United States: Ordinary Course Defense Examined By The 7th Circuit – Bucketing Analysis Rejected

Last Updated: November 16 2016
Article by Carl D. Neff

In the recent decision of Unsecured Creditors Comm. of Sparrer Sausage Co., Inc. v. Jason's Foods, 826 F.3d 388 (7th Cir. 2016), the Seventh Circuit overturned the bankruptcy court's application of the "bucketing" method to assess an ordinary-course defense to preference liability, concluding that range of invoice payment dates chosen as the baseline was arbitrarily narrow.

Jason's Foods, a wholesale meat supplier, provided meat products to Sparrer Sausage, a sausage manufacturing company. Their relationship stretched back two years before Sparrer filed for bankruptcy. During the 90-day preference period, Sparrer paid 23 invoices from Jason's totaling $586,658. The creditors committee filed a complaint to recover the payments to Jason's as avoidable preferences.

The bankruptcy court determined that before the preference period, Sparrer paid invoices from Jason's within 16 to 28 days. Of the 23 invoices that Sparrer Sausage paid during the preference period, 12 fell within this range, so the bankruptcy court 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 court concluded that these payments, which totaled $306,110, were not ordinary and must be returned to the bankruptcy estate. The district court affirmed, and Jason's appealed.

Although Jason's and committee stipulated to a historical period that covered all 234 invoices that Sparrer paid before the preference period, the bankruptcy court considered only 168 invoices. The court cut off the historical period seven months before the start of the preference period based on its conclusion that that date "marked the beginning of the debtor's financial difficulties" and that invoices paid after that date did not accurately reflect the norm when Sparrer was financially healthy. The bankruptcy court based its finding on the fact that the percentage of invoices paid 30 or more days after issuance increased significantly after that date. While acknowledging that the evidence of Sparrer's financial distress was "hardly overwhelming," and questioning the bankruptcy court's decision to disregard the parties' stipulation, the Seventh Circuit observed that the bankruptcy court "offered a reasoned explanation for his decision," which could not be overturned as clear error.

On the other hand, the circuit court found clear error in the bankruptcy court's application of the average-lateness method to conclude that invoices paid more than 6 days on either side of the 22-day average were outside the ordinary course. The bankruptcy court "applied Quebecor World and its so-called 'bucketing' analysis to support this conclusion, but neither the facts nor the bankruptcy court's analysis in that case bear any resemblance to this case."

The Seventh Circuit observed that

H]ere a 16-to-28-day baseline range encompasses just 64% of the invoices that Sparrer Sausage paid during the historical period. Even more problematically, the judge offered no explanation for the narrowness of this range. Why exclude invoices that Sparrer Sausage paid within 14 days when these payments were among the most common during the historical period? The same goes for invoices that Sparrer Sausage paid within 29 days. Indeed by adding just two days to either end of the range, the analysis would have captured 88% of the invoices that Sparrer Sausage paid during the historical period, a percentage much more in line with the Quebecor World analysis. Thus, a 16-to-28-day baseline appears not only excessively narrow but also arbitrary.

The circuit court pointed out that "Sparrer Sausage paid 9 of the 11 contested invoices within 14, 29, and 31 days of issuance. These payments fall either squarely within or just outside the 14-to-30-day range in which Sparrer Sausage paid the vast majority of invoices during the historical period. As such they are precisely the type of payments that the ordinary-course defense protects: recurrent transactions that generally adhere to the terms of a well-established commercial relationship. Sparrer Sausage paid the other 2 invoices 37 and 38 days after they were issued, which is substantially outside the 14-to-30-day baseline."

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