How To Reduce Preference Exposure on New Accounts:  Takeaways from In re KH Funding Company

12.10.2015

For preference actions, many bankruptcy practitioners are familiar with establishing ordinary course of business, one of the three major defenses.  Typically, the ordinary course of business defense is shown by comparing the days to pay during the preference period as compared to the days to pay during a set range of time prior to the preference period, most often between one and two years.  But what happens when you or your client has just taken on a new customer and within 90 days, the customer files bankruptcy?  Are you barred from asserting the ordinary course of business defense in a subsequent preference action?

In the KH Funding Co. v. Escobar (In re KH Funding Co.), No. 10-37371-TJC, 2015 WL 7307891, (Bankr. D. Md. Nov. 18, 2015) case, the U.S. Bankruptcy Court for the District of Maryland aligned with the majority of courts addressing this issue and held that a history of pre-preference period prior deadlines is not necessary to establish an ordinary course of business defense, even in the case of an insider.  There, the court looked to transactions between the debtor and similar third parties (in this case, other contractors) to determine whether the allegedly preferential transfers were ordinary.  Ultimately, the Court found that the days to pay for the insider varied too widely from similar third parties and, as such, ordinary course of business did not apply to reduce preference exposure.  The Court also indicated in dicta that ordinary course of business may be established by compliance with the payment terms of an applicable contract or “what is normal between the parties.”

Notably, there appears to be a split within the Fourth Circuit on this issue.  Compare Hovis v. Stambaugh Aviation, Inc. (In re Air S. Airlines), 247 B.R. 165, 173 (Bankr. D.S.C. 2000) (“[T]he Court also must consider other factors, such as the conduct of the parties to determine whether any unusual conduct took place which would require the Court to set the subject transactions aside as preferential pursuant to § 547(b).”), with Conti v. Sampson-Bladen Oil Co., Inc. (In re Clean Burn Fuels, LLC), No. 11-80562C-7D, 2014 WL 2987330, at *6 (Bankr. M.D.N.C. July 1, 2014) (“If, however, the Creditor fails to establish a baseline from which the Court can compare the disputed transfers, the inquiry ends as the court is unable to ascertain the subjective standard of comparison. In such instance, the section 547(c)(2)(A) defense likewise must fail.”).