Unsecured Creditors Committee of Sparrer Sausage Co. v. Jason's Foods, Inc.

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 15-2356
THE UNSECURED CREDITORS COMMITTEE
OF SPARRER SAUSAGE COMPANY, INC.,
Plaintiff-Appellee,
v.
JASON’S FOODS, INC.,
Defendant-Appellant.
____________________
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 14 C 7879 — Ronald A. Guzmán, Judge.
____________________
ARGUED DECEMBER 7, 2015 — DECIDED JUNE 10, 2016
____________________
Before FLAUM, WILLIAMS, and SYKES, Circuit Judges.
SYKES, Circuit Judge. During the 90-day preference period
preceding its Chapter 11 bankruptcy filing, Sparrer Sausage
Company paid invoices it received from Jason’s Foods, Inc.,
one of its suppliers, totaling roughly $587,000. The Unse-
cured Creditors Committee asked that these payments be
returned to the bankruptcy estate as avoidable preferences
under § 547(b) of the Bankruptcy Code. Jason’s Foods agreed
2 No. 15-2356
that the payments were avoidable preferences but claimed
an exception under 11 U.S.C. § 547(c)(2)(A) for otherwise
preferential transfers made in the ordinary course of busi-
ness.
The bankruptcy judge allowed Jason’s Foods to keep a
significant share of the challenged payments but held that
the timing of certain payments departed too drastically from
the companies’ past practice to be considered ordinary. The
judge imposed preference liability on Jason’s Foods for
11 invoices that he determined were paid either too early or
too late to be treated as ordinary—specifically, invoices
Sparrer Sausage paid within 14, 29, 31, 37, and 38 days of
issuance. The district court affirmed and Jason’s Foods
appealed.
We reverse. Nothing in the record suggests that it was
unusual for Sparrer Sausage to pay invoices from Jason’s
Foods within 14, 29, and 31 days of issuance given its pay-
ment history before the preference period. The only pay-
ments that can fairly be deemed out of the ordinary are those
made 37 and 38 days after receipt of invoice. Jason’s Foods’
preference liability is limited to those invoices and is entirely
offset by invoices Sparrer Sausage failed to pay.
I. Background
Jason’s Foods, a wholesale meat supplier, provided un-
processed meat products to Chapter 11 debtor Sparrer
Sausage, a sausage manufacturing company. Their relation-
ship stretched back as far as February 2, 2010, and continued
until Sparrer Sausage filed its petition for Chapter 11 bank-
ruptcy on February 7, 2012. During the 90-day preference
No. 15-2356 3
period preceding this filing, Sparrer Sausage paid 23 invoic-
es from Jason’s Foods totaling $586,658.10.
In September 2013 the Unsecured Creditors Committee
filed a complaint to recover those payments from Jason’s
Foods. The Committee argued that the payments were
avoidable preferences—payments that Jason’s Foods was
required to return to the bankruptcy estate for the benefit of
Sparrer Sausage’s unsecured creditors. See 11 U.S.C. § 547(b).
Jason’s Foods conceded that the payments met the statutory
definition of an avoidable preference but asserted two
affirmative defenses under § 547(c). First, Jason’s Foods
argued that the otherwise preferential transfers were made
in the ordinary course of business and thus were nonavoid-
able under § 547(c)(2). Alternatively, Jason’s Foods argued
that it had provided meat products to Sparrer Sausage in
January and February of 2012 without receiving payment
and that this new value offset its preference liability under
§ 547(c)(4).
The bankruptcy judge first considered Jason’s Foods’ or-
dinary-course defense and determined that before the
preference period, Sparrer Sausage generally paid invoices
from Jason’s Foods within 16 to 28 days. Of the 23 invoices
that Sparrer Sausage paid during the preference period, 12
fell within this range, so the judge concluded that these
12 payments were ordinary and thus nonavoidable. The
remaining 11 invoices were paid within 14, 29, 31, 37, and
38 days of the invoice date. The judge concluded that these
payments, which totaled $306,110.23, were not ordinary and
must be returned to the bankruptcy estate for the benefit of
Sparrer Sausage’s unsecured creditors.
