1999 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

6-10-1999

US Trustee v. First Jersey Sec.

Precedential or Non-Precedential:

Docket 98-5236,98-5290

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Recommended Citation

"US Trustee v. First Jersey Sec." (1999). 1999 Decisions. Paper 153.

http://digitalcommons.law.villanova.edu/thirdcircuit_1999/153
Filed June 10, 1999 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

Nos. 98-5236 and 98-5290 

IN RE: FIRST JERSEY SECURITIES, INC., 

 Debtor 

UNITED STATES TRUSTEE; SECURITIES 

& EXCHANGE COMMISSION 

v. 

FIRST JERSEY SECURITIES, INC. 

(D.C. Civil No. 95-5455) 

IN RE: FIRST JERSEY SECURITIES, INC., 

 Debtor 

SECURITIES & EXCHANGE COMMISSION 

v. 

FIRST JERSEY SECURITIES, INC. 

(D.C. Civil No. 95-5456) 

 Securities & Exchange Commission, 

 Appellant, No. 98-5236 

 United States Trustee, 

 Appellant, No. 98-5290 

Appeal from the United States District Court 

For the District of New Jersey 

(D.C. Civil Nos. 95-5455 and 95-5456) 

District Judge: Honorable Mary Little Cooper 
Argued March 1, 1999 

BEFORE: ALITO and McKEE, Circuit Judges, 

and SCHWARTZ, District Judge* 

(Opinion filed June 10, 1999) 

 Katharine B. Gresham (Argued) 

 Securities & Exchange Commission 

 450 Fifth Street, N.W. 

 Washington, D.C. 20549 

 Attorney for Appellant 

 No. 98-5236 

 Deborah R. Kant (Argued) 

 William Kanter 

 United States Department of Justice 

 Civil Division 

 10th & Pennsylvania Avenue, N.W. 

 Washington, D.C. 20530 

 Attorneys for Appellant 

 No. 98-5290 

 Walter J. Greenhalgh (Argued) 

 Duane, Morris & Heckscher 

 One Gateway Center, Suite 1210 

 Newark, New Jersey 07102 

 Attorney for Appellee 

OPINION OF THE COURT 

SCHWARTZ, Senior District Judge 

This appeal addresses the propriety of the appointment of 

counsel for a debtor in possession, where the debtor 

transferred restricted securities to its counsel in payment 

for pre-petition services on the eve of its filing for 

bankruptcy. The United States Trustee ("Trustee") and the 

_________________________________________________________________ 

*Hon. Murray M. Schwartz, Senior United States District Judge for the 

District of Delaware, sitting by designation. 

 2 
Securities and Exchange Commission ("SEC") contend the 

law firm of Robinson, St. John, & Wayne ("RSW") was

disqualified from serving as counsel for the debtor, First 

Jersey Securities, because it held an interest adverse to the 

debtor's estate by reason of the transfer to it of the 

restricted securities. The Bankruptcy Court and the United 

States District Court for the District of New Jersey held the 

debtor could retain RSW as counsel. Because counsel

received a preference under Section 547 of the Bankruptcy 

Code, 11 U.S.C. S 547, we will reverse and remand. 

I. 

First Jersey Securities, Inc.1 (the "debtor" or "First 

Jersey") filed a voluntary petition for relief under Chapter 

11 of the Bankruptcy Code on August 7, 1995. 11 U.S.C. 

S 101 et seq. This action was prompted after the SEC 

prevailed in a securities fraud action against First Jersey 

and its 100% shareholder, Robert Brennan, and obtained 

an order for them to disgorge $75 million in illegal 

proceeds. S.E.C. v. First Jersey Securities, Inc., 890 F. Supp. 

1185 (S.D.N.Y. 1995), aff 'd in part, rev'd in part, 101 F.3d 

1450 (2d Cir. 1996). Obtaining that order left the SEC as 

the largest unsecured creditor of the debtor. 

Concurrent with the filing of the petition, the debtor filed 

an application pursuant to S 327(a) of the Bankruptcy Code 

to retain RSW as its counsel. First Jersey owed thefirm 

approximately $389,000 for legal services rendered prior to 

the filing for bankruptcy primarily for work performed in 

the securities fraud litigation.2 On the same day of its 

_________________________________________________________________ 

1. First Jersey was a discount broker-dealer specializing in the 

underwriting, trading, and distribution of low-priced securities. The 

company was found to have committed securities fraud by selling 

securities to its customers at prices that included excessive markups, 

and by failing to disclose to its customers thefirm's control over the 

respective securities' trading markets. 

