Lead Opinion
When, within 90 days before declaring bankruptcy, the debtor makes a payment to an unsecured creditor, the payment is a “preference,” and the trustee in bankruptcy can recover it and thus make the creditor take pot luck with the rest of the debtor’s unsecured creditors. 11 U.S.C. § 547. But there is an exception if the creditor can show that the debt had been incurred in the ordinary course of the business of both the debtor and the creditor, § 547(c)(2)(A); that the payment, too, had been made and received in the ordinary course of their businesses, § 547(e)(2)(B); and that the payment had been “made according to ordinary business terms.” § 547(c)(2)(C). The first two requirements are easy to understand: of course to defeat the inference of preferential treatment the debt must have been incurred in the ordinary course of business of both debtor and creditor and the payment on account of the debt must have been in the ordinary course as well. But what does the third requirement — that the payment have been “made according to ordinary business terms” — add? And in particular does it refer to what is “ordinary” between this debtor and this creditor, or what is ordinary in the market or industry in which they operate? The circuits are divided on this question, compare In re Fred Hawes Organization, Inc.,
Tolona, a maker of pizza, issued eight checks to Rose, its sausage supplier, within 90 days before being thrown into bankruptcy by its creditors. The checks, which totaled a shade under $46,000, cleared and as a result Tolona’s debts to Rose were paid in full. Tolona’s other major trade creditors stand to receive only 13<r on the dollar under the plan approved by the bankruptcy court, if the preferential treatment of Rose is allowed to stand. Tolona, as debtor in possession, brought an adversary proceeding against Rose to recover the eight payments as voidable preferences. The bankruptcy judge entered judgment for Tolona. The district judge reversed. He thought that Rose did not, in order to comply with section 547(c)(2)(C), have to prove that the terms on which it had extended credit to Tolona were standard terms in the industry, but that if this was wrong the testimony of Rose’s executive vice-president, Stiehl, did prove it. The parties agree that the other requirements of section 547(c)(2) were satisfied.
Rose’s invoices recited “net 7 days,” meaning that payment was due within seven days. For years preceding the preference period, however, Tolona rarely paid within seven days; nor did Rose’s other customers. Most paid within 21 days, and if they paid later than 28 or 30 days Rose would usually withhold future shipments until payment was received. Tolona, however, as an old and valued customer (Rose had been selling to it for fifteen years), was permitted to make payments beyond the 21-day period and even beyond the 28-day or 30-day period. The
It may seem odd that paying a debt late would ever be regarded as a preference to the creditor thus paid belatedly. But it is all relative. A debtor who has entered the preference period — who is therefore only 90 days, or fewer, away from plunging into bankruptcy — is typically unable to pay all his outstanding debts in full as they come due. If he pays one and not the others, as happened here, the payment though late is still a preference to that creditor, and is avoidable unless the conditions of section 547(c)(2) are met. One condition is that payment be in the ordinary course of both the debtor’s and the creditor’s business. A late payment normally will not be. It will therefore be an avoidable preference.
This is not a dryly syllogistic conclusion. The purpose of the preference statute is to prevent the debtor during his slide toward bankruptcy from trying to stave off the evil day by giving preferential treatment to his most importunate creditors, who may sometimes be those who have been waiting longest to be paid. Unless the favoring of particular creditors is outlawed, the mass of creditors of a shaky firm will be nervous, fearing that one or a few of their number are going to walk away with all the firm’s assets; and this fear may precipitate debtors into bankruptcy earlier than is socially desirable. In re Xonics Imaging, Inc., supra,
From this standpoint, however, the most important thing is not that the dealings between the debtor and the allegedly favored creditor conform to some industry norm but that they conform to the norm established by the debtor and the creditor in the period before, preferably well before, the preference period. That condition is satisfied here — if anything, Rose treated Tolona more favorably (and hence Tolona treated Rose less preferentially) before the preference period than during it.
But if this is all that the third subsection of 547(c)(2) requires, it might seem to add nothing to the first two subsections, which require that both the debt and the payment be within the ordinary course of business of both the debtor and the creditor. For, provided these conditions are fulfilled, a “late” payment really isn’t late if the parties have established a practice that deviates from the strict terms of their written contract. But we hesitate to conclude that the third subsection, requiring conformity to “ordinary business terms,” has no function in the statute. We can think of two functions that it might have. One is evidentiary. In re Loretto Winery, Ltd.,
The functions that we have identified, combined with a natural reluctance to cut out and throw away one-third of an important provision of the Bankruptcy Code,
We conclude that “ordinary business terms” refers to the range of terms that encompasses the practices in which firms similar in some general way to the creditor in question engage, and that only dealings so idiosyncratic as to fall outside that broad range should be deemed extraordinary and therefore outside the scope of subsection C. In re SPW Corp.,
Tolona might have argued that the district judge gave insufficient deference to the bankruptcy judge’s contrary finding. The district judge, and we, are required to accept the bankruptcy judge’s findings on questions of fact as long as they are not clearly erroneous. Fed.R.Bankr.P. 8013; In re Bonnett,
The judgment reversing the bankruptcy judge and dismissing the adversary proceeding is
Affirmed.
Dissenting Opinion
dissenting.
I agree with the majority that under 11 U.S.C. § 547(c)(2)(C) Rose was required to show that Tolona’s payments had been made in accordance with the ordinary business
The bankruptcy court discussed in some detail the evidence offered by Rose to show conformity to the standard terms of the industry. As the bankruptcy judge characterized it, what little evidence was offered was ambiguous. One of Rose’s salesmen testified that few of Rose’s customers paid within the 7-day terms of its contracts but three-quarters paid within 21 days. An accounts receivable clerk testified that most local accounts paid within 14 days. Most importantly, the executive vice-president of Rose, Dwight Stiehl, testified that Tolona’s credit practices conformed to industry-wide norms. But, the bankruptcy court pointed out, Stiehl’s answer did not explain which credit practices of Rose — either the contractual terms that stated “net 7 days” or the special exceptions for late customers — were generally applied in the industry. Furthermore, Stiehl conceded, inconsistently with his other testimony, that Tolona was one of an “exceptional group of customers of Rose ... fall[ing] outside the common industry practice and standards.” In light of these anomalies in the evidence, the bankruptcy judge concluded that Rose had failed to establish that Tolona’s payments fit the industry practice.
Under Bankruptcy Rule 8013, the district court on appeal must defer to the bankruptcy court’s findings of fact unless they are clearly erroneous. See, e.g., In re Bonnett,
I do not believe that such a summary reversal of a bankruptcy court’s findings of fact should stand. The district judge devoted most of his opinion to a defense of the view, which the court’s decision now rejects, that section 547(c)(2)(C) does not mandate an examination of “objective” industry standards if the debtor and the creditor had their own established course of dealing. Only in the final two paragraphs of its opinion did the district court touch upon the alternate theory that Stiehl’s testimony indicated that Tolona’s payment schedule actually did conform to industry-wide norms. Given the peremptory rejection of the bankruptcy court’s findings without a determination of clear error, I would reverse the district court’s decision and reinstate the decision of the bankruptcy court.
Notes
. Contrary to the position of the majority, I believe that Tolona did raise this issue on appeal. Part II of Tolona's brief recited the bankruptcy court’s conclusion that Rose had failed to carry its burden of proof, and further explained why that conclusion was justified on the record. While admittedly Tolona did not invoke the words "clear error,” it indicated its belief that the bankruptcy court's factual determinations should have been upheld, and, equivalently, that the district court paid them insufficient deference.