4 No. 15-2356
Turning next to the new-value defense, the judge found
that Sparrer Sausage had not paid for $63,514.91 worth of
meat products it received from Jason’s Foods in January and
February of 2012. The judge credited that amount to Jason’s
Foods as an offset against its preference liability and entered
judgment in favor of the Unsecured Creditors Committee in
the amount of $242,595.32. The judgment was affirmed on
appeal to the district court, and this appeal followed.
II. Discussion
We review the bankruptcy court’s conclusions of law de
novo and its findings of fact for clear error. Kovacs v. United
States, 614 F.3d 666, 672 (7th Cir. 2010). A factual finding is
clearly erroneous if “although there is evidence to support it,
the reviewing court on the entire evidence is left with the
definite and firm conviction that a mistake has been commit-
ted.” Id. (quotation marks omitted).
As a general rule, payments made to a creditor during
the 90-day period before a debtor files for bankruptcy are
avoidable preferences. See 11 U.S.C. § 547(b). The rule pre-
vents inequitable distribution of the debtor’s assets to fa-
vored creditors and protects the struggling debtor against
the predatory behavior of nervous creditors. In re Tolona
Pizza Prods. Corp., 3 F.3d 1029, 1032 (7th Cir. 1993). But the
rule contains an exception, codified in § 547(c)(2), aimed at
“leav[ing] undisturbed normal commercial and financial
relationships and protect[ing] recurring, customary credit
transactions.” Kleven v. Household Bank F.S.B., 334 F.3d 638,
642 (7th Cir. 2003) (quotation marks omitted).
To that end, § 547(c)(2) provides that an otherwise pref-
erential transfer is nonavoidable
No. 15-2356 5
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 transferee; or
(B) made according to ordinary business
terms[.]
The creditor asserting this defense to preference liability
bears “the burden of proving the nonavoidability of a trans-
fer under subsection (c).” 11 U.S.C. § 547(g).
Jason’s Foods and the Unsecured Creditors Committee
stipulated that Sparrer Sausage incurred all debts owed to
Jason’s Foods in the ordinary course of business, so we’re
concerned only with Sparrer Sausage’s payment of those
debts. In this regard Jason’s Foods proceeds under
§ 547(c)(2)(A), commonly referred to as the subjective ordi-
nary-course defense. 1
1 Prior to its amendment by the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005, § 547(c)(2) required a creditor to prove
both that the transfer was made in the ordinary course of business
between the debtor and the creditor and that the transfer was made
according to ordinary business terms. 11 U.S.C. § 547(c)(2) (2003);
Kleven v. Household Bank F.S.B., 334 F.3d 638, 641–42 (7th Cir. 2003). These
requirements are commonly referred to as the subjective and objective
components of the ordinary-course defense. The 2005 amendments made
these components disjunctive. Pub. L. No. 109-8, § 409, 119 Stat. 23, 106
(2005).
6 No. 15-2356
The subjective ordinary-course defense asks whether the
payments the debtor made to the creditor during the prefer-
ence period are consistent with the parties’ practice before the
preference period. Tolona Pizza, 3 F.3d at 1032. The inquiry is
not governed by any “‘precise legal test,’” Lovett v.
St. Johnsbury Trucking, 931 F.2d 494, 497 (8th Cir. 1991)
(quoting In re Fulghum Constr. Corp., 872 F.2d 739, 743 (6th
Cir. 1989)), but generally entails using the debtor’s payment
history to calculate a baseline for the companies’ dealings
and then comparing preference-period payments to that
baseline, cf. Kleven, 334 F.3d at 642–43. While “substantial
deviations from established practices” are not protected, the
ordinary-course defense “allow[s] suppliers and other
furnishers of credit to receive payment within the course
that has developed in the commercial relationship between
the parties.” In re Tenn. Chem. Co., 112 F.3d 234, 238 (6th Cir.
1997).