2. Lead counsel for RSW was Walter Greenhalgh. RSW subsequently 

disbanded, and its successor firm, St. John & Wayne was substituted as 

counsel. Later, Duane, Morris & Heckscher was substituted as counsel 

when Greenhalgh joined that firm. At all times, Greenhalgh has been 

lead counsel for the debtor in possession. 

 3 
Chapter 11 filing, the debtor transferred 200,001 shares of 

unregistered restricted stock in International Thoroughbred 

Breeders, Inc. ("ITB") to RSW.3 This stock was to be 

liquidated by RSW, with payments to be made in the 

following manner: $200,000 as a retainer for representation 

in the bankruptcy proceedings; $250,000 for payment on 

firm invoices for representation in the securities fraud 

litigation, with any excess to be returned to the debtor. The 

$250,000 was to be considered full payment for the 

$389,327 due for pre-petition services. The firm waived the 

remaining pre-petition balance, thereby eliminating itself as 

a creditor of the debtor. Apparently, shares in ITB were the 

debtor's only meaningful resource, as its bankruptcy 

petition listed only $22,367 in other assets. Ultimately, 

RSW found a buyer for the shares, and transferred all of 

the ITB stock for $600,003. RSW kept $450,000 and 

returned the remainder to the debtor. While the transfer of 

stock was noted in both the debtor's petition and counsel's 

petition to be retained as counsel, neither party disclosed 

the payment was made within 90 days of the debtor filing 

for bankruptcy. 

On August 11, 1995, four days after the filing of the 

petition, the Trustee, joined by the SEC three days later, 

objected to the appointment of RSW as counsel, arguing the 

firm was not "disinterested" as is required by the 

Bankruptcy Code. 11 U.S.C. S 327(a). The Trustee and the 

SEC (collectively referred to as "SEC") maintained the 

transfer of ITB restricted stock was a preferential payment, 

thereby disqualifying RSW from acting as counsel for the 

debtor because it held an interest adverse to the estate. 

RSW, in response, submitted a certification asserting the 

payment was made in the ordinary course of business, was 

not preferential, and was deemed timely payment. It did not 

disclose the date of the stock transfer. What occurred in the 

Bankruptcy Court and District Court is set forth below. 

_________________________________________________________________ 

3. Because the ITB shares were unregistered, they could only be sold 

under an exemption provided by Section 4 of the Securities Act. 15 

U.S.C. S 77d. 

 4 
A. Bankruptcy Court 

On August 24, 1995, the Bankruptcy Court held a 

hearing on the debtor's application to retain RSW as its 

counsel. The SEC contended the payment of RSW's prepetition claim was a voidable preference under the 

Bankruptcy Code, 11 U.S.C. S 547(b),4 which is a cause for 

disqualification under Section 327(a).5 During the hearing, 

RSW acknowledged the stock transfer took place within the 

90 day preference period, but contended it was made in the 

ordinary course of business, and not made in exchange for 

an "antecedent debt". Counsel explained the $250,000 

payment was for a series of invoices from January through 

May 1995, as well as for work done in June and July of 

that year. He stated, 

 [T]he normal course of doing business with the debtor 

 for at least the past 12 months and probably going 

 back a year and a half or two years, would be a method 

 where we would generate an invoice, we would then 

 submit a group of invoices after several months, . .. 

 submit that to the debtor, discuss with the debtor a 

 method of payment, and the debtor would make

 payment on those groups of invoices. 

Bankruptcy Docket No. 30, August 24, 1995 Hearing at 31. 

The Bankruptcy Court approved the debtor's application 

to retain RSW from the bench on August 24, 1995 and

subsequently issued a written opinion. In re Brennan, 187 

_________________________________________________________________ 

4. Section 547(b) of the Code permits a trustee to avoid certain prebankruptcy transfers as "preferences" where the debtor transfers 

property to a creditor for an antecedent debt made within 90 days before 

filing for bankruptcy. In re Molded Acoustical Products, Inc., 18 F.3d 

217, 

217 (3d Cir. 1994). 

