Magazine article Business Credit

Acting vs. Asking: Communication and the Ordinary Course Defense

Magazine article Business Credit

Acting vs. Asking: Communication and the Ordinary Course Defense

Article excerpt

A bankruptcy filing stops everything, at least as far as collections are concerned. The automatic stay forbids creditors from conducting further action to collect what they're owed, and violating it carries the dangerous penalty of being found in contempt of court, resulting in fines, damages and legal fees that are piled on to the creditor's already lamentable position of having a debtor in bankruptcy.

After the automatic stay takes effect, creditors that have been paid within the 90 days preceding their debtor's filing can be hit with preference claims. If such claims are proved to be legitimate, the creditor must repay whatever it received that the court has deemed preferential to the debtor's estate for redistribution among all creditors. Congress intended that the amounts recovered would then be redistributed to all unsecured creditors to level the playing field. In reality, preferences are more often than not used to pay for the trustees recovery activity, or to pay down secured creditors further up the ladder.

NACM hasn't made the Bankruptcy Code's preference statutes a cornerstone of its government affairs program for the last five years for nothing. Section 547 of the Code governing the administration and avoidance of these payments is one of the most controversial because it so regularly fails the class of unsecured creditors that it was designed to protect. Creditors caught up in preference claims from trustees are also required to prove their own defense, which is to say they're assumed to be guilty of having received a preferential payment from the jump.

As long as the burden of proof lies with the creditor, good trustees make hay while the sun shines, issuing preference demands to every creditor paid within the 90-day period preceding bankruptcy, regardless of that payment's size or legitimacy, in an effort to shake more dollars loose for the estate, and poking holes wherever possible in the creditor's defenses.

The most popular of these defenses is undoubtedly the ordinary course of business defense, which encourages creditors to maintain the status quo in their relationships with financially-distressed customers. Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), creditors had to prove that the payments were ordinary between the creditor and the debtor (the subjective prong) and ordinary within industry standards (the objective prong). BAPCPA changed the defense to allow creditors to prove either one of those options in defense against a claim.


Still, there are many things that can derail either prong of the ordinary course defense, including certain types of communication. Some types of contact that result in a payment can effectively negate the creditor's defense, and trustees are well aware of this. Knowing that this is the case can help a creditor weigh the risks of a future preference case. % trustee is likely to believe that the creditor pressured the debtor to make the payment and that the pressure was behavior outside the ordinary course," said Deborah Thorne, Esq. of Barnes and Thornburg, LLP, who noted that this is when consistent, solid policies and procedures come to the creditor's aid. "Courts are more likely to side with the creditor if the procedures within the department were consistent," she said, noting that certain actions, even if they were consistently applied, would be hard to defend. "Cutting off the shipment of goods until payment is received on old debt is an exception to that, however."


Not every credit department has a policy or set of procedures designed for every single contingency. Frankly, such a thing would be impossible to create, and would probably do more to stifle the department than protect it. Still, when it comes to how a creditor conducts its communication with a struggling debtor, an ounce of prevention can go a long way toward protecting their defenses from eager trustees. …

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