Normal Course Of Business Preference Defense:
Evaluating Industry Payment Patterns
By: Lynne Richardson
Bankruptcy Group Manager
Air Products and Chemicals Inc.

When selling on terms to marginal accounts, the risk exists that the debtor will file in bankruptcy, leaving the creditor in the position of not being paid for goods delivered and potentially facing a preference demand if the debtor was paying outside of terms. Not all preference demands are clear in their verbiage of "on account of antecedent debt" or "outside of normal course." What is normal for one creditor may not be normal for the industry. Adding to the complexity, the demands for preferences often require the creditor to go into their records and retrieve records, which in some cases do not match the records of the debtor.

The courts have held that §547(c)(2)(C) specifies transfers be made "according to ordinary business terms." Ordinary business terms can mean ordinary to the relationship between the debtor and the creditor or ordinary for the industry. The challenges for the creditor begin once notification is received, to develop a clear understanding of the relationship of the creditor’s historical records to that of the debtor and the industry.

Typically the initial reaction of a creditor to a preference demand letter is to research corporate records and make an initial determination as to the validity of the preference demand. The result of the research generally indicates that the referenced invoices were paid beyond terms. Often this positions the creditor to negotiate with the trustee in an effort to reduce the amount of the preference to be paid. However, this approach at times may be effective, it does not provide insight into how the debtor paid invoices in relation to how other companies paid in their industry.

Researching outside of internal records begins with understanding SIC codes, Standard Industrial Classification Codes as established by OSHA. The SIC Division Structure is categorized into ten divisions. Within each division are major groupings by industry, followed by another grouping that is more specific to the industry. Companies can belong to different SIC codes, depending on their product or service lines. To fully understand the payment patterns of the debtor, a comparison of payment habits should be made to other companies in the same SIC code as the debtor. Obtaining the SIC code for the debtor is rather straightforward, as various credit reporting agencies will assist in providing this information on the debtor. Once the SIC Code is known, industry information is published on a quarterly basic by NACM and the Credit Research Foundation. This information includes average days delinquent by year, by quarter. The calculation required to determine if the payment habits of the debtor are mirroring the payment habits reported by industry is: the days to pay the invoices, minus term, plus the delinquency rate. For example, if the preference demand is for invoices that were paid in 45 days and the industry norm is 12 days, the normal course of payments for the industry becomes 42 (30-day terms plus the 12-day industry norm). By the definition of 547, debtor payment habits compared to the published payment statistics by SIC Code is, arguably “normal course”.

Another tact in addressing the “industry norm” is to look at the industry’s economic condition at the time the payment is made. It is not surprising to discover the payment habits of the debtor are the same as that of the industry, especially if the industry is depressed, and therefore not subject to the 547 definition of a preference.

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