A Sensible Proposal to Amend the Ordinary Course of Business Defense
The ordinary course of business defense is the most frequently invoked defense to a preference claim, and probably has generated more litigation than any other provision of the preference statute. Typically, the debtor has paid the creditor during the preference period outside the time period (seven days, 30 days, etc.) provided in the invoice or agreement between the parties. The creditor asserts that such "late" payments were common and within the course of conduct of the parties; the debtor responds that the payments were outside both the parties' course of dealing and common industry practice.
Proof of the parties' course of dealing is simple, even if application of the law to the facts is not. The creditor has business records showing shipping dates, invoice dates, payment dates, form of payment, etc. (The same documentary evidence also shows whether the creditor has a new value defense to all or part of the claim under §547(c)(4) of the Bankruptcy Code.) The creditor may choose to supplement the documentary evidence with testimony from a credit officer. Similarly, the debtor or trustee may call an employee or former employee to testify about any coercive practices by the creditor evidencing that challenged payments fell outside the parties' ordinary course of business.
The creditor's burden to show that the transfers were made according to "ordinary business terms" is more problematic. The clear consensus of the courts is that the creditor need not prove (as some trustees had argued) that the transfers were in accord with prevalent industry practice, but only that the transfers fall within the broad range of practices used in the industry. The 7th Circuit in Tolona Pizza Products articulated the test:
We conclude that "ordinary business terms" refers to 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.
A number of other courts have adopted this formulation, sometimes substituting the term "unusual" for "idiosyncratic."
While some courts have found the testimony of a creditor's officer sufficient to show industry practice, many courts have found that the creditor failed to meet its burden where it did not introduce independent expert testimony on industry practices. Some courts have said unequivocally that how the debtor and creditor conduct their business with other parties is not in itself sufficient to show ordinary business terms. In In re Washington Manufacturing Company, for example, the creditor proffered the testimony of its president on industry terms, "based upon his experience with a contractors' group and upon his knowledge of what other similar contractors told him their billing experiences were." The court rejected that testimony as hearsay, noting the "inherent problem with the defendant's president attempting to testify about the industry's ordinary business terms." The court stated:
[W]hen the only testimony supporting §547(c)(2)(C) is self-serving testimony of the defendant's president, the court can not say that the defendant has established the element of proof of the ordinary business terms of the industry in the defendant's favor... 
The court advised that "defendants would be well served to have independent expert witnesses testify as to the ordinary business terms of the industry."
The Proposed Amendment
Where there is an established course of dealing between the parties, the purpose of the preference statute is not served by requiring the creditor to prove that the transfers also were made in accordance with "ordinary business terms." As the 7th Circuit explained in Tolona Pizza Products, "the most important thing is not that the dealings between the debtor and the allegedly favored creditor conform to some industry norm but that they conform to the norm established by the debtor and the creditor in the period before, preferably well before, the preference period." The NBRC staff expressed the same view:
The proposal adopts the view that the conduct between the parties should prevail to the extent that there was enough pre-petition conduct to establish a course of dealing. A disjunctive test telescopes the ordinary course inquiry on the course of conduct between the parties. In the event there is not enough pre-petition conduct to establish a course of dealing, then industry standards should supply the ordinary course benchmark. The proposal accomplishes this result without effecting a significant statutory change...
If the parties have sufficient pre-petition conduct to establish a course of dealing, the proposal eliminates any argument that the course of dealing did not comply with industry standards, and therefore, that the transfer was not in the ordinary course of business. Preference litigation in this area should be simplified as a result of the proposal.
Indeed, it is difficult to articulate circumstances where a trustee should prevail even though payments were made in the ordinary course of business between the debtor and creditor. The court in Tolona Pizza Products, explaining a possible function of subsection C, pointed out that a creditor might permit late payments from the debtor during the pre-preference period in order to strengthen the argument to protect payments during the preference period as being within the ordinary course of business. That scenario, while hypothetically possible, seems far removed from the realities of commercial practice. Another court stated, citing an equally unlikely scenario, that "behavior like filing lawsuits or attaching assets may be ordinary between the parties but be unusual in the industry, and so even an attachment or lawsuit 'routine' between the parties may fail to fall within the purview of subsection C."
