Following Third Circuit precedent where there may be a circuit split, Bankruptcy Judge Craig T. Goldblatt of Delaware held that the “ordinary course” defense to a preference is not available when the creditor “was imposing credit pressure on the debtor to extract payment and thus reduce its own exposure.”

Early in his January 15 opinion, Judge Goldblatt foreshadowed the outcome when he said that “the ordinary course defense is intended to capture circumstances in which the debtor’s decision to make the payment was simply business as usual, . . . not terms that are imposed when a debtor runs into financial trouble.”

Tightened Credit Terms

The debtor was a retailer. The creditor was a “logistics provider” that arranged for shipments of goods to the debtor’s locations.

Originally, the debtor had a $3 million credit limit, with payments due in 30 days. When the debtor was encountering “financial distress,” Judge Goldblatt said that the creditor responded by tightening credit terms.” Specifically, the creditor first lowered the credit limit to $1.75 million and later to $1 million. In addition, email correspondence showed that the creditor was imposing “credit pressure.” At one point, the creditor imposed a “credit hold” and refused to make shipments without a $300,000 wire transfer.

The debtor confirmed a chapter 11 plan creating a liquidating trust. The trust filed a preference complaint against the debtor for about $3.1 million.

When the trustee filed a motion for summary judgment, the creditor raised the ordinary course defense but conceded that all of the elements of a preference were present under Section 547(b). Judge Goldblatt characterized the creditor as contending that the ordinary course defense “ought to be available so long as the credit pressure it applied to the debtor was commonplace within the relevant industry.”

Credit Pressure Isn’t ‘Ordinary’

Judge Goldblatt was charged with ruling on the applicability of the ordinary course defense contained in Section 547(c)(2). The subsection provides that a trustee may not avoid a preferential 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.”

Judge Goldblatt explained that the defense “is intended to encourage vendors to continue to deal with distressed companies on ordinary terms.” He said it is an “objective test [that] looks to the general norms of the creditor’s industry.”

The creditor, Judge Goldblatt said, was primarily relying on its credit manager, who testified that “it is common in the transportation and logistics industry for a supplier to tighten the credit terms once it becomes clear that a customer is facing financial difficulty.”

Judge Goldblatt said that the case was calling on him to decide

whether “ordinary course” means terms that are ordinary when dealing with a healthy company, or whether the defense is still available when the defendant was imposing credit pressure on the debtor, so long as the defendant can show that it was customary in the relevant industry to impose such credit pressure on customers in financial distress.

Judge Goldblatt cited the Third Circuit for having “expressly rejected the claim . . . that conduct of the defendant . . . should be treated as ordinary because it was similar to the treatment the defendant afforded to two other vendors.” In re Molded Acoustical Prods. Inc., 18 F.3d 217, 227 (3d Cir. 1994).

Again citing the Third Circuit, Judge Goldblatt went on to say,

One’s dealings with companies facing financial distress is not the measure of ordinariness. Rather, “ordinary terms are those which prevail in healthy, not moribund, creditor-debtor relationships.”

Id.

Drawing from the Third Circuit, Judge Goldblatt said that the purpose of the ordinary course defense “is to ‘deter[] the failing debtor from treating preferentially its most obstreperous or demanding creditors” and to “discourag[e] … creditors from racing to dismember the debtor.’” Id. at 219.

As further support for his conclusion, Judge Goldblatt cited other authority where the Third Circuit “found that the debtor’s payments were not made in the ordinary course when the defendant . . . ‘tightened its credit terms [and] imposed a credit limit.’” In re Hechinger Inv. of Delaware, Inc., 489 F.3d 568, 578 (3d Cir. 2007).

Judge Goldblatt said that his decision was in accord with a recent opinion by Delaware’s Bankruptcy Judge Mary F. Walrath in In re Center City Healthcare LLC, 664 B.R. 208 (Bankr. D. Del. Aug. 27, 2024). He described Judge Walrath as having said that the ordinary course standard “is based on the terms that prevail when the debtor is healthy, not in financial distress.” To read ABI’s report on Center City, click here.

Judge Goldblatt granted partial summary judgment in favor of the trustee by striking the creditor’s ordinary course defense. Disputed issues of fact regarding “new value” precluded entry of final judgment.