Tolona Pizza Products Corp., Matter of, 92-3386

• Citation: 3 F.3d 1029
• Decision Date: 19 August 1993
• Docket Number: No. 92-3386,92-3386
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)
• Parties: , 24 Bankr.Ct.Dec. 963, Bankr. L. Rep. P 75,395 In the Matter of TOLONA PIZZA PRODUCTS CORPORATION, Debtor-Appellant.

Page 1029

3 F.3d 1029

62 USLW 2136, 24 Bankr.Ct.Dec. 963, Bankr.

L. Rep. P 75,395

In the Matter of TOLONA PIZZA PRODUCTS CORPORATION, Debtor-Appellant.

No. 92-3386.

United States Court of Appeals,

Seventh Circuit.

Argued May 6, 1993.

Decided Aug. 19, 1993.

Daniel A. Zazove, Towbin & Zazove, Chicago, IL, Warren R. Fuller, Karen Arndt Berres, argued, South Barrington, IL, for Rose Packing Co., Inc.

Richard S. Alsterda, argued, Alexis R. Logan, Coffield, Ungaretti, Harris & Slavin, Chicago, IL, for Tolona Pizza Products Corp.

Before POSNER, FLAUM, and RIPPLE, Circuit Judges.

POSNER, Circuit Judge.

When, within 90 days before declaring bankruptcy, the debtor makes a payment to an unsecured creditor, the payment is a "preference," and the trustee in bankruptcy can recover it and thus make the creditor take pot luck with the rest of the debtor's unsecured creditors. 11 U.S.C. Sec. 547. But there is an exception if the creditor can show that the debt had been incurred in the ordinary course of the business of both the debtor and the creditor, Sec. 547(c)(2)(A); that the payment, too, had been made and received in the ordinary course of their businesses, Sec. 547(c)(2)(B); and that the payment had been "made according to ordinary business terms." Sec. 547(c)(2)(C). The first two requirements are easy to understand: of course to defeat the inference of preferential treatment the debt must have been incurred in the ordinary course of business of both debtor and creditor and the payment on account of the debt must have been in the ordinary course as well. But what does the third requirement--that the payment have been "made according to ordinary business terms"--add? And in particular does it refer to what is "ordinary" between this debtor and this creditor, or what is ordinary in the market or industry in which they operate? The circuits are divided on this question, compare In re Fred Hawes Organization, Inc., 957 F.2d 239, 243-44 (6th Cir.1992), and WJM, Inc. v. Massachusetts Dept. of Public Welfare, 840 F.2d 996, 1011 (1st Cir.1988), with Lovett v. St. Johnsbury Trucking, 931 F.2d 494, 499 (8th Cir.1991); J.P. Fyfe, Inc. v. Bradco Supply Corp., 891 F.2d 66, 71 n. 5 (3d Cir.1989), and In re Craig Oil Co., 785 F.2d 1563, 1565 (11th Cir.1986) (per curiam), the scholarly literature inconclusive, 4 Collier on Bankruptcy p 547.10 at p. 547-50 (Lawrence P. King 15th ed. 1993); Vern Countryman, "The Concept of a Voidable Preference in Bankruptcy," 38 Vand.L.Rev. 713, 772-73 (1985); David J. DeSimone, "Section 547(c)(2) of the Bankruptcy Code: The Ordinary Course of Business Exception Without the 45 Day Rule," 20 Akron L.Rev. 95, 123-28 (1986); Lissa Lamkin Broome, "Payments on Long-Term Debt as Voidable Preferences: The Impact of the 1984 Bankruptcy Amendments," 1987 Duke L.J. 78, 86, our court undecided, In re Xonics Imaging, Inc., 837 F.2d 763, 766 (7th Cir.1988); In re Excello Press, Inc., 967 F.2d 1109, 1114 (7th Cir.1992), the bankruptcy judges divided. Id.

