The Bankruptcy Code’s Section 547(b) allows a trustee or debtor in possession to recover property transferred to a creditor, known as a preference action. However, the Code also provides defenses to a preference action, including the ordinary course of business defense.

Outlined in Section 547(c)(2) of the Bankruptcy Code, the ordinary course of business defense safeguards routine transactions between a debtor and creditor, encouraging creditors to engage with distressed companies. The defense applies if the property transfer served as payment for a debt incurred by the debtor in the ordinary course of business or its financial affairs, and was made in the ordinary course of business or financial affairs or according to ordinary business terms.

The court determines whether a transfer was made in the ordinary course through a subjective inquiry, considering factors such as the length of the business relationship, the size of the transfer compared to previous payments, and any unusual actions by either party.

Whether a transfer was made according to ordinary business terms is an objective inquiry. The creditor must demonstrate that the transfer aligns with common practice in the debtor’s or creditor’s industry, often requiring an industry expert.

Key points to remember include:

• The burden of proof lies with the creditor to show the transfer meets the ordinary course of business defense.
• Initial transactions between a creditor and a debtor may fall within the ordinary course of business defense, depending on the jurisdiction.
• Late payments can be preferential if inconsistent with past practices.
• Pressure to receive payment does not automatically disqualify a payment from being made in the ordinary course of business.

To assert the ordinary course of business defense, creditors should maintain thorough documentation with business counterparties and seek competent legal counsel. Read the full article here.