The power of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to avoid pre-bankruptcy preferential transfers is an important tool designed to promote the bankruptcy policy of equality of distribution and to generate value for the bankruptcy estate that can be used to pay creditors and/or fund a plan. However, the Bankruptcy Code contains certain defenses to avoidance, including the "ordinary course payment" defense, which incentivizes vendors and other creditors to continue doing business with financially distressed entities.
Courts disagree on the scope of the defense and, in particular, whether its requirement (in some cases) that payments be made according to "ordinary business terms" means business terms applied when a debtor is in good financial health, as distinguished from terms imposed when the debtor is in financial distress. The U.S. Bankruptcy Court for the District of Delaware weighed in on this debate in In re Fred's Inc., No. 19-11984 (CTG), 2025 WL 208536 (Bankr. D. Del. Jan. 15, 2025). The court granted partial summary judgment to a liquidating trustee in preference litigation, ruling that "ordinary business terms" within the meaning of section 547(c)(2)(B) of the Bankruptcy Code should be assessed in accordance with the "healthy debtor" standard rather than based upon customary industry practice tightening credit terms for financially distressed entities. Because the creditor/transferee applied "credit pressure" to the debtor once it became financially distressed, the court ruled that the creditor could not rely on the ordinary course payment defense.
The Ordinary Course of Business Payment Defense to Preferential Transfer Avoidance
Section 547(b) of the Bankruptcy Code provides that a trustee or DIP, "based on reasonable due diligence in the circumstances of the case and taking into account a party's known or reasonably knowable affirmative defenses under subsection (c)," may avoid any transfer made by an insolvent debtor within 90 days of a bankruptcy petition filing (or up to one year, if the transferee is an insider) "to or for the benefit of a creditor ... for or on account of an antecedent debt," if the creditor, by reason of the transfer, receives more than it would have received in a chapter 7 liquidation and the transfer had not been made. 11 U.S.C. ' 547(b).
Section 547(c) sets forth nine defenses or exceptions to preference avoidance. One of those is the "ordinary course payment" defense in section 547(c)(2), which provides as follows:
The trustee may not avoid under this section a transfer ... to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was'(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms ....
11 U.S.C. ' 547(c)(2).
The ordinary course payment defense was intended to "leave undisturbed normal commercial and financial relationships and protect recurring, customary credit transactions which are incurred and paid in the ordinary course of business of both the debtor and the debtor's transferee." Comm. of Unsecured Creditors of Gregg Appliances v. Curtis Int'l Ltd. (In re hhgregg, Inc.), 636 B.R. 545, 549 (Bankr. S.D. Ind. 2022) (quoting Kleven v. Household Bank, F.S.B., 334 F.3d 638, 642 (7th Cir. 2003)); accord Desmond v. Northern Ocean Liquidating Corp. (In re Nat'l Fish and Seafood, Inc.), 2024 WL 1422665 (Bankr. D. Mass. Apr. 1, 2024); In re Liquidating Est. of H&P, Inc., 648 B.R. 767 (Bankr. W.D. Pa. 2023). The defense "is formulated to induce creditors to continue dealing with a distressed debtor so as to kindle its chances of survival without a costly detour through, or a humbling ending in, the sticky web of bankruptcy." Fiber Lite Corp. v. Molded Acoustical Prods. (In re Molded Acoustical Prods.), 18 F.3d 217, 219-220 (3d Cir. 1994) (citations omitted); accord Auriga Polymers Inc. v. PMCM2, LLC as Tr. for Beaulieu Liquidating Tr., 40 F.4th 1273, 1288 (11th Cir. 2022) (citing In re BFW Liquidation, LLC, 899 F.3d 1178, 1193 (11th Cir. 2018)). Section 547(c)(2)'s legislative history indicates that its purpose is "to leave undisturbed normal financial relations." H.R. Rep. No. 95-595, at 373 (1977)); see generally Collier on Bankruptcy ("Collier") ' 547.04 [2] (16th ed. 2024) ("This section is intended to protect recurring, customary credit transactions that are incurred and paid in the ordinary course of business of the debtor and the debtor's transferee.").
Section 547(c)(2) is an affirmative defense, meaning that the preference defendant bears the burden of proof. See 11 U.S.C. ' 547(g); Gulf City Seafoods, Inc. v. Ludwig Shrimp Co., Inc. (In re Gulf City Seafoods, Inc.), 296 F.3d 363, 367 (5th Cir. 2002); In re Liquidating Est. of H&P, Inc., 648 B.R. 767, 790 (Bankr. W.D. Pa. 2023).
Section 547(c)(2) was amended in 2005. It previously provided as follows:
The trustee may not avoid under this section a transfer ... to the extent that such transfer was'(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; (B) made in the ordinary course of business or financial affairs of the debtor and the transferee; and (C) made according to ordinary business terms.
11 U.S.C. ' 547(c)(2) (amended in 2005) (emphasis added).
The 2005 amendments made successful invocation of the ordinary course payment defense considerably easier. A transferee still must demonstrate that a challenged transfer was "in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee." However, under amended section 547(c)(2), a transferee's additional evidentiary burden is limited to proving either: (i) that the transfer was made "in the ordinary course of business or financial affairs of the debtor and the transferee"; or (ii) that the transfer was made according to "ordinary business terms." See Baumgart v. Savani Props. (In re Murphy), 2021 WL 2524946, at *2 (Bankr. N.D. Ohio Apr. 19, 2021); accord In re ASPC Corp., 658 B.R. 455 (Bankr. S.D. Ohio 2024) (ruling that the defendant in preference litigation need only demonstrate that the payment satisfied one'but not...
