Advo-System, Inc. v. Maxway Corp.

• Decision Date: 14 October 1994
• Docket Number: ADVO-SYSTE,No. 93-2487,P,INCORPORATE,93-2487
• Citation: 37 F.3d 1044
• Parties: , 26 Bankr.Ct.Dec. 211, Bankr. L. Rep. P 76,140 laintiff-Appellant, v. MAXWAY CORPORATION; Danners, Incorporated, by and through their official committee of unsecured creditors, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 1044

37 F.3d 1044

63 USLW 2307, 26 Bankr.Ct.Dec. 211, Bankr.

L. Rep. P 76,140

ADVO-SYSTEM, INCORPORATED, Plaintiff-Appellant, v. MAXWAY CORPORATION; Danners, Incorporated, by and through their official committee of unsecured creditors Defendants-Appellees.

No. 93-2487.

United States Court of Appeals Fourth Circuit.

Argued May 9, 1994.

Decided Oct. 14, 1994.

ARGUED: Lacy H. Reaves, Poyner & Spruill, L.L.P., Raleigh, NC, for appellant. Rebecca Sofley Henderson, Durham, Wyche, Story, Whitley & Henderson, Charlotte, NC, for appellees. ON BRIEF: Donna S. Richter, Eric P. Stevens, Poyner & Spruill, L.L.P., Raleigh, NC, for appellant. Albert F. Durham, Durham, Wyche, Story, Whitley & Henderson, Charlotte, NC, for appellees.

Before WILKINSON and MICHAEL, Circuit Judges, and DUPREE, Senior United States District Judge for the Eastern District of North Carolina, sitting by designation.

Affirmed by published opinion. Judge MICHAEL wrote the opinion, in which Judge WILKINSON and Senior Judge DUPREE joined.

OPINION

MICHAEL, Circuit Judge:

Chapter 11 debtors Maxway Corporation and Danners, Incorporated, by and through their Official Committee of Unsecured Creditors (collectively "Maxway"), brought an action pursuant to 11 U.S.C. Sec. 547(b) to recover preference payments made by Maxway to one of its unsecured creditors, Advo-System, Incorporated ("Advo"). Advo asserted as a defense that the preference payments fell within the ordinary course of business exception in 11 U.S.C. Sec. 547(c)(2) and therefore were not avoidable. The bankruptcy court granted Maxway's motion for summary judgment, holding that Advo could not satisfy the ordinary course of business exception. The district court affirmed. Advo appeals, and we affirm.

I.

Generally, when a debtor makes a payment to an unsecured creditor within 90 days before a bankruptcy petition is filed, that payment is a "preference." See 11 U.S.C. Sec. 547(b). The trustee in bankruptcy may recover such a payment from the unsecured creditor, thereby forcing that creditor to stand at the back of the line with the rest of the debtor's unsecured creditors. However, the unsecured creditor has several shields with which it can defend against the trustee's avoidance power. See 11 U.S.C. Sec. 547(c). One such shield, and a prominent one at that, is found in Sec. 547(c)(2); it is known as the "ordinary course of business" exception. This exception says that the trustee may not avoid a debtor's payment to an unsecured creditor if the creditor can show, among other things, that the payment was made in the ordinary course of business of the debtor and the unsecured creditor (subsection B) and that the payment was made according to ordinary business terms (subsection C). 11 U.S.C. Sec. 547(c)(2). In this case, the debtor, Maxway, made ten preference payments to one of its unsecured creditors, Advo. The issues raised in this appeal are whether Advo can satisfy subsections B and C. Because this circuit has not heretofore adopted a rule of construction for subsection C, we adopt one today, and we conclude that Advo cannot meet it.

II.

Advo is a targeted direct mail marketing company that maintains computerized residential lists organized by zip code. Advo prints a customer's advertisements and then mails them directly to those households most likely to purchase the customer's products or services. According to Advo, it is the only direct mail advertising firm to offer its services on a nationwide basis.

Advo's general business practice is as follows. After an order is received, but before printing and distribution of the customer's advertisements, Advo estimates the cost of the customer's order and sends to the customer a standard form "pre-invoice." That invoice says that "[a]ll distribution and printing services require prepayment." Advo generally requires its customers to prepay for its services because Advo has to pay postage costs when it mails the advertisements. Then, shortly after the advertisements are mailed, Advo forwards to the customer a final invoice reflecting the actual cost of the order. The actual cost on the final invoice may differ from the estimated cost on the pre-invoice if, for example, the advertisements are sent to fewer or more households than originally anticipated. The final invoice says "net payable on receipt."

