Anyone who has been involved in a bankruptcy is probably familiar with the term “preference payment.” A preference payment is a payment made to a creditor within 90 days prior to the filing of a bankruptcy petition by a debtor or within 1 year prior to the filing of the bankruptcy petition if the creditor is deemed to be an “insider” of the debtor, such as an officer or key shareholder of a corporate debtor. A claim of “preference” means the bankruptcy trustee may seek to recover the payment. Such payments are called a preference payment because the creditor would receive more than it would normally be entitled to receive under the United States Bankruptcy Code (the “Code”). The Code however provides certain defenses to the bankruptcy trustee’s power to recapture preference payments. One such defense is known as “the ordinary course of business.”
Prior to the amendment of the Code by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Amendment”), to establish an ordinary course of business defense, a creditor was required to prove the payment was received within the ordinary course of its business or the financial affairs of the creditor and debtor (e.g., payments were regularly made between 60-90 days after the date of the billing) and that such practice was according to ordinary business terms. Ordinary business terms were established by proof that the payment practice was customary within either the creditor’s or debtor’s industry.
As a result of the Amendment, a creditor can establish an ordinary course of business defense if the creditor can prove that payment was received either within the ordinary course of business or financial affairs of the creditor and debtor, or the payment was based upon ordinary business terms. In interpreting the Amendment’s ordinary business terms provision, the bankruptcy courts require the creditor to prove the payment was consistent with the customary payment practices of both the debtor’s and creditor’s industries.
If you have any questions about preference payments, please telephone a member of the firm.