5. Section 327(a) provides: "[T]he trustee, with the court's approval, may 

employ one or more attorneys . . . that do not hold or represent an 

interest adverse to the estate, and that are disinterested persons, to 

represent or assist the trustee in carrying out the trustee's duties under 

this title." 11 U.S.C. S 327(a). Pursuant to 11 U.S.C. S 1107, the debtor 

in possession has the right to seek the employment of professionals 

subject to S 327(a). If, in fact, the $250,000 payment for pre-petition 

services was a preference, RSW would not be a "disinterested person" 

within the meaning of the statute. 

 5 
B.R. 135 (Bankr. D. N.J. 1995). That Court held the SEC 

did not present a prima facie case that RSW received a 

voidable preference under Section 547(b) of the Bankruptcy 

Code. Specifically, the Bankruptcy Court found there was 

no prima facie showing of a transfer to "satisfy an

antecedent debt owed by the debtor before such transfer 

was made", as is required under S 547(b)(2).6 In re Brennan, 

187 B.R. at 153. The Court reasoned a debt is not"owed" 

within the meaning of the statute until payment is past 

due, even if the debt is antecedent. It accepted RSW's 

assertion that the debtor's financial obligation to the firm 

was not past due, and consequently the payment was 

deemed timely. 

In the alternative, the Court found the transfer of stock, 

even if a preference, was not a voidable preference because 

it was a payment made in the ordinary course of business 

under Section 547(c). If the transfer was incurred and made 

in the ordinary course of business between the parties, and 

made according to ordinary business terms, then the

transfer cannot be avoided by the debtor's estate. 11 U.S.C. 

S 547(c)(2).7 In addition, the Court dismissed the SEC's 

claim that the debtor and counsel failed to disclose 

adequately the details of the pre-petition transfer of the 

stock. The Bankruptcy Court concluded, "The U.S. Trustee 

and the SEC therefore failed to establish that the payment 

in question is probably an avoidable preference. The mere 

accusation that it could be avoidable is not sufficient to 

disqualify Robinson." In re Brennan, 187 B.R. at 154. 

B. District Court 

The SEC and Trustee appealed the decision of the 

Bankruptcy Court to the United States District Court for 

_________________________________________________________________ 

6. Section 547(b)(2) provides that "the trustee may avoid any transfer of 

an interest of the debtor in property . . . for or on account of an 

antecedent debt owed by the debtor before such transfer was made." 

7. Section 547(c)(2) provides that a "trustee may not avoid under this 

section a transfer . . . to the extent that such transfer was -- (A) in 

payment of a debt incurred by the debtor in the ordinary course of 

business or financial affairs of the debtor and the transferee; (B) made 

in the ordinary course of business or financial affairs of the debtor and 

the transferee; and (C) made according to ordinary business terms." 

 6 
the District of New Jersey, contending the Bankruptcy 

Court erred in finding the law firm was not disqualified 

under S 327(a). The District Court filed a memorandum and 

order affirming the Bankruptcy Court's decision. In re First 

Jersey Securities, Inc., No. 95-5455 (D. N.J.filed April 9, 

1998). 

The Court agreed with the Bankruptcy Court that the

transfer of ITB stock did not constitute a preference under 

S 547(b), and therefore, RSW should not be disqualified. 

The District Court also concluded the stock transfer was 

not made on account of an antecedent debt owed by the 

debtor before the transfer was made. Finally, the Court 

declined to address the Bankruptcy Court's conclusion that 

the stock transfer payment was made in the ordinary

course of business. 

II. 

The District Court exercised jurisdiction under 28 U.S.C. 

S 158(a) to review the Bankruptcy Court'sfinal order 

approving the debtor's application for retention of counsel. 

This Court has jurisdiction under 28 U.S.C. S 158(d) to 

review the District Court's final order. United States Trustee 

v. Price Waterhouse, 19 F.3d 138 (3d Cir. 1994). 

Our standard of review of a District Court's 

determination on appeal from a Bankruptcy Court decision 

has been articulated on numerous occasions. "As an 

appellate court twice removed from the primary tribunal, 

we review both the factual and legal determinations of the 

district court for error." Universal Minerals, Inc. v. C.A. 