Maxway was a discount retail chain before it went out of business in 1991. Between 1986 and 1990, Maxway was one of Advo's customers, with Advo printing and distributing Maxway's direct mail advertisements. On October 7, 1988, Maxway filed a petition under Chapter 11 of the Bankruptcy Code. In the 90-day period preceding the filing of its Chapter 11 petition (July 9, 1988, through October 7, 1988), Maxway made twelve payments to Advo. Two of the twelve payments were prepayments for Advo's services. The other ten payments, totalling $177,506.33, were payments for services previously rendered. Because these ten payments were, among other things, made on account of an antecedent debt, they were preferences under 11 U.S.C. Sec. 547(b). Of the $177,506.33, Maxway paid around $50,000 by official bank check less than one week prior to the filing of the bankruptcy petition. Before that payment, Maxway had always paid Advo by company check.

On August 13, 1991, Maxway brought an action against Advo pursuant to Sec. 547(b) to recover the $177,506.33 in preference payments. Advo answered that the ten preference payments were made in the ordinary course of business and therefore were exempt under Sec. 547(c)(2) from the trustee's avoidance power. The parties filed cross motions for summary judgment. In an August 6, 1992, order, the bankruptcy court granted Maxway's motion for summary judgment and denied Advo's; the court held that Advo could not satisfy subsections B and C of Sec. 547(c)(2). In an October 28, 1993, order, the district court affirmed, apparently concluding that Advo could not satisfy subsection C. Advo now appeals to this court. We base our affirmance on Advo's failure to satisfy subsection C. As a result, we do not reach the issue of whether the payments fit subsection B. ¹

III.

To repeat, section 547(b) allows a trustee to avoid certain payments made by a debtor to its unsecured creditor within the 90-day period preceding the filing of the bankruptcy petition. ² Two major policies drive Sec. 547(b):

First, the avoidance power promotes the "prime bankruptcy policy of equality of distribution among creditors" by ensuring that all creditors of the same class will receive the same pro rata share of the debtor's estate. Second, the avoidance power discourages creditors from attempting to outmaneuver each other in an effort to carve up a financially unstable debtor and offers a concurrent opportunity for the debtor to work out its financial difficulties in an atmosphere conducive to cooperation.

Morrison v. Champion Credit Corp. (In re Barefoot), 952 F.2d 795, 797-98 (4th Cir.1991) (citations omitted) (quoting H.R.Rep. No. 595, 95th Cong., 2d Sess. 178 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, 6138); see also Harman v. First Am. Bank of Md. (In re Jeffrey Bigelow Design Group, Inc.), 956 F.2d 479, 488 (4th Cir.1992) ("Congress was concerned that creditors would race to the courthouse to dismember the [debtor] or that a debtor would favor certain creditors over others").

Advo concedes that the ten payments at issue here are preferences under Sec. 547(b). However, Advo argues that the payments are not avoidable because, Advo says, the payments fall within the ordinary course of business exception in Sec. 547(c)(2). Section 547(c)(2) says that the trustee may not avoid a transfer:

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.

Advo has the burden of proving by a preponderance of the evidence that each payment satisfies each of Sec. 547(c)(2)'s three subsections. See 11 U.S.C. Sec. 547(g); Logan v. Basic Distribution Corp. (In re Fred Hawes Org., Inc.), 957 F.2d 239, 242 (6th Cir.1992). "This inquiry is 'peculiarly factual.' " Bigelow, 956 F.2d at 486 (quoting In re First Software Corp., 81 B.R. 211, 213 (Bankr.D.Mass.1988)).

Maxway acknowledges that the payments were made in the ordinary course of the parties' business and thus Advo has satisfied subsection A. Whether Advo made its case under subsections B and C is disputed. As we explain below, Advo cannot satisfy subsection C and therefore cannot take advantage of the ordinary course of business exception.

A.

Subsection C says that payments must be "made according to ordinary business terms." 11 U.S.C. Sec. 547(c)(2)(C). What does this phrase mean? Specifically, what is the appropriate benchmark from which we determine whether a preference payment's credit terms are "ordinary"? The Code does not tell us. In fact, the Code fails to define any of the phrases in Sec. 547(c)(2). Section 547(c)(2)'s legislative history tells us simply that the "purpose of this exception is to leave undisturbed normal financial relations, because it [such an exception to the trustee's general avoidance powers] does not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor's slide into bankruptcy." S.Rep. No. 989, 95th Cong., 2d Sess. 88 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5874.

Seizing upon the Code's silence, Advo urges us to use a subjective analysis under subsection C. Specifically, Advo argues that business terms are not unusual so long as they are consistent with the terms used between the debtor and this particular creditor in their prior course of dealing. However, Advo recognizes that a majority of the federal...