Unsecured Creditors Comm. of Sparrer Sausage Co. v. Jason's Foods, Inc., 15-2356

• Decision Date: 10 June 2016
• Docket Number: No. 15-2356,15-2356
• Citation: 826 F.3d 388
• Parties: The Unsecured Creditors Committee of Sparrer Sausage Company, Inc., Plaintiff–Appellee, v. Jason's Foods, Inc., Defendant–Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

826 F.3d 388

The Unsecured Creditors Committee of Sparrer Sausage Company, Inc., Plaintiff–Appellee

v.Jason's Foods, Inc., Defendant–Appellant.

No. 15-2356

United States Court of Appeals, Seventh Circuit.

Argued December 7, 2015

Decided June 10, 2016

Richard Scott Alsterda, Theodore Eric Harman, Attorneys, Nixon Peabody LLP, Chicago, IL, for Appellant.

Pamela Joy Leichtling, Scott N. Schreiber, I, Attorneys, Clark Hill PLC, Chicago, IL, for Appellee.

Before Flaum, Williams, and Sykes, Circuit Judges.

Sykes

, Circuit Judge.

During the 90-day preference period preceding its Chapter 11 bankruptcy filing, Sparrer Sausage Company paid invoices it received from Jason's Foods, Inc., one of its suppliers, totaling roughly $587,000. The Unsecured Creditors Committee asked that these payments be returned to the bankruptcy estate as avoidable preferences under § 547(b) of the Bankruptcy Code

. Jason's Foods agreed that the payments were avoidable preferences but claimed an exception under 11 U.S.C. § 547(c)(2)(A) for otherwise preferential transfers made in the ordinary course of business.

The bankruptcy judge allowed Jason's Foods to keep a significant share of the challenged payments but held that the timing of certain payments departed too drastically from the companies' past practice to be considered ordinary. The judge imposed preference liability on Jason's Foods for 11 invoices that he determined were paid either too early or too late to be treated as ordinary—specifically, invoices Sparrer Sausage paid within 14, 29, 31, 37, and 38 days of issuance. The district court affirmed and Jason's Foods appealed.

We reverse. Nothing in the record suggests that it was unusual for Sparrer Sausage to pay invoices from Jason's Foods within 14, 29, and 31 days of issuance given its payment history before the preference period. The only payments that can fairly be deemed out of the ordinary are those made 37 and 38 days after receipt of invoice. Jason's Foods' preference liability is limited to those invoices and is entirely offset by invoices Sparrer Sausage failed to pay.

I. Background

Jason's Foods, a wholesale meat supplier, provided unprocessed meat products to Chapter 11 debtor Sparrer Sausage, a sausage manufacturing company. Their relationship stretched back as far as February 2, 2010, and continued until Sparrer Sausage filed its petition for Chapter 11 bankruptcy on February 7, 2012. During the 90-day preference period preceding this filing, Sparrer Sausage paid 23 invoices from Jason's Foods totaling $586,658.10.

In September 2013 the Unsecured Creditors Committee filed a complaint to recover those payments from Jason's Foods. The Committee argued that the payments were avoidable preferences—payments that Jason's Foods was required to return to the bankruptcy estate for the benefit of Sparrer Sausage's unsecured creditors. See 11 U.S.C. § 547(b)

. Jason's Foods conceded that the payments met the statutory definition of an avoidable preference but asserted two affirmative defenses under § 547(c). First, Jason's Foods argued that the otherwise preferential transfers were made in the ordinary course of business and thus were nonavoidable under § 547(c)(2). Alternatively, Jason's Foods argued that it had provided meat products to Sparrer Sausage in January and February of 2012 without receiving payment and that this new value offset its preference liability under § 547(c)(4).

The bankruptcy judge first considered Jason's Foods' ordinary-course defense and determined that before the preference period, Sparrer Sausage generally paid invoices from Jason's Foods within 16 to 28 days. Of the 23 invoices that Sparrer Sausage paid during the preference period, 12 fell within this range, so the judge concluded that these 12 payments were ordinary and thus nonavoidable. The remaining 11 invoices were paid within 14, 29, 31, 37, and 38 days of the invoice date. The judge concluded that these payments, which totaled $306,110.23, were not ordinary and must be returned to the bankruptcy estate for the benefit of Sparrer Sausage's unsecured creditors.

Turning next to the new-value defense, the judge found that Sparrer Sausage had not paid for $63,514.91 worth of meat products it received from Jason's Foods in January and February of 2012. The judge credited that amount to Jason's Foods as an offset against its preference liability and entered judgment in favor of the Unsecured Creditors Committee in the amount of $242,595.32. The judgment was affirmed on appeal to the district court, and this appeal followed.