Hughes & Co., 669 F.2d 98, 101-2 (3d Cir. 1981). Our 

vantage point is identical to that of the District Court, "so 

we review the bankruptcy court's findings by the standards 

the district court should employ to determine whether the 

district court erred in its review." Id. at 102. Accordingly, 

the Bankruptcy Court's findings of fact are reviewable for 

clear error. In re Continental Airlines, 125 F.3d 120, 128 (3d 

Cir. 1997). Legal determinations are subject to plenary 

review. Id. The Bankruptcy Court's exercise of discretion is 

reviewed for abuse thereof. In re Engel, 124 F.3d 567, 571 

(3d Cir. 1997). 

 7 
III. 

The SEC urges this Court to reverse the District Court's 

decision approving the retention of RSW as counsel for the 

debtor. It argues the Court erred in finding the stock 

transfer was not a voidable preference under 11 U.S.C. 

S 547, and that error led it to conclude RSW was qualified 

to serve as counsel to the debtor under 11 U.S.C.S 327. 

The SEC also urges the transfer of the ITB restricted stock 

was not made in the ordinary course of business as 

outlined in 11 U.S.C. S 547(c)(2). Finally, the SEC asserts 

the District Court erred in finding RSW's disclosures 

concerning the stock transfer payments were sufficient 

under S 327(a). Because we conclude the stock transfer was 

a preferential payment not made in the ordinary course of 

business, we need not address whether RSW adequately 

disclosed the stock payments to the Bankruptcy Court. 

A. Stock Transfer as Preferential Payment 

Section 327(a) of the Bankruptcy Code provides for the 

trustee (or the debtor in possession), with the Court's 

approval, to employ attorneys "that do not hold or represent 

an interest adverse to the estate," and that are 

"disinterested persons." 11 U.S.C. S 327(a); 11 U.S.C. 

S1107. In order for counsel to be retained, "counsel must 

`not hold or represent an interest adverse to the estate' and 

must be a `disinterested person.' " In re BH&P Inc., 949 

F.2d 1300, 1314 (3d Cir. 1991) (citing In re Star 

Broadcasting, Inc., 81 B.R. 835, 838 (Bankr. D. N.J. 1988)). 

A "disinterested person" is defined as one who does not 

have an interest materially adverse to the interest of the 

estate, by reason of any direct or indirect relationship with 

the debtor, or for any other reason. 11 U.S.C. S 101(14)(e). 

The standards regarding adverse interests underS 327(a) 

are outlined in In Re Marvel Entertainment Group, Inc., 140 

F.3d 463, 476 (3d Cir. 1998). In that case, we held: 

 (1) Section 327(a), as well as 327(c), imposes a per se 

 disqualification as trustee's counsel of any attorney 

 who has an actual conflict of interest; 

 (2) the district court may within its discretion-- 

 pursuant to S 327(a) and consistent with 327(c) -- 

 8 
 disqualify an attorney who has a potential conflict of 

 interest and 

 (3) the district court may not disqualify an attorney on 

 the appearance of conflict alone. 

Id. A Court may consider an interest adverse to the estate 

when counsel has "a competing economic interest tending 

to diminish estate values or to create a potential or actual 

dispute in which the estate is a rival claimant." In re 

Caldor, Inc., 193 B.R. 165, 171 (Bankr. S.D.N.Y. 1996) 

(where Trustee objected to retention of counsel by official 

committee of unsecured creditors in Chapter 11 case); In re 

Star Broadcasting, Inc., 81 B.R. 835, 838 (Bank. D.N.J. 

1988) (where Bankruptcy Court held law firm held actual 

conflict of interest in representing both debtors in 

possession). 

In summary, S 327(a) mandates disqualification when

there is an actual conflict of interest, allows for it when 

there is a potential conflict, and precludes it based solely 

on an appearance of conflict. In the situation where the 

debtor in possession seeks to retain counsel, as is the case 

here, the Code provides, "[A] person is not disqualified for 

employment under S 327 of this title by a debtor in

possession solely because of such person's employment by 

representation of the debtor before the commencement of 

the case." 11 U.S.C. S 1107(b). Where there is an actual 

conflict of interest, however, disqualification is mandatory. 

In re Marvel Entertainment Group, 140 F.3d at 476. A 

preferential transfer to RSW would constitute an actual 

conflict of interest between counsel and the debtor, and 

would require the firm's disqualification. In re BH&P, 949 

F.2d at 1316-1317. 

