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. e du/thir dc ir c uit_1999/153Filed 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 CooperArgued 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 appointm ent of counsel for a debtor in possession, where the debto r 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") a nd the

___________________________________________________ ______________

*Hon. Murray M. Schwartz, Senior United States Dist rict Judge for the District of Delaware, sitting by designation.

2Securities 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 adve rse 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 Jerse y held the
debtor could retain RSW as counsel. Because counsel received a preference under Section 547 of the Bank ruptcy Code, 11 U.S.C. S 547, we will reverse and remand.

I.

First Jersey Securities, Inc.1 (the "debtor" or "Fi rst Jersey") filed a voluntary petition for relief unde r Chapter 11 of the Bankruptcy Code on August 7, 1995. 11 U.S .C. S 101 et seq. This action was prompted after the SE C prevailed in a securities fraud action against Firs t Jersey and its 100% shareholder, Robert Brennan, and obtai ned an order for them to disgorge $75 million in illega l 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 deb tor filed an application pursuant to S 327(a) of the Bankrupt cy Code to retain RSW as its counsel. First Jersey owed the firm approximately $389,000 for legal services rendered prior to the filing for bankruptcy primarily for work perfor med in the securities fraud litigation.2 On the same day o f its

___________________________________________________ ______________

1. First Jersey was a discount broker-dealer specia lizing in the underwriting, trading, and distribution of low-pric ed securities. The company was found to have committed securities frau d 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 subst ituted as counsel when Greenhalgh joined that firm. At all times, Gre enhalgh has been lead counsel for the debtor in possession.

3Chapter 11 filing, the debtor transferred 200,001 s hares of

unregistered restricted stock in International Thor oughbred Breeders, Inc. ("ITB") to RSW.3 This stock was to b e liquidated by RSW, with payments to be made in the following manner: $200,000 as a retainer for repres entation 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 d ebtor. The $250,000 was to be considered full payment for the $389,327 due for pre-petition services. The firm wa ived 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 bankruptc y petition listed only $22,367 in other assets. Ultim ately, RSW found a buyer for the shares, and transferred a ll of the ITB stock for $600,003. RSW kept $450,000 and

returned the remainder to the debtor. While the tra nsfer of stock was noted in both the debtor's petition and c ounsel's petition to be retained as counsel, neither party d isclosed the payment was made within 90 days of the debtor f iling for bankruptcy.

On August 11, 1995, four days after the filing of t he petition, the Trustee, joined by the SEC three days later, objected to the appointment of RSW as counsel, argu ing the firm was not "disinterested" as is required by the Bankruptcy Code. 11 U.S.C. S 327(a). The Trustee an d 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 fo r the
debtor because it held an interest adverse to the e state. RSW, in response, submitted a certification asserti ng 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 occur red in the Bankruptcy Court and District Court is set forth be low.

___________________________________________________ ______________

3. Because the ITB shares were unregistered, they c ould only be sold under an exemption provided by Section 4 of the Sec urities Act. 15

U.S.C. S 77d.

4A. Bankruptcy Court

On August 24, 1995, the Bankruptcy Court held a hearing on the debtor's application to retain RSW a s its counsel. The SEC contended the payment of RSW's pre petition claim was a voidable preference under the Bankruptcy Code, 11 U.S.C. S 547(b),4 which is a ca use for disqualification under Section 327(a).5 During the hearing, RSW acknowledged the stock transfer took place with in the 90 day preference period, but contended it was made in the ordinary course of business, and not made in exchan ge for an "antecedent debt". Counsel explained the $250,00 0 payment was for a series of invoices from January t hrough 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 t he debtor for at least the past 12 months and probably going back a year and a half or two years, would b e a method where we would generate an invoice, we would then submit a group of invoices after several mon ths, . .. 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 a t 31.

The Bankruptcy Court approved the debtor's applicat ion to retain RSW from the bench on August 24, 1995 and subsequently issued a written opinion. In re Brenna n, 187

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4. Section 547(b) of the Code permits a trustee to avoid certain prebankruptcy transfers as "preferences" where the deb tor transfers property to a creditor for an antecedent debt made within 90 days before filing for bankruptcy. In re Molded Acoustical Prod ucts, Inc., 18 F.3d 217, 217 (3d Cir. 1994).

5. Section 327(a) provides: "[T]he trustee, with th e court's approval, may employ one or more attorneys . . . that do not hold or represent an interest adverse to the estate, and that are disint erested 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 paym ent for pre-petition services was a preference, RSW would not be a "disi nterested person" within the meaning of the statute.

