Defending Preferential Transfers: The Ordinary Business Terms Defense- Part III: How Courts Apply Today's Ordinary Business Terms Defense

Now that the ordinary business terms defense stands on its own as an independent defense, courts are compelled to focus specifically on whether the ordinary business terms test has been satisfied.  As before, the burden is on the creditor to establish the ordinary business terms defense, using essentially the same four factors as the subjective test (timing, amount, manner and circumstances of payment), but with the focus being on business terms in the relevant industry, rather than the course of business between creditor and debtor.  In defending a transfer using the ordinary business terms defense, a creditor must (i) define the relevant industry, (ii) establish what the business practices are in that industry, and (iii) demonstrate to the court that the business relationship between the creditor and the debtor falls within business practices generally common to the industry.

Courts mostly agree that pre-2005 cases interpreting the requirements of the ordinary business terms defense remain good law.  For example, the Court of Appeals for the Ninth Circuit interprets "ordinary business terms" to mean that the payment at issue was "ordinary in relation to prevailing business standards."  The Ninth Circuit Court further held that "[o]nly a transaction that is so unusual or uncommon as to render it an aberration in the relevant industry falls outside the broad range of terms encompassed by the meaning of 'ordinary business terms.'"  Further, "[i]f the terms in question are ordinary for industry participants under financial distress, then that is ordinary for the industry."

Similarly, the Court of Appeals for the Eighth Circuit interprets "ordinary business terms" to mean "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)."  Further, "ordinary business terms" must include those terms employed by similarly situated debtors and creditors facing the same or similar problems.  "If the terms in question are ordinary for industry participants under financial distress, then that is ordinary for the industry."

A long-term business relationship with the debtor is also useful in establishing an ordinary business terms defense, and the more cemented (as measured by its duration) the pre-insolvency relationship between the debtor and the creditor, the more a creditor will be allowed to vary its credit terms from the industry norm, yet remain with the safe harbor of Bankruptcy Code section 547(c)(2).

In short, the adoption by certain courts of a test requiring only that a creditor's business terms not be an "aberration" or "idiosyncratic" in the relevant industry greatly enhances a creditor's ability to satisfy the ordinary business terms defense.

Next time:  Part IV – Proving up the Ordinary Business Terms Defense.

Ordinary Course Defense, Preferential Transfers, insolvency-insights