II. Discussion

We review the bankruptcy court's conclusions of law de novo and its findings of fact for clear error.

Kovacs v. United States , 614 F.3d 666, 672 (7th Cir. 2010)

. A factual finding is clearly erroneous if “although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.” Id. (quotation marks omitted).

As a general rule, payments made to a creditor during the 90-day period before a debtor files for bankruptcy are avoidable preferences. See 11 U.S.C. § 547(b)

. The rule prevents inequitable distribution of the debtor's assets to favored creditors and protects the struggling debtor against the predatory behavior of nervous creditors. In re Tolona Pizza Prods. Corp. , 3 F.3d 1029, 1032 (7th Cir. 1993). But the rule contains an exception, codified in § 547(c)(2), aimed at “leav[ing] undisturbed normal commercial and financial relationships and protect[ing] recurring, customary credit transactions.” Kleven v. Household Bank F.S.B. , 334 F.3d 638, 642 (7th Cir. 2003) (quotation marks omitted).

To that end, § 547(c)(2)

provides that an otherwise preferential transfer is nonavoidable

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 transferee; or

(B) made according to ordinary business terms[.]

The creditor asserting this defense to preference liability bears “the burden of proving the nonavoidability of a transfer under subsection (c).” 11 U.S.C. § 547(g)

.

Jason's Foods and the Unsecured Creditors Committee stipulated that Sparrer Sausage incurred all debts owed to Jason's Foods in the ordinary course of business, so we're concerned only with Sparrer Sausage's payment of those debts. In this regard Jason's Foods proceeds under § 547(c)(2)(A)

, commonly referred to as the subjective ordinary-course defense.¹

The subjective ordinary-course defense asks whether the payments the debtor made to the creditor during the preference period are consistent with the parties' practice before the preference period. Tolona Pizza , 3 F.3d at 1032

. The inquiry is not governed by any “ ‘precise legal test,’ ” Lovett v. St. Johnsbury Trucking , 931 F.2d 494, 497 (8th Cir. 1991) (quoting In re Fulghum Constr. Corp ., 872 F.2d 739, 743 (6th Cir. 1989) ), but generally entails using the debtor's payment history to calculate a baseline for the companies' dealings and then comparing preference-period payments to that baseline, cf.

Kleven , 334 F.3d at 642–43. While “substantial deviations from established practices” are not protected, the ordinary-course defense “allow[s] suppliers and other furnishers of credit to receive payment within the course that has developed in the commercial relationship between the parties.” In re Tenn. Chem. Co. , 112 F.3d 234, 238 (6th Cir. 1997).

Jason's Foods challenges the bankruptcy judge's determination that Sparrer Sausage typically paid invoices within 16 to 28 days, arguing that this calculation does not accurately reflect the companies' payment practices before the preference period. This is really two arguments in one. Jason's Foods challenges the judge's use of an abbreviated historical period rather than the companies' entire payment history and also argues that the baseline comprises a too-narrow range of days surrounding the average invoice age during the historical period.

A. Historical Period

Calculating the baseline payment practice between two companies requires identifying a historical period that reflects the companies' typical payment practices. See, e.g. , In re Quebecor World (USA), Inc. , 491 B.R. 379, 387 (Bankr. S.D.N.Y. 2013)

(“The Court must first determine the appropriate pre-preference time period to use in establishing a baseline of dealings between the parties.”). In Tolona Pizza we directed courts to look to “the norm established by the debtor and the creditor in the period before, preferably well before, the preference period.” 3 F.3d at 1032. That directive doesn't require truncating the historical period “well before” the beginning of the preference period but simply underscores that the baseline should reflect payment practices that the companies established before the onset of any financial distress associated with the debtor's impending bankruptcy. See

In re Affiliated Foods Sw. Inc. , 750 F.3d 714, 720 (8th Cir. 2014) (“To make a sound comparison, ‘[n]umerous decisions support the view that the historical baseline should be based on a time frame when the debtor was financially healthy.’ ” (quoting Quebecor World , 491 B.R. at 387 )).

In some cases this may require truncating the historical period before the start of the preference period if the debtor's financial difficulties have already substantially altered its dealings with the creditor. See, e.g. , In re Circuit City Stores, Inc. , 479 B.R. 703, 710 (Bankr. E.D. Va. 2012)

; In re H.L. Hansen Lumber Co. of Galesburg, Inc. , 270 B.R. 273, 279 (Bankr. C.D. Ill. 2001). In other cases it will be necessary to consider the entire pre-preference period. See, e.g. , Affiliated Foods , 750 F.3d at 720 ; Quebecor World , 491 B.R. at 387. In all cases the contours of the historical period should be grounded in the companies'...