BAPCPA Impact on Preference Mediation

BAPCPA Impact on Preference Mediation

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While the amendments to the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005"2 (BAPCPA) affecting consumer bankruptcy have been receiving the most media attention, other aspects of BAPCPA will also have huge consequences in consumer and business cases alike. Notable among these are the changes to §547(c)(2) of the Code, the so-called "ordinary course defense" to preference actions. This article examines how the revamping of the ordinary course defense will result in more mediation activity than in the past, especially in jurisdictions such as Delaware, where all preference actions must be mediated.

The Law Prior to BAPCPA

The major change in §547(c)(2) is in the method a creditor can now use to prove that an allegedly preferential transfer was made in the ordinary course and, accordingly, not avoidable. Presently, and prior to the effective date of BAPCPA (Oct. 17, 2005), a creditor must satisfy a three-pronged test for this defense to be successful.3 A creditor must prove not only that the transfer was incurred and then paid in the ordinary course of business or financial affairs of both the debtor and the creditor, but also that the transfer met industry standards by being "made according to ordinary business terms." Failure to meet this last test means defeat in the courts, even if the first two tests are met. In addition, preparing and presenting this defense is often time-consuming and costly, since the overwhelming majority of courts require expert testimony from sources other than the creditor,4 although a minority of decisions do allow personnel of the creditor to testify as experts under certain circumstances.5

A major consequence of this creditor's dilemma is to tilt a preference action in favor of a debtor or trustee seeking to recover a preferential transfer. A creditor looking at the prospect of seeking out an expert to testify as to industry standards very often faces a huge obstacle: Where can such an expert be found? In many instances, the only source is to go to a competing entity for personnel with such expertise. This necessity raises the obvious risk of revealing confidential company information as the price of success in a potentially lengthy and expensive preference trial. The perils of bringing that "expert" into the company tent are often far less preferable than settling the matter with the debtor or trustee. As a result, a large number of preference cases are settled between the parties even prior to reaching the mediation stage, perhaps for amounts greater than the merits of case might justify.

Ordinary Course Under BAPCPA

Under BAPCPA, proving ordinary course will be significantly easier. Essentially, the amendments remove the requirement to prove all three elements of §547(c)(2) prior to the amendments. Upon BAPCPA's effective date, §547(c)(2) will provide:

(c) The trustee may not avoid under this section a transfer—
(2) 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....

By repositioning former subsection (A) in the main paragraph and characterizing former subsections (B) and (C) as disjunctive tests, a creditor now need only show that the alleged preference occurred in its and the debtor's ordinary course of business or financial affairs and that the transfer was paid either in the ordinary course of business or financial affairs or made according to ordinary business terms. In other words, if the creditor can demonstrate that the initial transaction was incurred in the ordinary course of both parties to the transaction, it can win if it can prove either payment in the ordinary course or payment according to industry standards.

Therefore, while a creditor may not find it any easier to prove incurrence and payment of the debt in the ordinary course of business, the new statute will most likely relieve creditors of the burdensome requirement of proving the existence of ordinary business terms among the parties. The burden of proof for the former defenses seems not to have changed. However, the defending creditor will no longer have to look for experts and engage in more lengthy trial preparation to establish the latter defense. In fact, over time, we may see the demise of ordinary business terms as a defense in ordinary course preference actions, except in those isolated instances where a lack of dealings between the parties necessitates reference to industry standards.

This analysis doesn't mean to suggest that there will be fewer preference actions filed by debtors, trustees or plan administrators. In fact, there may be more. While BAPCPA may dissuade a debtor or trustee from bringing certain preference actions in the first place,6 it is still probable that preference actions for larger amounts will be filed with increasing regularity. What BAPCPA does imply, however, is that creditors, armed with an easier ordinary-course defense, will be less likely to settle in one-on-one negotiations with their adversary. Knowing that they probably won't need expert testimony, and the greater amount of trial preparation that defense imports, will cause creditors to conclude that it's more advantageous to stiffen their settlement posture than to settle for an amount that is favorable to a debtor's estate. In other words, a creditor, because he doesn't have to meet the three-pronged test of the old §547(c)(2), may look at settlement in a new way.

