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Home / Case News / The Relevant Question Under Sec 547 (c) (2) is not Whether the Transactions were Ordinary with Respect to Some Objective Standard in the Industry, But Whether They Were Consistent with the Course of Dealings Between the Particular Parties

The Relevant Question Under Sec 547 (c) (2) is not Whether the Transactions were Ordinary with Respect to Some Objective Standard in the Industry, But Whether They Were Consistent with the Course of Dealings Between the Particular Parties

January 25, 2019, New York – Prior to its bankruptcy, Debtor Goodnight Sleep Store, Inc. operated four retail stores and sold beds, mattresses, and related products. By mid-2016, Goodnight was unable to meet its operational costs as they came due and had also fallen significantly behind in paying quarterly payroll withholding taxes. On August 11, 2016, Goodnight entered an agreement with Defendant Funding Metrics designed to sell or assign $140,000 of its future customer receipts, accounts, and contract rights in exchange for an immediate cash infusion of $96,190. Under the arrangement, Funding Metric was to receive daily payments of $1,272.73 swept from Goodnight’s operating bank account from future retail sale proceeds until the agreed sum was paid. Even after this, Goodnight continued to struggle to make financial ends meet. It sought a second round of funding from Funding Metrics and the parties entered a second and virtually identical financial arrangement with cash and credit components totaling $115,000. Goodnight continued to suffer severe financial stress including overdrawn bank accounts, negative income and eventually filed for bankruptcy.

The Trustee initiated adversary proceedings and sought avoidance of preferential transfers pursuant to 11 U.S.C. § 547 and avoidance of constructively fraudulent transfers made without adequate consideration pursuant to 11 U.S.C. § 548. Funding Metrics asserted that even if the agreement supported a preference action under § 547, Funding Metrics had no preference liability pursuant to the ordinary course of business defense set forth in 11 U.S.C. § 547 (c)(2). The Defendant contended that the daily ACH drafts were part of the ordinary course of dealings between the parties. The Trustee argued that the ordinary course exception did not apply because these transactions were outside of the scope of the Debtor’s ordinary business, which was mattress sales, and that the two parties did not have a relationship long enough to form the basis of an “ordinary course” analysis between themselves. The Trustee also argued that the Defendant did not provide any evidence of industry standards to aid the determination of the baseline ordinary course. The Defendant countered that “the ordinary course did not require a certain frequency or regularity.” It pointed out that while the Debtor’s business was indeed selling mattresses, the business also necessarily involved the procurement of funding for the business operations.

The Court held that since the Debtor sold or assigned its accounts receivable to the Defendant for a discounted amount, the Defendant’s right to payment under the agreements gave rise to a claim under the Bankruptcy Code and provided the foundation for debt for purposes of trustee’s 11 U.S.C.S. §§ 547 and 548 claims. The Court next held that the Defendant failed to meet its burden on summary judgment to prove an industry standard ordinary course exception under §547 (c)(2). The Court reasoned that while the agreements were made in the ordinary course of business, it is not the loan but the transfers that must be reviewed. The Court found that there were numerous unexplained downward and upward deviations; drafts returned for insufficient funds; missed payments; and other deviations from the norm. Neither party made any effort to explain the deviations and it cannot be discerned from the available record which payments were normal and which deviated from ordinary terms.

The Court accordingly held that a more thorough review of the last three months of transfers was required to determine whether all can be saved by the ordinary course exception, or which transfers deviate and therefore were preferences. The Court ordered the case to proceed to trial on the non-insider preference assertion where Funding Metrics may present evidence on its affirmative defense that the transfers were made in the ordinary course of business.

As regards to the Trustee’s fraudulent conveyance argument, the Court stated that the Debtor did receive something of value — cash infusions – and in exchange, the Defendant received a daily payment to satisfy a legal obligation. The Court determined that an assessment of reasonably equivalent value must take into account any intangible value that a party receives. The Court highlighted that Funding Metrics provided a funding option to the Debtor when no other lender did. The Defendant provided Goodnight a tenuous lifeline to remain in business and that lifeline was a value received by the Debtor. Thus, the Court granted the summary judgment to the Defendant on the 11 U.S.C.S. § 548(a)(1)(B) claim.

Bircher v. Funding Metrics, LLC (In re A Goodnight Sleepstore, Inc.), Nos. 17-03274-5-JNC, 17-00056-5-JNC, 2019 Bankr. LEXIS 190 (Bankr. E.D.N.C. Jan. 25, 2019)