Ames Merchandising Corp. v. Cellmark Paper Inc. (In re Ames Dept. Stores, Inc.), 2011 Bankr. LEXIS 969 (Bankr. S.D.N.Y. Mar. 28, 2011)

In Ames Merchandising Corp. v. Cellmark Paper Inc. (In re Ames Dept. Stores, Inc.), the debtors, a merchandising corporation and its affiliates, operated retail stores and utilized printed circulars as promotional materials.  The debtors commenced an avoidance action under Section 547 of the Bankruptcy Code to avoid and recover payments made to a paper supplier.  The Court found that the payments received by the paper supplier were avoidable because they were not made in the ordinary course of business, even in the absence of payment pressure from the defendant. 

Bankruptcy Code Section 547 allows a trustee or debtor in possession to avoid a transfer made by a debtor while insolvent to or for the benefit of a creditor on account of an antecedent debt within 90 days (or one year in the case of an insider) of the petition date, where such transfer enables the creditor to receive more than it would have received in a chapter 7 liquidation.

Bankruptcy Code Section 547(c)(2) provides that the trustee may not avoid a transfer: to the extent that such transfer was in payment of a debt incurred by the debtor in the “ordinary course” of business or financial affairs of the debtor and the transferee, and such transfer was — (A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms.

Prior to and at the beginning of the 90-day preference period, the debtors utilized an automated accounts payable program.  At that time, the debtors paid all invoices in full at or near the invoice due date.  During the 90-day preference period, the debtors’ executives, on their own initiative, decided that some vendors would not be paid at all and other vendors would be paid earlier. In so doing, they overrode the automated accounts payable system to make early payments to certain important creditors, which included the defendant. 

The defendant argued that the transfers were protected by the ordinary course of business defense notwithstanding the early payment, because the defendant did not apply any payment pressure on the debtors.

The plaintiff argued that notwithstanding the lack of payment pressure, the early payments were not ordinary because they deviated from prior “days-to-payment” terms.  The plaintiff also argued that manually overriding the accounts payable system to pay certain vendors early further evidences that the payments were not ordinary. 

The Court stated that the absence of creditor pressure did not, in and of itself, establish that transactions were ordinary.  The Court considered the totality of the circumstances and held that the payments to the defendant were not ordinary.  The Court noted that the debtors overrode their automated payment system to stop payments to certain vendors and make early payments to other vendors that the debtors deemed important.  Thus, the Court concluded that even in the absence of payment pressure, the unilateral change in payments by the debtors rendered the transfers preferential.

Commentary

Ames demonstrates the various factors weighed by bankruptcy courts while undertaking the very factual ordinary course of business analysis.  Parties prosecuting and defending preference actions should be cognizant of any changes in business practices by a debtor such as unilateral adjustments to accounts payable systems that take place prior to or during the preference period in determining whether a payment was indeed “ordinary.”