Tolona, a maker of pizza, issued eight checks to Rose, its sausage supplier, within 90 days before being thrown into bankruptcy by its creditors. The checks, which totaled a shade under $46,000, cleared and as a result Tolona's debts to Rose were paid in full. Tolona's other major trade creditors stand to receive only 13cents on the dollar under the plan approved by the bankruptcy court, if the preferential treatment of Rose is allowed to stand. Tolona, as debtor in possession, brought an adversary proceeding against Rose to recover the eight payments as voidable preferences. The bankruptcy judge entered judgment for Tolona. The district judge reversed. He thought that Rose did not, in order to comply with section 547(c)(2)(C), have to prove that the terms on which it had extended credit to Tolona were standard terms in the industry, but that if this was wrong the testimony of Rose's executive vice-president, Stiehl, did prove it. The parties agree that the other requirements of section 547(c)(2) were satisfied.

Rose's invoices recited "net 7 days," meaning that payment was due within seven days. For years preceding the preference period, however, Tolona rarely paid within seven days; nor did Rose's other customers. Most paid within 21 days, and if they paid later than 28 or 30 days Rose would usually withhold future shipments until payment was received. Tolona, however, as an old and valued customer (Rose had been selling to it for fifteen years), was permitted to make payments beyond the 21-day period and even beyond the 28-day or 30-day period. The eight payments at issue were made between 12 and 32 days after Rose had invoiced Tolona, for an average of 22 days; but this actually was an improvement. In the 34 months before the preference period, the average time for which Rose's invoices to Tolona were outstanding was 26 days and the longest time was 46 days. Rose consistently treated Tolona with a degree of leniency that made Tolona (Stiehl conceded on cross-examination) one of a "sort of exceptional group of customers of Rose ... fall[ing] outside the common industry practice and standards."

It may seem odd that paying a debt late would ever be regarded as a preference to the creditor thus paid belatedly. But it is all relative. A debtor who has entered the preference period--who is therefore only 90 days, or fewer, away from plunging into bankruptcy--is typically unable to pay all his outstanding debts in full as they come due. If he pays one and not the others, as happened here, the payment though late is still a preference to that creditor, and is avoidable unless the conditions of section 547(c)(2) are met. One condition is that payment be in the ordinary course of both the debtor's and the creditor's business. A late payment normally will not be. It will therefore be an avoidable preference.

This is not a dryly syllogistic conclusion. The purpose of the preference statute is to prevent the debtor during his slide toward bankruptcy from trying to stave off the evil day by giving preferential treatment to his most importunate creditors, who may sometimes be those who have been waiting longest to be paid. Unless the favoring of particular creditors is outlawed, the mass of creditors of a shaky firm will be nervous, fearing that one or a few of their number are going to walk away with all the firm's assets; and this fear may precipitate debtors into bankruptcy earlier than is socially desirable. In re Xonics Imaging, Inc., supra, 837 F.2d at 765; In re Fred Hawes Organization, Inc., supra, 957 F.2d at 243 n. 5.

From this standpoint, however, 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. That condition is satisfied here--if anything, Rose treated Tolona more favorably (and hence Tolona treated Rose less preferentially) before the preference period than during it.

But if this is all that the third subsection of 547(c)(2) requires, it might seem to add nothing to the first two subsections, which require that both the debt and the payment be within the ordinary course of business of both the debtor and the creditor. For, provided these conditions are fulfilled, a "late" payment really isn't late if the parties have established a practice that deviates from the strict terms of their written contract. But we hesitate to conclude that the third subsection, requiring conformity to "ordinary business terms," has no function in the statute. We can think of two functions that it might have. One is evidentiary. In re Loretto Winery, Ltd., 107 B.R. 707, 710 (9th Cir. BAP 1989); In re Morren Meat & Poultry Co., 92 B.R. 737, 740-41 (W.D.Mich.1988); DeSimone, supra, at 127-28. If the debtor and creditor dealt on terms that the creditor testifies were normal for them but that are wholly unknown in the industry, this casts some doubt on his (self-serving) testimony. Preferences are disfavored, and subsection C makes them more difficult to prove. The second possible function of the subsection is to allay the concerns of creditors that one or more of their number may have worked out a special deal with the debtor, before the preference period, designed to put that creditor ahead of the others in the event of bankruptcy. It may seem odd that allowing late payments from a debtor would be a way for a creditor to make himself more rather than less assured of repayment. But such a creditor does have an advantage during the preference period, because he can receive late payments then and they will still be in the ordinary course of business for him and his debtor.

The functions that we have identified, combined with a natural reluctance to cut out and throw away one-third of an important provision of the Bankruptcy Code persuade us that the creditor must show that the payment he received was made in accordance with the ordinary business...