The Bankruptcy Code's avoidable preference provision, 

11 U.S.C. S 547(b), allows a bankruptcy trustee to recover 

certain transfers a debtor made prior to filing a petition in 

bankruptcy. The trustee must show that the transfer was: 

 1) to or for the benefit of a creditor; 

 2) for or on account of an antecedent debt owed by the 

 debtor before such transfer was made; 

 3) made while the debtor was insolvent; 

 9 
 4) made -- on or within 90 days before the date of the 

 filing of the petition; . . . 

 5) that enables such creditor to receive more than 

 such creditor would receive if -- 

 A) the case were a case under Chapter 7 of this ti tle; 

 B) the transfer had not been made; and 

 C) such creditor received payment of such debt to 

 the extent provided by the provisions of this title 

11 U.S.C. S 547(c)(2). The Bankruptcy Court and District 

Court held the SEC did not make a prima facie showing the 

stock transfer likely satisfied the requirement that the 

transfer be "for or on account of an antecedent debt owed 

by the debtor before such transfer was made." 11 U.S.C. 

S 547(b)(2). The Courts below found all other elements of 

Section 547(b) were established, a conclusion with which 

we are in accord. 

The Bankruptcy Court reasoned that not only must the 

debt be antecedent, but also the payment of a debt must be 

past due, as a prerequisite for establishing a voidable 

preference under S 547(b)(2). RSW certified the transfer of 

the securities was in the ordinary course of business 

dealings between the two parties, and was deemed timely 

payment. It further represented the invoices submitted by 

the firm did not constitute a final bill of an amount owed to 

the firm. Rather, the firm would negotiate with the debtor 

over several months worth of invoices, and adjust the bill 

accordingly. An invoice was not finalized until after 

negotiations. With respect to the final bill with First Jersey, 

the debtor agreed to pay $250,000 for legal services 

rendered from January to July 1995 almost simultaneously 

with the conclusion of negotiations over the final bill. The 

parties agreed the $250,000 was in settlement of the 

invoices presented by RSW for legal work performed from 

January to May 1995 (which totaled $314,327), as well as 

for work performed in June and July 1995 for which RSW 

had not yet generated an invoice ($75,000). RSW thus 

argues the payment was made before the debt was actually 

past due. The Bankruptcy Court agreed, reasoning the debt 

was not due prior to the time the payment was made. The 

 10 
District Court concurred with this conclusion under the 

same legal reasoning. 

The District Court's legal interpretation of S 547(b)(2) is 

reviewed de novo. Under the language of the statute, in 

order to constitute a preferential payment, First Jersey 

must have owed an antecedent "debt" to RSW, and that 

debt must have been incurred "before the transfer was 

made." 11 U.S.C. S 547(b)(2). The Bankruptcy Code defines 

a debt as a "liability on a claim." 11 U.S.C.S 101(12). In 

turn, the Code defines a claim broadly. A "claim" means: (A) 

right to payment, whether or not such right is reduced to 

judgment, liquidated, unliquidated, fixed, contingent, 

matured, unmatured, disputed, undisputed, legal, 

equitable, secured, or unsecured. 11 U.S.C. S 101(5). Under 

this broad definition of claim, "all legal obligations of the 

debtor, no matter how remote or contingent, will be able to 

be dealt with in the bankruptcy case." Senate Report at 22, 

1978 U.S. Code Cong. & Admin. News 5787, 5808. In 

addition, as debt is defined as a liability on a claim, it is 

coextensive with the definition of a claim, and both are 

construed broadly. Pennsylvania Dep't of Pub. Welfare v. 

Davenport, 495 U.S. 552, 110 S.Ct. 2126, 109 L.Ed.2d 588 

(1990). It follows "when a creditor has a claim against a 

debtor -- even if the claim is unliquidated, unfixed, or 

contingent -- the debtor has incurred a debt to the

creditor." In re Energy Cooperative, Inc., 832 F.2d 997, 1001 

(7th Cir. 1987). 

The SEC contends First Jersey incurred a debt to RSW 

when the law firm performed legal services on the debtor's 

behalf. We agree. Courts which have considered this issue 

have concluded, consistent with the statutory definitions, 

that an antecedent debt owed by the debtor occurs when a 

right to payment arises -- even if the claim is not fixed, 

liquidated, or matured. See 11 U.S.C. S 101(5); In re 

Bennett Funding Group, Inc., 220 B.R. 739, 742 (2d Cir. 

