Determining the proper bookends when establishing a Historical Period for an ordinary course of business defense (“OCOB”) can be highly contentious in preference litigation. The same can be said for determining which methodology is most appropriate for analyzing preference period transfers and even when to apply a given defense. Thankfully, Judge Walrath recently issued a very helpful opinion, Stanziale v. Superior Technical Resources, Inc. (In re Powerwave Technologies, Inc.), Adv. No. 15-50085 (MFW) (Bankr. D. Del. Apr. 13, 2017), which touches upon all of those issues. While the decision’s ultimate utility may be limited by the fact that the judge was merely addressing a summary judgment motion (the “Motion”) and found factual disputes precluded a decision on the merits, the opinion should still prove useful.
The Powerwave cases began in January 2013 and the instant adversary proceeding was initiated approximately two years later. Defendant in the adversary proceeding provided workforce solutions to the Debtors pursuant to an agreement, and during the Preference Period, received approximately $383,336.55 in transfers (the “Transfers”). During the Preference Period, Defendant sent the Debtors correspondences about the Debtors’ aging accounts and ultimately changed payment terms from net 45 to net 7. Defendant further demanded payment in full during this time.
The Parties’ Positions
While Defendant did not contest that the predicate elements of the Transfers had been met, it argued the defenses under 11 U.S.C. §§ 547(c)(2) and (4) abrogated or eliminated its exposure. It based these defenses on several assertions:
- All of the Transfers were protected from avoidance by the subjective and objective OCOB defenses
- For 547(c)(2)(A) purposes, Defendant argued in favor of using the “Range” and “Batch” Methods
- Any portion not protected by OCOB were subject to reduction by applying the subsequent new value defense under 547(c)(4)
Plaintiff-Trustee disagreed, of course, and argued instead:
- Defendant’s method for determining which Transfers were OCOB created factual disputes
- Specifically, Plaintiff-Trustee argued Defendant used a Historical Period (“Historical Period”) that was almost 50% narrower than the one espoused by the Plaintiff-Trustee
- Moreover, Plaintiff-Trustee argued the “Range” and “Batch” Methods for determining ordinariness are inappropriate, favoring instead the “Days Sales Outstanding” (“DSO”), “Inter-quartile”, and “Standard Deviation” methods.
- Defendant engaged in unusual collection activity during the preference period
- Subsequent new value defense cannot be decided before the Court determines OCOB applicability
The Court’s Decision
In denying Defendant’s Motion, the Court addressed each of the foregoing arguments and counterarguments in turn, but in sum, Judge Walrath found too many facts in dispute to render a decision at the summary judgment stage. Nevertheless, her opinion is instructive.
The Proper Historical Period
The Court noted the Parties’ dispute over the proper Historical Period – specifically, whether Defendant’s proposed Historical Period captured enough of its history with the Debtors. Noting that that “the Historical Period should encompass the time period when the debtor was financially healthy,” the Court found that Defendant did “not include a sustained period when the Debtor was financially sound.” As such, a factual dispute existed.
Subjective OCOB Methodologies
Judge Walrath addressed the following five OCOB methodologies, although the lack of agreement on the Historical Period prevented her from applying any of them at this time:
- The Court noted that without the proper historical baseline, the Range method (in which a defendant asserts that if a given preferential transfer fell within the days to pay range seen in the Historical Period, it should be excluded from avoidance) could inappropriately include outlier payments that do not accurately reflect the Parties’ OCOB. The judge noted that simply citing to other cases that use the range method isn’t sufficient, and Defendant’s citations were factually much narrower in any event (comparing the 34-371 historical range here to other cases with ranges of 7-67 days, 35-73 days, 0-33 days, 65-168 days, 0-31 days, 28-76 days).
- The Court found the Batch method (which derives a standard deviation range by taking the average age of invoices paid in each batch) likewise inappropriate, as the number of invoices paid per batch ranged from 1-133, with higher amounts paid during the Preference Period than in the Historical Period.
- The DSO Method involves multiplying the total amount of an invoice by the number of days that it took to be paid. That number is then divided by the total amount of the invoices in that batch. Defendant argued that even if the DSO method results in the 23-day spread between the historical and preference periods alleged by Plaintiff-Trustee, 23 days is not out of the ordinary between the Parties. Again, the absence of a proper Historical Period foreclosed this method’s application.
- The Plaintiff-Trustee’s proposed Inter-quartile range found that 50% of invoices were paid within a 15-day spread, with anything falling outside of that range allegedly not OCOB. Defendant objected that the Inter-quartile method has no precedent in Delaware, but the Court dismissed “lack of acceptance” of a given method as a means for precluding its use. Judge Walrath noted that “courts may consider a variety of mathematical formulas when deciding the consistency among payments.”
- Standard Deviation
- The Plaintiff-Trustee’s Standard Deviation analysis resulted in a range of approximately 75 days (roughly 37 days on either side of the Historical Period average). Defendant did not address the argument, and as with the other methodologies, factual issues precluded application at this time.
As to Plaintiff-Trustee’s assertion that Defendant’s Preference Period collection activity (i.e. calling/emailing about late payments, change of payment terms, etc.) was unusual, the Court found there was a factual dispute as to whether such behavior was in fact normal between the Parties.
Objective OCOB Approaches
Defendant also asserted a defense under section 547(c)(2)(B), arguing it was classified as an employment agency in the administrative and waste management services industry; Plaintiff-Trustee countered that its classification was unclear, and thus the proper “industry” for 547(c)(2)(B) purposes was in dispute. The Court found that while “a creditor has “considerable latitude in defining what the relevant industry is” and “expert testimony is not required”, a “sufficiently detailed basis is needed to establish the relevant industry.” Given the classification dispute, the Court found summary judgment inappropriate.
The Sequencing of 547(c) Defenses
Lastly, Defendant argued that its subsequent new value defense under 547(c)(4) eliminated any remaining exposure it may still have from the Transfers. Plaintiff-Trustee argued, however, that analysis under 547(c)(4) is premature until the 547(c)(2) OCOB review is confirmed. The Court sided with Plaintiff-Trustee, finding Defendant’s
new value calculations were based on the remaining Transfers being “otherwise unavoidable” according to its calculations under the ordinary course of business defense. However, the Court has found that there are disputes as to material facts regarding the ordinary course of business defense. Therefore, the Court must deny the Defendant’s Motion for Summary Judgment as to the new value defense until the ordinary course of business defense is determined.
In sum, the Motion was denied.
Even without any application of the various OCOB methodologies discussed above, this opinion provides preference practitioners (on either side) with a section 547(c)(2) road map. Moreover, the decision reaffirms that a viable “Historical Period” should capture an ample ‘healthy period’ of a debtor’s history, though what constitutes “healthy”, of course, should remain subject to intense dispute. In addition, the Court advises – on these facts, at least – that subsequent new value should not be applied before resolution of what constitutes OCOB.
A copy of the Opinion can be found here.