The proposal would simplify preference litigation and make ordinary course litigation more efficient by eliminating the burden on both parties to retain experts. Such costs may seem inconsequential in the infrequent multi-million dollar preference case, but more frequently the added costs and related legal fees (in preparing or deposing the witness, calling the witness at trial) of even $5,000 to $10,000 are disproportionate to the amount at issue in the litigation. Many preference cases, including those that have generated appellate decisions, involve less than $100,000. In Hawes, the first case in the 6th Circuit to discuss §547(c)(2)(C) at length, the amount in controversy was $21,760; in Tolona Pizza Products, the claim was about $46,000; in Roblin Industries, the claim was about $53,000. From the perspective of the creditor, which bears the burden of proof and is spending its own money, the issue is not one of expense alone but of settlement leverage. The reality is that in smaller cases the imposition of this additional hurdle affords settlement leverage to the trustee having nothing to do with the merits of the case.
A related benefit of the proposed amendment is that the parties are relieved of having to identify an expert competent to testify about industry payment practices. In some cases it may be impracticable regardless of cost to introduce evidence "based on first-hand knowledge gained from exposure to the competitors' collection practices." Firms keep such practices confidential, and must be concerned about the antitrust implications of sharing information. While on occasion industry trade groups may be able to supply data on terms and collection practices, in many instances such information either is not available or is of limited scope. A witness' personal knowledge may be limited to the particular firms for or with whom he or she has worked.
The proposed amendment would not affect those cases where a creditor's pre-preference period dealings with the debtor were not sufficient to establish a course of dealing, which are far less common and tend to present different issues. In the majority of cases, however, the proposed amendment would result in cheaper, fairer litigation.
[*] The proposal is one of several recommended by the ABI Preference Task Force. [RETURN TO TEXT] In re Tolona Pizza Prods. Corp., 3 F.3d 1029, 1033 (7th Cir. 1993) (emphasis in original).[RETURN TO TEXT]
See, e.g., Luper v. Columbia Gas of Ohio Inc. (In re Carled Inc.), 91 F.3d 811, 818 (6th Cir. 1996); Lawson v. Ford Motor Co. (In re Roblin Indus.), 78 F.3d 30, 38-40 (2d Cir. 1996); Advo-System Inc. v. Maxway Corp., 37 F.3d 1044, 1049 (6th Cir. 1994); Fiber Lite Corp. v. Molded Acoustical Prods. Inc. (In re Molded Acoustical Prods. Inc.), 18 F.3d 217, 224-26 (3d Cir. 1994); Jones v. United Savings & Loan Ass'n (In re U.S.A. Inns of Eureka Springs), 9 F.3d 680, 685 (8th Cir. 1993).[RETURN TO TEXT]
See, e.g.,In re Fred Hawes Org. Inc., 957 F.2d 239, 246 (6th Cir. 1992); Schwinn Plan Comm. v. AFS Cycle & Co. Ltd. (In re Schwinn Bicycle Co.), 205 B.R. 557 (Bankr. N.D. Ill. 1997); In re Washington Mfg. Co., 144 B.R. 376, 380-81 (Bankr. M.D. Tenn. 1992); In re Pearson Indus. Inc., 142 B.R. 831, 844-45 (Bankr. C.D. Ill. 1992). [RETURN TO TEXT]
 The problems in choosing an expert are illustrated by Huffman v. New Jersey Steel Corp. (In re Valley Steel Corp.), 182 B.R. 728 (Bankr. W.D. Va. 1995). The trustee called as a witness the corporate credit director of one of the defendant's competitors; the defendant cross-examined by citing the witness's testimony in a preference case where his employer had been named as a defendant. [RETURN TO TEXT]