Jason’s Foods challenges the bankruptcy judge’s determi-
nation that Sparrer Sausage typically paid invoices within 16
to 28 days, arguing that this calculation does not accurately
reflect the companies’ payment practices before the prefer-
ence period. This is really two arguments in one. Jason’s
Foods challenges the judge’s use of an abbreviated historical
period rather than the companies’ entire payment history
and also argues that the baseline comprises a too-narrow
range of days surrounding the average invoice age during
the historical period.
A. Historical Period
Calculating the baseline payment practice between two
companies requires identifying a historical period that
reflects the companies’ typical payment practices. See, e.g., In
No. 15-2356 7
re Quebecor World (USA), Inc., 491 B.R. 379, 387 (Bankr.
S.D.N.Y. 2013) (“The Court must first determine the appro-
priate pre-preference time period to use in establishing a
baseline of dealings between the parties.”). In Tolona Pizza
we directed courts to look to “the norm established by the
debtor and the creditor in the period before, preferably well
before, the preference period.” 3 F.3d at 1032. That directive
doesn’t require truncating the historical period “well before”
the beginning of the preference period but simply under-
scores that the baseline should reflect payment practices that
the companies established before the onset of any financial
distress associated with the debtor’s impending bankruptcy.
See In re Affiliated Foods Sw. Inc., 750 F.3d 714, 720 (8th Cir.
2014) (“To make a sound comparison, ‘[n]umerous decisions
support the view that the historical baseline should be based
on a time frame when the debtor was financially healthy.’”
(quoting Quebecor World, 491 B.R. at 387)).
In some cases this may require truncating the historical
period before the start of the preference period if the debt-
or’s financial difficulties have already substantially altered
its dealings with the creditor. See, e.g., In re Circuit City
Stores, Inc., 479 B.R. 703, 710 (Bankr. E.D. Va. 2012); In re H.L.
Hansen Lumber Co. of Galesburg, Inc., 270 B.R. 273, 279 (Bankr.
C.D. Ill. 2001). In other cases it will be necessary to consider
the entire pre-preference period. See, e.g., Affiliated Foods,
750 F.3d at 720; Quebecor World, 491 B.R. at 387. In all cases
the contours of the historical period should be grounded in
the companies’ payment history rather than dictated by a
fixed or arbitrary cutoff date. Accord Affiliated Foods, 750 F.3d
at 720 (“Obviously, when considering this type of fact-
intensive issue, what is appropriate in one case is not neces-
sarily appropriate in the next case.”).
8 No. 15-2356
Here, Jason’s Foods and the Unsecured Creditors Com-
mittee stipulated to a historical period spanning February 2,
2010, to November 7, 2011, which encompassed all
235 invoices that Sparrer Sausage paid before the preference
period. Sparrer Sausage paid these invoices within 8 to
49 days, with an average invoice age of almost 25 days at the
time of payment. The bankruptcy judge disregarded this
stipulation. Citing the increasing lateness of payments after
April 15, 2011, the judge considered only the 168 invoices
that Sparrer Sausage paid prior to that date. Sparrer Sausage
paid these invoices within 8 to 38 days, with an average
invoice age of 22 days.
Jason’s Foods argues that the bankruptcy judge’s deci-
sion to truncate the historical period approximately seven
months before the start of the preference period was clearly
erroneous. We disagree. The judge determined that April 15,
2011, “mark[ed] the beginning of the debtor’s financial
difficulties” and that invoices paid after that date did not
accurately reflect the norm when Sparrer Sausage was
financially healthy. That finding is not without support in
the record. Prior to April 15, 2011, Sparrer Sausage made its
latest payments 38 days after the invoice date; after April 15,
2011, Sparrer Sausage paid numerous invoices 40 or more
days after the invoice date, with some as late as 45 days.
Moreover, the percentage of invoices that Sparrer Sausage
paid 30 or more days after issuance increased from 5.95%
between February 2, 2010, and April 15, 2011, to 46.3%
between April 16, 2011, and November 7, 2011.
