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HHGREGG AND THE PREFERENCE DEMANDS AGAINST SUPPLIERS: STEPS FOR THE CREDIT TEAM TO PROTECT PAYMENTS Ronald Clifford, Esq. [email protected] Scott Blakeley, Esq. [email protected] 1 HHGregg Bankruptcy Filed for Chapter 11 Bankruptcy on March 6, 2017 Followed by closing of 88 unprofitable locations Announced on April 7, 2017 that 132 additional stores would close Bankruptcy Preferences The purpose of the preference provision is two-fold: Creditors are discouraged from racing to the courthouse to dismember a debtor, thereby hastening its slide into bankruptcy. Debtors are deterred from preferring certain creditors by the requirement that any creditor that receives a greater payment than similarly situated creditors disgorge the preference so that like creditors receive an equal distribution of the debtor's assets. 3 4 Quick Refresher: Elements of a Preference Transfer of property of the debtor To or for the benefit of a creditor For or on account of an antecedent debt Made while the debtor was insolvent Made on or within 90 days before the filing of the petition (or, for an insider, within one year of the filing) Enables the creditor to receive more than it otherwise would in a Chapter 7 Liquidation 5 How the Preference Game is Typically Played Chapter 7 vs. Chapter 11 Creditors Committee/ Trustee 6 How the Preference Game is Typically Played Prosecuting party makes demand for 80-90% of the transfers and sometimes provides an analysis of available defenses – do not rely on their analysis Respond or take chances on whether an action will be filed? Statute of limitations looming? Money in the estate to pursue preferences? Preferences are now commonly pursued in virtually all corporate chapter 7 cases and all chapter 11 cases Cases are often pursued earlier in the cases to pay administrative expenses 7 How the Preference Game is Typically Played How to respond? Written response that includes all defenses, including an analysis of the ordinary course of business defense Is employing an attorney/ expert witness necessary? Demand or complaint? Does your new value defense apply to less than 50% of the transfers? Complicated transactions? Hybrid approach Preparing client information in electronically usable formats Actively working with attorney/ expert witness to analyze the defenses Using an attorney/ expert witness can garner more respect and avoid a shakedown 8 Contemporaneous Exchange Transfer intended by debtor and creditor to be a contemporaneous exchange Transfers paying invoices for product shipped on COD/CIA basis Must meet two elements: Intent Substantially contemporaneous Check v. Wire: What’s the Risk? Where the customer pays by check, and the check is NSF, the vendor loses its contemporaneous exchange defense and may lose its OCB defense Conversely, payment by wire will clear the same day or ACH will clear the next day, thus ensuring the substantially contemporaneous nature of the exchange 9 The Ordinary Course of Business Defense What is it? Transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs Can be either subjectively or objectively ordinary Subjective test: transfer made in the ordinary course of business or financial affairs of the debtor and the transferee; or Objective test: transfer made according to ordinary business terms in the industry The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 BAPCPA made the subjective and objective tests disjunctive, thereby making it easier for creditors to establish ordinariness 10 Subjective Ordinary Course Factors considered by the court: The length of time the parties engaged in the type of dealing at issue; Whether the subject transfers were in an amount more than usually paid; 11 Subjective Ordinary Course Factors Considered by the Court: Whether the payments at issue were tendered in a manner different from previous payments; Days to Pay – averages vs. ranges Changes in payment amount Changes in payment method Changes in credit limit/credit terms Was the credit limit reduced? Were terms tightened? 12 Subjective Ordinary Course Factors Considered by the Court: Whether the creditor appears to engage in unusual action to collect on the debt Repeated phone calls and/or emails In-person meetings Contact by senior management Whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor's deteriorating financial condition. 13 Issues Underlying the Ordinary Course Analysis Identifying the Baseline Period for the Purpose of Comparing Historical Transfers with 90 Day Payments Establishing the Baseline The standard is the 12 months, but I recommend 24 months minimum if susuitable, leading up to the preference period, but the creditor may go back farther. In fact, the longer a payment history is, the more credibility it will command in court As a general rule of thumb, the creditor should cherry pick the historical range that most closely mirrors the preference period transactions Significance of “liquidity events” in identifying baseline period First-time and once-off payments 14 Objective OCB “Objectively ordinary” according to industry standards Which industry? The creditor’s or the debtor’s? Prior to BAPCPA, courts were split on the issue The Fourth Circuit Court of Appeals had considered prevailing terms within the creditor’s industry The Eighth Circuit Court of Appeals had considered prevailing terms within the debtor’s industry However, the court, in National Gas Distributors (Bankr. E.D.N.C. 2006), held that the transfers must be ordinary according to: The creditor’s industry; The debtor’s industry; and General business standards 15 Objective OCB To establish the industry norms, use sources of public information on payments days, DSO, and DPO, such as: CRF National Summary of Domestic Trade Receivables; RMA Financial Ratio Benchmarks; and D&B Reports Capital I.Q For public companies only 16 AES Thames During the Preference Period, Defendant sent eight invoices to the Debtor, five of which were due on November 26, 2010 and three of which were due on December 26, 2010. The Debtor paid the invoices at 19 and 10 days late. These transfers became the subject of this suit, brought by the Plaintiff-Trustee. Trustee argued that it was appropriate to analyze only whether the Debtor consistently paid Defendant on the due date specified in the agreement; Defendant’s preferred approach was to measure from invoice date to payments 17 AES Thames: Holding A late payment of 10 to 19 days was not unprecedented in the parties’ relationship. The Transfers paid multiple invoices together, just as the Debtor had done historically. Payments were always made by wire. There was no attempt by Defendant to gain an advantage over other creditors during the Preference Period. The difference in payment timing “without more, … should [not] preclude application of the ordinary course of business defense.” 