Effect on Mediation

Consequently, while the overall number of preference actions may decrease due not only to the new venue restrictions but also to a more detailed examination of the merits by preference plaintiffs, those cases that are filed may find both parties in a more rigid posture. Prior to BAPCPA, after a preliminary vetting period, a plaintiff was prone to file as many preference actions as there were transfers within the preference period. In addition, these actions could be filed in the court where the main case was pending, thereby subjecting the creditor to facing a trial hundreds, perhaps thousands, of miles away from its base of operations. Under BAPCPA, that is no longer the case.7

With the amendments to BAPCPA in place, a preference plaintiff would be well advised to scrutinize the merits of potential preference cases very closely to weed out cases that would be unproductive because of an inconvenient venue or an amount that does not meet the new threshold of 28 U.S.C. 1409(b). This task puts a greater burden on debtors, trustees and plan administrators in the larger chapter 11 cases, and perhaps because of this increased due diligence effort, preference plaintiffs are likely to believe more strongly in the merits of their cases and adopt a firmer stance in dealing with defendants. Moreover, as previously noted, given the relaxation in the ordinary-course defense requirements, a creditor will also have a stiffer backbone in its negotiations.

Since all preference actions in the Delaware Bankruptcy Court must be mediated,8 and assuming that other jurisdictions, while not necessarily following the Delaware model, will nonetheless seek to mediate a number of preference cases in an effort to clear their trial calendars, the harder settlement posture of parties to preferences will mean that more matters will go to mediation instead of being settled by the parties themselves.

Settlement of cases prior to trial is still the best solution to legal disputes. The amendments to BAPCPA, however, will mean that a mediator will have to exercise his or her best techniques to bring about this desired result.


It is certain that Congress didn't have mediation on its mind when it changed the ordinary-course defense. However, it is also probable that mediation activity will markedly increase as a result of this major change to the preference statute.


1 Howard N. Gorney is senior counsel at Nixon Peabody LLP and is a member of the panel of mediators in the Delaware Bankruptcy Court. He is resident in the firm's Boston office and concentrates his practice in mediation and other forms of alternative dispute resolution. His email address is [email protected]. Return to article

2 P. L. 109-8 (S. 256). April 20, 2005. Return to article

3 The present §547(c)(2), says, in relevant part:

(c) The trustee may not avoid a transfer under this section—
(2) to the extent that such transfer was—
(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee;
(B) made in the ordinary course of business or financial affairs of the debtor and the transferee; and
(C) made according to ordinary business terms. Return to article

4 Wallach v. Vulcan Stream Forging Co. (In re D. J. Management Group Inc.), 164 B. R. 831, 837 (Bankr. W.D.N.Y. 1994); In re Wash. Mfg. Co., 144 B. R. 376, 380 (Bankr. M.D. Tenn. 1992). Return to article

5 In re Midway Airlines Inc., 69 F.3d 792, 797-798 (7th Cir. 1995); Morris v. Kansas Drywall Supply Co. (In re Classic Drywall Inc.), 121 B. R. 69 (D. Kan. 1990). Return to article

6 BAPCPA has changed the venue rules for certain preference actions. Section 410 of BAPCPA amends 28 U.S.C. §1409(b) to provide that actions against a noninsider for less than $10,000 must be brought in the home district of the defendant. Return to article

7 See fn 5. P.L. 109-8 (S. 256), §410 (April 20, 2005), amending 28 U.S.C. §1409(b). Return to article

8 As of March 14, 2005, the office of the clerk of the Delaware Bankruptcy Court reported that there were 10,895 adversary proceedings currently pending. (Source: minutes of mediator's meeting, March 14, 2005). Presumably, the overwhelming majority of those cases are preferences, all of which must go to mediation by virtue of the court's standing order dated April 7, 2004. Return to article

Journal Date: 
Friday, July 1, 2005