We acknowledge that the evidence of Sparrer Sausage’s
financial distress after April 15, 2011, is hardly overwhelm-
ing, and we question the judge’s decision to disregard the
No. 15-2356 9
parties’ stipulation. Sparrer Sausage did not experience a
marked “liquidity crisis” or other stark change in its pay-
ment practices after April 15, 2011. Circuit City, 479 B.R. at
710; see also Hansen Lumber, 270 B.R. at 278–79. But the bank-
ruptcy judge offered a reasoned explanation for his decision,
and his reasons were grounded in Sparrer Sausage’s pay-
ment history and supported by the record. Accordingly, we
cannot say that the judge’s decision to truncate the historical
period after April 15, 2011, was clear error.
B. Baseline of Dealings During the Historical Period
Using the truncated historical period of February 2, 2010,
to April 15, 2011, the judge determined that Sparrer Sausage
typically paid invoices from Jason’s Foods within 16 to
28 days. He arrived at this baseline by calculating the aver-
age invoice age during the historical period (22 days) and
adding 6 days on both sides of that average. Jason’s Foods
argues that the judge should have used the total range of
invoice ages during the historical period—8 to 38 days—as
the baseline. We agree that the judge erred in this step of the
analysis, but only in part. The judge’s choice of methodology
was sound, but the application was flawed.
Bankruptcy courts typically calculate the baseline pay-
ment practice between a creditor and debtor in one of two
ways: the average-lateness method or the total-range meth-
od. The average-lateness method uses the average invoice
age during the historical period to determine which pay-
ments are ordinary, while the total-range method uses the
minimum and maximum invoice ages during the historical
period to define an acceptable range of payments. See
Quebecor World, 491 B.R. at 387–88.
10 No. 15-2356
Each of these methodologies has strengths and weak-
nesses, and the decision to apply one or the other rests
within the bankruptcy judge’s discretion. While the average-
lateness method better compensates for outlier payments
during the historical period, the total-range method often
provides a more complete picture of the relationship be-
tween the creditor and debtor. Compare id. (rejecting the
total-range method because “that proposed methodology
captures outlying payments that skew the analysis of what is
ordinary”), with In re Am. Home Mortg. Holdings, Inc.,
476 B.R. 124, 138 (Bankr. D. Del. 2012) (applying the total-
range method because the average invoice age did not
“‘portray the complete picture’ of the payment history”
between the creditor and debtor).
We see no reason to disturb the bankruptcy judge’s deci-
sion to use the average-lateness method rather than the total-
range method here. Admittedly none of the invoices that
Sparrer Sausage paid during the historical period appear to
be such extreme outliers that they would skew the baseline
calculation. See In re Moltech Power Sys., Inc., 327 B.R. 675, 681
(Bankr. N.D. Fla. 2005) (“[C]ommon sense would seem to
indicate that the court should be hesitant to embrace analysis
by range when so doing would incorporate aberrations that
artificially widen the range, thus presenting an inaccurate
portrait of the actual ordinary course of business between
the parties.”). But that’s not enough, standing alone, to upset
the judge’s determination that the average-lateness method
would better capture Jason’s Foods and Sparrer Sausage’s
payment relationship.
The judge’s application of the average-lateness method is
more problematic. He began by observing that the average
No. 15-2356 11
invoice age rose from 22 days during the historical period to
27 days during the preference period. We’re skeptical that a
five-day difference in the average invoice age is substantial
enough to take any of the preference-period payments
outside the ordinary course. Bankruptcy courts have
deemed comparable deviations immaterial and held that all
preference-period payments were ordinary on this basis. In
re Archway Cookies, 435 B.R. 234, 244 (Bankr. D. Del. 2010)
(4.9-day difference); In re Am. Camshaft Specialties, Inc.,
444 B.R. 347, 356 (Bankr. E.D. Mich. 2011) (4-day difference).
That said, a discrepancy that is immaterial in the context of
one business relationship might well be aberrational in the
context of another. Accord In re Jeffrey Bigelow Design Grp.,
Inc., 956 F.2d 479, 486 (4th Cir. 1992) (recognizing that the
“‘focus of [the] inquiry must be directed to an analysis of the
business practices which were unique to the particular
parties under consideration’” (quoting In re Fulghum Constr.
