Reversing the bankruptcy court, a district judge in Delaware ruled that one standard deviation may not be used on a motion for summary judgment as the only factor in deciding whether an alleged preference was negated by the “ordinary course defense,” when the standard deviation analysis was not accompanied by undisputed expert testimony.

The corporate debtor confirmed a chapter 11, creating a liquidating trust to pursue preferences and other avoidance actions. One of the trust’s suits was a $129,000 preference action against a provider of pest-control services. The debtor always paid outside of the 30-day terms in the invoices, and payments often covered several invoices.

The defendant filed a motion for summary judgment stating that the invoices were paid within an average of 128 days and a weighted average of 115 days during the preference period. In the so-called base period going back two years before the preference period, the average was 100 days, with a weighted average of 104 days.

The defendant stated that all of the $129,000 in allegedly preferential transfers was paid within the one standard deviation range of 20 to 179 days.

In opposition to summary judgment, the trust gave reasons why “the standard deviation approach does not work.”

The bankruptcy court granted the defendant’s motion for summary judgment and dismissed the complaint by adopting only the standard deviation analysis rather than other methodologies, such as range of payments, average lateness or bucketing. The trust appealed.

Standard Deviation Requires Proof by Expert Testimony

The appeal turned on the “ordinary course” defense to a preference in Section 547(c)(2), which says that a trustee may not avoid a transfer “made in the ordinary course of business or financial affairs of the debtor and the transferee.”

Although “ordinary course” is not defined in the Bankruptcy Code, District Judge Richard G. Andrews cited the Third Circuit in his October 29 opinion for saying that a transfer in the ordinary course should conform to the norm established by the debtor and the creditor before the preference period. He went on to say that “bankruptcy courts examine a variety of factors when determining whether the preference period conforms to the baseline norm,” giving “particular importance” to the amount of time elapsing between the invoice and payment.

In the lower court’s bench opinion, Judge Andrews said that the bankruptcy court decided that the standard deviation approach made “the most sense in the circumstances of the case.” After that, the result was “mathematical.”

Judge Andrews decided that the bankruptcy court “should not have granted summary judgment based on the record before it,” because the bankruptcy court should not have relied on “unsworn statements of fact and disputed issues of fact.” One of the unsworn statements, he said, alleged that one standard deviation was 26 to 179 days.

On appeal, Judge Andrews referred to the trust as having cited “articles questioning the applicability of standard deviation to non-normal data sets.” He went on to say that the defendant had given “no expert opinion on the appropriateness of using standard deviation with non-normal data distribution.”

To decide whether standard deviation was appropriate, Judge Andrews said that “an expert was needed” and that the question should be resolved by the bankruptcy court in the first instance.

Standard Deviation Can’t Be the Only Test

But there was more. Judge Andrews asked, “Why should standard deviation, to the exclusion of anything else, provide an up or down answer to the question of whether the ordinary course of business defense has been proved?”

Even if standard deviation could not be engineered to arrive at a desired result, Judge Andrews said “it does not mean that the result that is obtained resolves the issue of whether a payment is or is not in the ordinary course of business.” He was not “implying” that standard deviation should not be considered but that it “seems to replace consideration of the statutory term ‘ordinary course of business’ with a bright-line statistical test.”

“At most,” Judge Andrews said, “a statistical test is a tool, not an answer.” To the extent that standard deviation is employed, he said, “the result should be considered in conjunction with that of other statistical approaches to paint a full picture.”

Judge Andrews reversed the grant of summary judgment in favor of the defendant and remanded. He held that the “standard deviation analysis provided an insufficient basis for the determination that Defendant proved its ordinary course of business defense.”