B.A.P. 1998) (debt occurs "when the debtor previously 

obtained a property interest in the consideration provided 

by the creditor that gave rise to the debt"). The right to 

payment generally arises when the debtor obtains the goods 

or services. See, e.g., Id; In re Futoran, 76 F.3d 265, 267 

(9th Cir. 1996); In re Cybermech, Inc., 13 F.3d 818, 821 

(4th Cir. 1994); In re Energy Co-op, Inc., 832 F.2d at 1001. 

 11 
Under this reasoning, RSW had a claim at the time it 

performed legal services for First Jersey. Its claim was 

"antecedent" for purposes of Section 547(b)(2). The payment 

of $250,000 from the sale of ITB stock was to settle the 

debt owed by First Jersey for past legal services rendered 

between January and July 1995. We agree with our sister 

circuits and other courts that legal claims arise when the 

legal services are performed, not when the bill itself is 

presented to the client. See, e.g., In re Florence Tanners, 

Inc., 209 B.R. 439, 447 (Bankr. E.D. Mich. 1997); In re 

Investment Bankers, Inc., 136 B.R. 1008, 1018 (D. Colo. 

1989), aff'd, 4 F.3d 1556 (10th Cir. 1993). 

In In re Florence Tanners, an attorney claimed he did not 

receive a preferential transfer because he received payment 

before he had sent an invoice for his services. The Court 

disagreed, and held "a debt for legal services arises when 

the services are performed, not when the subsequent

invoice is issued." 209 B.R. at 447. Similarly, the

Bankruptcy Appellate Panel in In re Bennett Funding Group 

concluded that, since a law firm which provided legal 

services "had a claim, mature or unmatured, that it could 

then assert against a debtor's bankruptcy estate if payment 

was not made at the time a petition was filed . . . the debt 

was `antecedent' for purposes of Section 547(b)(2)." 220 

B.R. 739, 742 (B.A.P. 2d Cir. 1998). 

The policies underlying the preference section in the 

bankruptcy statute cry out for the conclusion that a debt 

arises when legal services are provided, not when a law firm 

issues an invoice. The overriding intent in enactingS 547(b) 

was to promote equal distribution among a debtor's 

creditors. The preference section discourages creditors from 

racing to the courthouse to dismember the debtor during 

its slide into bankruptcy, and it furthers the policy of equal 

distribution among similarly situated creditors. 5 Collier on 

Bankruptcy, S 547-9; 1978 Code Cong. & Admin. News 

5787, 6138. 

The Bankruptcy Court's reasoning that a debt is not

owed until payment is past due is not found in the 

preference statute, 11 U.S.C. S 547. Its absence is readily 

understandable. If the Bankruptcy Court's conclusions 

were permitted to stand, the preference provision of the 

 12 
Bankruptcy Code would be largely vitiated. The Bankruptcy 

Court's judicial gloss would allow creditors to retain a prepetition payment simply by asserting that the payment was 

"timely," as was done by RSW. Pronouncing a payment is 

"timely" does not make it so. Moreover, such an approach 

would lead to inequality among similarly situated creditors, 

and allow for both strategic behavior and collusion by 

creditors to secure preferential treatment prior to a debtor 

filing its petition. This approach would "leave to the creditor 

the discretion to determine the date the obligation was 

incurred, creating the possibility not only of inequality of 

treatment of similarly-situated creditors (depending on the 

vagaries of their billing practices), but also the opportunity 

for a particular creditor, who foresees that his debtor is 

approaching bankruptcy, to secure preferential treatment 

for himself by the timing of the bill." Matter of Emerald Oil 

Co., 695 F.2d 833, 837 (5th Cir. 1983). 

In this case, the stock transfer resulted in a large 

diminution of the value of the debtor's estate, and a serious 

depletion of assets of the estate available to other creditors. 

Similarly situated creditors were not treated equally. 

Moreover, RSW, as the debtor's counsel, was in a unique 

position to secure preferential treatment for itself-- as it 

knew the debtor was going to file for bankruptcy in the 

imminent future. First Jersey's payment to RSW depleted 

the estate of its only significant asset that would have been 

available to its other creditors. This is the type of payment 

Congress intended the preference section to reach. We have 

no trouble concluding the stock transfer was a preference 

under Section 547 of the Bankruptcy Code. As such, RSW 

had an actual conflict with the debtor and was therefore 

disqualified from serving as counsel under S 327, unless 

payment to it was in the ordinary course of business. 