Corp., 872 F.2d at 743)). Given the fact-intensive, context-
specific nature of the ordinary-course defense, we are un-
willing to upset the judge’s decision on this basis.
But the judge’s subsequent finding—that invoices paid
more than 6 days on either side of the 22-day average were
outside the ordinary course—was clear error. The judge
applied Quebecor World and its so-called “bucketing” analy-
sis to support this conclusion, but neither the facts nor the
bankruptcy court’s analysis in that case bear any resem-
blance to this case. In Quebecor World the average invoice age
during the historical period was 27.56 days, while the aver-
age invoice age during the preference period was 57.16
days—a difference of nearly 30 days. 491 B.R. at 388. Given
such a stark disparity, the bankruptcy court grouped histori-
cal-period invoices “in buckets by age.” Id. That analysis
12 No. 15-2356
revealed that the debtor paid 88% of invoices during the
historical period within 11 to 40 days after the invoice date.
Expanding this range by five days on the high end, the court
determined that any invoices paid more than 45 days after
the invoice date were outside the ordinary course. Id.
Here a 16-to-28-day baseline range encompasses just 64%
of the invoices that Sparrer Sausage paid during the histori-
cal period. Even more problematically, the judge offered no
explanation for the narrowness of this range. Why exclude
invoices that Sparrer Sausage paid within 14 days when
these payments were among the most common during the
historical period? The same goes for invoices that Sparrer
Sausage paid within 29 days. Indeed by adding just two
days to either end of the range, the analysis would have
captured 88% of the invoices that Sparrer Sausage paid
during the historical period, a percentage much more in line
with the Quebecor World analysis. Thus, a 16-to-28-day
baseline appears not only excessively narrow but also arbi-
trary.
Sparrer Sausage paid 9 of the 11 contested invoices with-
in 14, 29, and 31 days of issuance. These payments fall either
squarely within or just outside the 14-to-30-day range in
which Sparrer Sausage paid the vast majority of invoices
during the historical period. As such they are precisely the
type of payments that the ordinary-course defense protects:
recurrent transactions that generally adhere to the terms of a
well-established commercial relationship. Sparrer Sausage
paid the other 2 invoices 37 and 38 days after they were
issued, which is substantially outside the 14-to-30-day
baseline. We conclude that Jason’s Foods’ preference liability
is limited to these payments, which total $60,679.00.
No. 15-2356 13
C. New-Value Defense
Finally, we turn briefly to Jason’s Foods’ new-value de-
fense. Under § 547(c)(4), a preferential transfer is offset “to
the extent that, after such transfer, such creditor gave new
value to or for the benefit of the debtor.” A creditor may
avail itself of this defense if, after receiving a preferential
transfer from the debtor, it advanced additional, unsecured
credit that remains unpaid. In re Prescott, 805 F.2d 719, 727
(7th Cir. 1986). The premise underlying the new-value
defense is that by extending new value to the debtor without
receiving payment, the creditor has effectively replenished
the bankruptcy estate in the same way that returning a
preferential transfer would. In re Globe Bldg. Materials, Inc.,
484 F.3d 946, 950 (7th Cir. 2007).
It’s undisputed that Jason’s Foods supplied $63,514.00
worth of meat products to Sparrer Sausage between January
18, 2012, and February 6, 2012, well after Sparrer Sausage
paid at least some invoices during the preference period. The
parties also agree that Sparrer Sausage never paid Jason’s
Foods for these products. Jason’s Foods is therefore entitled
to a reduction of its preference liability in this amount. See
5 COLLIER ON BANKRUPTCY ¶ 547.04[4][e] at 565–69 (Alan N.
Resnick & Henry J. Sommer eds., 16th ed. 2015) (noting that
§ 547(c) defenses may be used cumulatively). Because the
new value that Jason’s Foods extended to Sparrer Sausage
($63,514.00) exceeds its remaining preference liability
($60,679.00), that liability is entirely offset.
REVERSED AND REMANDED.