18 Conex Holdings Conex Trustee sought to avoid seven transfers made during the Preference Period, totaling $1,181,583.84. Defendant claimed that the transfers were made in the ordinary course of the dealings between the parties Defendant moved for summary judgment based on its ordinary course of business defense 19 Conex Holdings Court found that the parties had been doing business for approximately 16 months and this duration was sufficient for the Court to determine the ordinary course of business between them. Even considering four “outlying” payments (made 95, 81, 78, and 77 days after invoice), which increased the difference in the average days to pay between the prePreference Period and Preference Period payments by 7 days, the Court found that the timing of the payments was still in the ordinary course of business. 20 New Value What is it? After allegedly preferential transfer, vendor subsequently extends goods or services (or credit for those goods or services) to the debtor Key Issues in New Value Timing is everything When the vendor ships the goods vs. when the debtor receives the goods When the debtor’s check is received by the vendor vs. when the debtor’s check clears or is written Paid vs. Unpaid Do postpetition shipments/services qualify for new value? Not in the Third Circuit New value paid by third party? 21 Friedman’s, Inc. v. Roth Staffing Cos., LLP The Facts: Friedman’s made $81,997.57 in payments to Roth Staffing for services provided during the preference period After the preferential transfers, but prior to Friedman’s January 22nd, 2008 bankruptcy filing, Roth Staffing provided $100,660.88 in services to Friedman’s With one of its first day motions, Friedman’s motioned the court to authorize payment of certain pre-petition wages and salaries (which included Roth’s services) Court authorized Friedman’s to pay $72,412.71 of the $100,660.88 owed When the Liquidating Trust filed suit against Roth Staffing to recover preferential transfers, the Trust argued that the $72,412.71 post-petition payment reduced the amount of new value Roth Staffing could assert (i.e. only entitled to $28,248.17 of the $100,660.88) 22 Friedman’s, Inc. v. Roth Staffing Cos., LLP The Holding Third Circuit Court of Appeals held that “where ‘an otherwise unavoidable transfer’ is made after the filing of a bankruptcy petition, it does not affect the new value defense.” If a vendor receives payment of its pre-petition invoices after the petition date, the vendor is not precluded from later using those same invoices as “subsequent new value” In other words, the bankruptcy petition effectively “fixes” the preference analysis 23 How to Apply Preference Defenses to Maximize Your Benefit The creditor may apply the three primary defenses of contemporaneous exchange, ordinary course of business and subsequent new value in the same case to eliminate its preferential exposure Order of Application First, apply contemporaneous exchange defense to any transfers paying invoices for product shipped on COD/CIA basis Second, apply ordinary course of business defense to the balance of the transfers and determine what transfers fall outside of the sale of service Third, apply any new value to net preference after OCB (transfers that fall outside of the OCB 24 Hot Topic Defenses Seasonality Critical vendors Assumption of contract Mechanic's lien rights Jury demand D&O and credit insurance Amended complaint and relation back 25 Tips and tricks: reducing preference exposure in the fact of customer’s insolvency/financial instability Do not change credit/payment terms if bankruptcy is looming Changing the manner in which or the time in which a customer pays invoices (especially if such change is incited by knowledge of the customer’s shaky financial standing) can render payments outside of the ordinary course of business, thereby increasing the creditor’ preferential exposure Creditor should also avoid accepting post-dated checks from customers if they have not issued such checks in prior course of business 26 Tips and tricks: reducing preference exposure in the fact of customer’s insolvency/financial instability Limit written demands and attempts to pressure the debtor into paying - Any evidence of unusual collection activity may render payments outside of the ordinary course of business, even if the days to pay are identical to pre-preference invoices Never put anything in writing that you would not want a Federal Bankruptcy Judge to see Use restructuring agreement to obtain payment on past due, while mitigating the preference clawback risk 27 Documents and information required to successfully defend against a preference clawback Pre-Preference Payment History (preferably 2 years before the preference period) Invoice dates, shipping dates, invoice numbers, invoice amounts, and billing terms for each invoice The payment date, payment amount, payment type, and document number for every transfer received from debtor. The payment history should include a statement of account, indicating which invoices each transfer was applied against The number of days between the invoice date, and the date payment was received for each invoice Parties’ correspondence (email, letters, etc.) 28 Documents and information required to successfully defend against a preference clawback Preference Period (90 days prior to debtor’s filing) Parties’ payment and shipment history (as detailed above) Statement of account for all unpaid invoices All invoices (paid and unpaid) issued during the preference period Copies of checks/receipts for all payments received during preference period (should include posting/clearing dates for all transfers) Parties’ correspondence (email, letters, etc.) Confirm the S.I.C. (Standard Industrial Classification) or NAICS (North American Industrial Classification System) Code for goods/services billed & paid during the preference period 29 Struggling Industries Retail Energy Food 30