B. Payment in the Ordinary Course of Business 

Even if a payment is considered a preference under 

Section 547(b), it may not be subject to avoidance if it was 

made in the ordinary course of business, as defined in 11 

U.S.C. S 547(c). The purpose of Section 547(c) is to leave 

undisturbed normal financial relations between a debtor 

and its creditors, even as a company approaches 

bankruptcy. It protects "recurring, customary credit 

 13 
transactions that are incurred and paid in the ordinary 

course of business of the debtor and the debtor's 

transferee." 5 Collier on Bankruptcy, 547-47. We conclude, 

however, that the debtor's stock transfer to RSW in this 

case was not made in the ordinary course of business 

dealings between the two parties, nor was it made 

according to ordinary business terms. 

In reaching the opposite conclusion, the Bankruptcy

Court concluded the stock transfer was made in the 

ordinary course of business, and was thus acceptable even 

if one concluded the payment constituted a preferential 

transfer under S 547(b). The Court accepted RSW's 

assertion that its ordinary billing procedure with First 

Jersey was to submit a number of invoices after several 

months, and then negotiate the amount and method of

payment. Counsel explained, "we would go to the debtor 

with the invoices in hand, submit them to the client, 

discuss with the client whether the bills should be

adjusted, and in most cases they were adjusted downward, 

and then work out some sort of a payment on that 

particular group of invoices." Bankruptcy Docket No. 30 at 

32. 

A trustee may not avoid a preferential transfer to the 

extent such transfer was: "(A) in payment of a debt incurred 

by the debtor in the ordinary course of business or

financial affairs of the debtor and transferee; (B) made in 

the ordinary course of business or financial affairs of the 

debtor and transferee; and (C) made according to ordinary 

business terms." 11 U.S.C. S 547(c)(2). The burden is on the 

transferee to satisfy each statutory element by a 

preponderance of the evidence. 11 U.S.C. S 547(g); J.P. Fyfe, 

Inc. of Florida v. Bradco Supply Corp., 891 F.2d 66, 69-70 

(3d Cir. 1989). 

It is undisputed the transfer of stock satisfies 

S 547(c)(2)(A) -- the debt was incurred for legal services 

provided by RSW to First Jersey in the normal course of 

business. The conflict arises as to the other two elements. 

The term "ordinary" is not defined in the bankruptcy 

statute. J.P. Fyfe teaches the determination of what is "in 

the ordinary course of business" is subjective, calling for 

the Court to consider whether the transfer was ordinary as 

 14 
between the debtor and the creditor. Factors such as 

timing, the amount and manner in which a transaction was 

paid are considered relevant. In re Yurika Foods Corp., 888 

F.2d 42, 45 (6th Cir. 1989). 

Employing these criteria, we conclude the payment was 

not made in the ordinary course of business. The timing of 

the payment to RSW is clearly suspect. The transfer of 

stock was made on the day the debtor filed its petition for 

bankruptcy. RSW did not show that the payment date fit a 

particular practice between the parties. Rather, all the 

record shows is that First Jersey made periodic payments 

during 1994 and 1995. These payments consisted of: 

 10/28/94 $300,000 

 12/07/94 $150,000 

 12/22/94 $150,000 

 02/10/95 $150,000 

 03/24/95 $150,000 

 05/31/95 $150,000 

We merely note the payment of $250,000 on August 7,

1995 deviates from the pattern of $150,000 payments from 

December 1994 to May 1995. However, we are very 

troubled by the absence in the record of any explanation for 

why the payment was made on the eve of the debtor'sfiling 

for bankruptcy. As First Jersey's counsel in the securities 

litigation, RSW had to know of the debtor's precarious 

financial position when it accepted restricted securities in 

lieu of cash payment because RSW prepared the 

bankruptcy petition filed on the same day as the stock was 

transferred to it. 

The RSW firm also failed to produce any evidence that 

the payment of legal bills by transfer of restricted stock was 

in the ordinary course of business between the parties. 

