in the bankruptcy court related to payments made by the debtor prior to the bankruptcy. Debtors-in-possession or trustees overseeing the case may bring “preference actions” seeking to recover transfers that the vendor received within the 90 days prior to the debtor filing for bankruptcy relief (or within a year of filing if that vendor or creditor is an “insider as defined by the bankruptcy code”).
One of the most common defenses asserted in response to these actions is to argue that the payments received from the debtor during the preference period were “made in the ordinary course of business or financial affairs of the debtor and the transferee” or “made according to ordinary business terms.” 11 U.S.C. § 547(c)(2). If a vendor is able to establish that the debtor’s payment fits under either of these scenarios, then the vendor may keep the payments it received during the preference period and it does not have to pay those funds back into the estate for distribution to other creditors.
However, a recent decision adversary proceeding in the Southern District of Indiana may shake up the certainty of this defense.
In Official Committee of Unsecured Creditors of Gregg Appliances, Inc. v. D&H Distributing Company (In re HHGregg, Inc., et al), Adv. Pro. No. 17-50282 [Doc. Nos. 75, 80-81), the vendor in question, D&H Distributing Company (“D&H), received more than $4 million in payments during the 90-day preference period. D&H argued that the payments received during the preference period were made pursuant to the agreed upon terms of payment that were in place between the debtors and D&H during that time. As such, the transfers were made within the ordinary course of business, as provided for in § 547(c)(2), and could not be recovered for the estate. The court disagreed and has ordered D&H to remit payment in the amount of $3,517,805.06 (plus prejudgment interest) for the transfers received by D&H that were not otherwise shielded from a separate defense under § 547.
Two of the major tipping points for the court were (1) the communications sent by the Debtor during the preference period and (2) the fact that the debtors prioritized payments to D&H at the urging of the debtors’ senior vice president of consumer electronics, Phillips. The communications in question regarding the debtors’ payments were notably sent by D&H’s vice president of retail sales rather than D&H’s credit team and were sent to Phillips rather than to the debtors’ accounts payable department. Further, the email communications had a “tone” different from D&H’s emails prior to the preference period and included “veiled threats” that D&H would withhold products during the holiday season if the debtors did not pay as required by the terms. While the debtors’ then-CFO did not expressly testify that these emails necessarily prompted the payments in question, he did testify that the debtors prioritized the payments to D&H over other creditors at Phillips’ urging. Even though the payments may have been made in accordance with the “ordinary business terms” in place, the tone used in the D&H communications placed pressure on the debtors to either make the payments or suffer through the holiday season and the payments were not made in the ordinary course of business.
This nuanced opinion highlights the importance of thinking about the role and potential impact of communications and the additional factors that courts are willing to consider in determining whether a creditor must refund the estate for preference period payments.
If you have questions regarding how your business can protect or defend itself from this type of action, please contact us or reach out directly at (412) 456-8163 or via email at firstname.lastname@example.org.