10th Circuit Holds That First Time Transactions Fall Within 11 U.S.C. 547(c)(2), Ordinary Course of Business Defense
October 16, 2015
Authored by: Michelle McMahon and Mark Duedall
In a decision that surprised many, the United Stated Circuit Court of Appeals for the Tenth Circuit (the “10th Circuit Court of Appeals”) affirmed decisions finding that a payment made on account of a first time transaction between a debtor and creditor can qualify for the ordinary course of business defense under 11 U.S.C. § 547(c)(2).
C.W. Mining Company (the “Debtor”) entered into an equipment agreement with a new contractor, SMC Electric Products, Inc. (“SMC”), in an attempt to increase the Debtor’s coal production. This agreement was reached several months before the filing of an involuntary bankruptcy petition. Within 90 days of the involuntary bankruptcy filing, the Debtor made the first payment under the agreement in the amount of $200,000 to SMC via wire transfer. The Trustee filed an adversary proceeding seeking to avoid and recover the $2000,000 payment under 11 U.S.C. §§ 547(b) and 550, as an alleged preferential transfer. The bankruptcy court ruled that the payment could not be avoided because it was made in the ordinary course of business of the Debtor and SMC and was therefore protected by 11 U.S.C. §§ 547(c)(2). The United States Bankruptcy Appellate Panel affirmed the bankruptcy courts decision.
In affirming the decision, the 10th Circuit Court of Appeals held that the fact that the Debtor and SMC had entered into the agreement for the first time and that the alleged preferential payment was the first payment under the agreement did not alter the applicability of 11 U.S.C. § 547(c)(2). Under § 547(c)(2), a trustee may not avoid a transfer “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” when “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.” The incurrence of the debt and the payment must be in the ordinary course of business for both the debtor and the transferee. See 11 U.S.C. § 547(c)(2) (emphasis added). The 10th Circuit Court of Appeals held that the statute refers to the “ordinary course of business or financial affairs of the debtor and the transferee,” not between the debtor and transferee. C.W. Mining, U.S. App. LEXIS 13981, at 10 (emphasis added). Further, the 10th Circuit Court of Appeals agreed with the Sixth, Ninth and Seventh Circuits that have held that a first time transaction can be protected by 11 U.S.C. § 547(c)(2). Wood v. Stratos Prod. Dev., LLC (In re Ahaza Sys. Inc.), 482 F.3d 1118, 1126 (9th Cir. 2007). (“[A] first-time debt must be ordinary in relation to this debtor’s and this creditor’s past practices when dealing with other, similarly situated parties.”); Kleven v. Household Bank F.S.B., 334 F.3d 638, 643 (7th Cir. 2003)( “[T]he court can imagine little (short of the certain knowledge that its debt will not be paid) that would discourage a potential creditor from extending credit to a new customer in questionable financial circumstances more than the knowledge that it would not even be able to raise the ordinary course of business defense, if it is subsequently sued to recover an alleged preference.”) (quoting Warsco v. Household Bank F.S.B., 272 B.R. 246, 252 (Bankr. N.D. Ind. 2002); Gosch v. Burns (In re Finn), 909 F.2d 903, 908 (6th Cir. 1990)(“Obviously every borrower who does something in the ordinary course of her affairs must, at some point, have done it for the first time.”).