RSW did not assert it had ever before received payment in 

the form of restricted securities. The stock in question was 

unregistered, and could not be sold publicly. In fact, RSW 

needed to find a sophisticated buyer for the securities -- 

and the shares were not sold until October 19, 1995. It 

defies reason that the Robinson firm would accept payment 

in an illiquid asset unless it knew the debtor was in serious 

financial difficulties and could not pay otherwise. The 

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manner and timing of the payment in the currency of

restricted ITB stock suggests the transfer was not made in 

the ordinary course of business between the parties. 

Moreover, the payment was not made "according to 

ordinary business terms", as is required by S 547(c)(2)(c). 

This phrase has been interpreted as encompassing"the 

practices in which firms similar in some general way to the 

creditor in question engage." In re Molded Acoustical 

Products, Inc., 18 F.3d 217, 224 (3d Cir. 1994)."Only 

dealings so idiosyncratic as to fall outside that broad range 

should be deemed extraordinary and therefore outside the 

scope of subsection C." Id., (citing Matter of Tolona Pizza 

Prods. Corp., 3 F.3d 1029, 1033 (7th Cir. 1993)). This Court 

emphasized, moreover, that "the more cemented [as 

measured by duration] the pre-insolvency relationship 

between the debtor and the creditor, the more the creditor 

will be allowed to vary its credit terms from the industry 

norm yet remain within the safe harbor of S 547(c)(2)." Id. 

at 225. 

While this test is deferential, it is not non-existent. The 

general practice of law firms is to receive cash in return for 

services, not restricted securities. See, e.g., In re Florence 

Tanners, Inc., 209 B.R. 439, 448 (Bankr. E.D. Mich 1997) 

(questioning "whether in the ordinary course of the legal 

business, clients pay lawyers with merchandise"). While law 

firms have begun to accept equity positions as payment 

from "start-up" companies with strong growth potential, the 

reasoning in these situations is the expectation by the law 

firm that the stock of the client will appreciate in value. In 

contrast, here the restricted stock is not of a client with 

growth potential, but of a third party. Moreover, the record 

reflects it was common practice for First Jersey to pay RSW 

only in cash. In fact, up until the day the Chapter 11 

petition was filed, there is no evidence in the record that 

First Jersey ever transferred securities, much less restricted 

securities, to RSW as payment for legal services. 

Finally, it very much appears that on August 7, 1997, 

First Jersey recognized its need for counsel to shepherd it 

through the chapter 11 proceedings. The obvious choice 

was RSW since it had continuously represented First Jersey 

as its legal troubles mounted. But there was a problem. 

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First Jersey owed RSW a substantial amount of money. 

Turning over the ITB stock to RSW was the only solution, 

especially since RSW represented ITB in the past, and 

presumably was familiar with the company. Be that as it 

may, payment of legal bills in restricted stock as a prelude 

to filing a bankruptcy Chapter 11 petition can hardly be 

construed as a payment "made according to ordinary 

business terms." 

Viewed in its totality, it is clear this payment was not 

made in the ordinary course of business. Accordingly, the 

preferential payment was a preference, creating an actual 

conflict of interest, and thus, disqualifying RSW as counsel 

for the debtor.8 

IV. Conclusion 

For the reasons set forth above, we find the District 

Court erred in holding that the stock transfer was not a 

preference under 11 U.S.C. S 547. The stock transfer 

created an actual conflict of interest, and therefore 

disqualification is mandatory. In addition, wefind the 

Bankruptcy Court erred in finding the transfer was exempt 

under S 547(c)(2) as a payment made in the ordinary course 

of business. 

Accordingly, we will reverse the District Court's order and 

direct the District Court to remand to the Bankruptcy 

Court with instructions to disqualify RSW and successor 

firms as counsel for First Jersey, and to take such further 

action as is consistent with this opinion.9 

_________________________________________________________________ 

8. Because we conclude the $250,000 payment constituted a preference, 

and counsel is disqualified, we do not reach the question of whether the 

debtor and RSW adequately disclosed information in RSW's application 

for employment as required by Rule 2014(a) of the Federal Rules of 

Bankruptcy Procedure and 11 U.S.C. S 327. 

9. We note the Bankruptcy Court warned RSW at the hearing that if the 

transfer is avoided as to the payment of the pre-petition debt, "[RSW] is 

subject not only to disgorgement of the preference, but also to the 

possible denial or reduction of compensation under Code section 328(c) 

as well." In re Brennan, 187 B.R. at 154. 

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A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 

 for the Third Circuit 

 18