Introduction
The United States Bankruptcy Code empowers trustees to recover certain pre-bankruptcy transfers of a debtor’s property. This power, however, is not absolute. Various defenses exist to protect legitimate transactions, and one such defense is the “ordinary course of business” exception. This article delves into this defense, using the illustrative case of In re National Gas Distributors.
Background: Trustee Avoidance Powers
When a company files for bankruptcy, the appointed trustee plays a crucial role in maximizing the value of the debtor’s estate for the benefit of creditors. One of the trustee’s key powers is the ability to “avoid” certain pre-bankruptcy transfers made by the debtor. This means the trustee can essentially reverse these transfers and recover the assets, ensuring they are available for fair distribution among creditors.
These avoidance powers are rooted in the principle of preventing debtors from unfairly favoring certain creditors or depleting assets just before filing for bankruptcy. However, not all pre-bankruptcy transfers are subject to avoidance. The law recognizes that legitimate business transactions should not be penalized.
The Ordinary Course of Business Defense
The “ordinary course of business” defense is a crucial safeguard against the overreach of trustee avoidance powers. This defense protects transfers made in the regular course of a debtor’s business operations. The rationale is simple: transactions that are customary and conducted according to standard industry practices should not be unwound merely because a company later faces financial distress.
To successfully invoke this defense, the party opposing the trustee must demonstrate that the challenged transactions were consistent with the debtor’s historical business practices and aligned with industry norms. This often involves providing evidence such as:
- Past payment histories
- Industry standards regarding payment terms and loan extensions
- Testimony from industry experts
Case Study: In re National Gas Distributors
The case of In re National Gas Distributors provides a practical example of how the ordinary course of business defense operates in a bankruptcy scenario.
Facts of the Case
National Gas Distributors, a company owned by Paul Lawing, found itself facing financial difficulties. The company had obtained various loans and lines of credit from Branch Banking and Trust Company. Notably, the loans were secured by personal assets belonging to Paul’s wife, Ann. As National’s financial troubles mounted, it made several payments to Branch in the weeks leading up to its bankruptcy filing. These payments included:
- Paying off an outstanding balance on a line of credit
- Paying off the balance of a working capital loan
- Transferring funds to collateralize existing letters of credit
The Trustee’s Challenge
Following National’s bankruptcy filing, the appointed trustee sought to avoid these payments to Branch. The trustee argued that the transfers improperly benefited Branch at the expense of other creditors and were made in anticipation of bankruptcy.
Branch’s Defense
Branch countered the trustee’s claims by arguing that the payments were exempt from avoidance because they were made in the ordinary course of business. Branch presented evidence to support its position, including:
- Evidence that extending loan maturity dates was a common practice within Branch and the banking industry.
- Evidence that borrowers often repaid loans within a few weeks prior to their maturity dates.
Outcome
The court ultimately sided with Branch, finding that the payments were indeed made in the ordinary course of business. The court recognized that extending loan terms and receiving payments close to maturity dates were established practices in the banking industry. This case underscores the importance of the ordinary course of business defense in protecting legitimate business transactions from being undone in bankruptcy proceedings.
Conclusion
The ordinary course of business defense plays a vital role in balancing the interests of creditors and promoting fairness in bankruptcy proceedings. By shielding customary business transactions from avoidance, the defense ensures that companies can operate without the fear that standard practices will be later scrutinized and unwound. This case highlights the importance of documenting standard business practices and industry norms, as this evidence can be crucial in defending against trustee avoidance actions.