Aftermath of COVID-19: The Know-How of an Ordinary Course Defense

Ordinary Course Defense represents a defense strategy that creditors will use to prevent the clawback of payments that were made by the debtor to a creditor during the preference period. The preference period is the duration of time before the debtor files for bankruptcy. Payments made to these creditors can be clawed back by the trustee and the courts and returned back to the debtors’ estate. The length of the preference periods depends on state laws, but it is typically 90 days for third parties and can be 2 years for related parties.

An ordinary course defense assignment typically involves analyzing the transfer that was made during the preference period and comparing that to the historical relationship and the historical payment history of the parties. From a creditor’s standpoint, it is important to show that the transfer at issue was made in payment of debt incurred by the debtor in the ordinary course of business and the transfer itself was made in the ordinary course of business for the debtor.

There are four considerations that an expert must consider when performing an ordinary course analysis. Those four factors are as follows:

• Consideration #1: The length the time the parties were engaged in the transaction at issue. The expert should consider various issues such as how long the relationship has been with the debtor and the creditor and how long they have been doing business together. This consideration should include an analysis of the frequency in which the creditor sent invoices to the debtor and what were the typical payment terms for each of the invoices. In addition, this consideration should include an analysis of how quickly the debtor paid the invoices and have there ever been delinquent payments in the past.
• Consideration #2: The amount or form of tender/payment when compared to historical tender/payment. This consideration should include an analysis of the typical invoice amounts and the frequency of goods and services that were provided to the debtor and whether or not the goods and services in question represented typical goods and services ordered by the debtor. In addition, this consideration also addresses the payment method in which the debtor has historically paid (i.e. credit card, check, wire transfer, etc.).
• Consideration #3: Whether the debtor or creditor engaged in unusual payment or collection activity when compared to their past payment or collection practices. This consideration should include an analysis of who from the debtor’s company authorized the payment in question to the creditor and whether that individual was the person who ordinarily authorized these types of payments. This consideration should also review internal controls for both the debtor and creditor and determine any changes in those controls. In addition, reviewing communications such as phone calls, emails and text messages can also provide insight for this consideration.
• Consideration #4: The circumstances under which the payment was made. This consideration focuses on analyzing any pressure from either side to make payment or review any time constraints on the goods and services provided. The expert should review the historical and customary practices and determine if the transaction in question was different than past practices.

For example, if a debtor typically makes payment 60 days after receiving an invoice but for the transaction in question, there was only a 20-day gap between invoice and payment dates, then the expert should investigate. Another example may be that invoices are typically sent quarterly, but in recent weeks, the invoices switched to being sent weekly. These examples represent discrepancies that may be critical in an ordinary defense analysis.

The type of documentation needed to perform an ordinary defense analysis includes but is not limited to bank statements, general ledgers, copies of checks and invoices, accounts receivable and accounts payable aging reports and other communications such as email and text messages.

The economic conditions right now are distressed and as we navigate through these challenging times, businesses will look to survive and avoid bankruptcy. The right experts, such as the team at Vallit Advisors, can consult on these issues and provide an analysis with the information needed to make informed decisions in a bankruptcy situation. To contact Vallit Advisors, click here.