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

did not present a prima facie case that RSW receive d a voidable preference under Section 547(b) of the Ban kruptcy Code. Specifically, the Bankruptcy Court found ther e was no prima facie showing of a transfer to "satisfy an antecedent debt owed by the debtor before such tran sfer 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"o wed" within the meaning of the statute until payment is past due, even if the debt is antecedent. It accepted RS W'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 bus iness under Section 547(c). If the transfer was incurred and made in the ordinary course of business between the part ies, 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 disclos e adequately the details of the pre-petition transfer of the stock. The Bankruptcy Court concluded, "The U.S. Tr ustee
and the SEC therefore failed to establish that the payment in question is probably an avoidable preference. Th e mere accusation that it could be avoidable is not suffic ient to disqualify Robinson." In re Brennan, 187 B.R. at 15 4.

B. District Court

The SEC and Trustee appealed the decision of the Bankruptcy Court to the United States District Cour t for

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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 tran sfer was made."

7. Section 547(c)(2) provides that a "trustee may n ot avoid under this
section a transfer . . . to the extent that such tr ansfer was -- (A) in payment of a debt incurred by the debtor in the ord inary course of
business or financial affairs of the debtor and the transferee; (B) made in the ordinary course of business or financial aff airs of the debtor and the transferee; and (C) made according to ordinary business terms."

6the District of New Jersey, contending the Bankrupt cy

Court erred in finding the law firm was not disqual ified under S 327(a). The District Court filed a memorand um 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 preferen ce under S 547(b), and therefore, RSW should not be disquali fied.
The District Court also concluded the stock transfe r was not made on account of an antecedent debt owed by t he debtor before the transfer was made. Finally, the C ourt declined to address the Bankruptcy Court's conclusi on 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 orde r 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 Sta tes 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 dec ision
has been articulated on numerous occasions. "As an appellate court twice removed from the primary trib unal, 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). Ou r vantage point is identical to that of the District Court, "so we review the bankruptcy court's findings by the st andards the district court should employ to determine wheth er the
district court erred in its review." Id. at 102. Ac cordingly, the Bankruptcy Court's findings of fact are reviewa ble for clear error. In re Continental Airlines, 125 F.3d 1 20, 128 (3d Cir. 1997). Legal determinations are subject to ple nary review. Id. The Bankruptcy Court's exercise of disc retion is reviewed for abuse thereof. In re Engel, 124 F.3d 5 67, 571 (3d Cir. 1997).

7III.

The SEC urges this Court to reverse the District Co urt's decision approving the retention of RSW as counsel for the debtor. It argues the Court erred in finding the st ock transfer was not a voidable preference under 11 U.S .C. S 547, and that error led it to conclude RSW was qu alified

to serve as counsel to the debtor under 11 U.S.C.S 327. The SEC also urges the transfer of the ITB restrict ed 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 disclosur es concerning the stock transfer payments were suffici ent under S 327(a). Because we conclude the stock trans fer was a preferential payment not made in the ordinary cou rse of business, we need not address whether RSW adequatel y disclosed the stock payments to the Bankruptcy Cour t.

A. Stock Transfer as Preferential Payment

Section 327(a) of the Bankruptcy Code provides for the trustee (or the debtor in possession), with the Cou rt'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, "counse l must `not hold or represent an interest adverse to the e state' 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 relatio nship with the debtor, or for any other reason. 11 U.S.C. S 10 1(14)(e). The standards regarding adverse interests underS 32 7(a) are outlined in In Re Marvel Entertainment Group, I nc., 140 F.3d 463, 476 (3d Cir. 1998). In that case, we held :

(1) Section 327(a), as well as 327(c), impos es 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 discre tion-- pursuant to S 327(a) and consistent with 327 (c) --

8disqualify an attorney who has a potential c onflict 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 ten ding to diminish estate values or to create a potential or actual dispute in which the estate is a rival claimant." I n re Caldor, Inc., 193 B.R. 165, 171 (Bankr. S.D.N.Y. 19 96) (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 ac tual conflict of interest in representing both debtors i n 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 bas ed solely on an appearance of conflict. In the situation wher e the debtor in possession seeks to retain counsel, as is the case here, the Code provides, "[A] person is not disqual ified for employment under S 327 of this title by a debtor in possession solely because of such person's employme nt by representation of the debtor before the commencemen t of the case." 11 U.S.C. S 1107(b). Where there is an a ctual 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 ac tual
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 provisio n, 11 U.S.C. S 547(b), allows a bankruptcy trustee to recover certain transfers a debtor made prior to filing a p etition 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 o wed by the debtor before such transfer was made;

3) made while the debtor was insolvent;

94) made -- on or within 90 days before the d ate of the

filing of the petition; . . .

5) that enables such creditor to receive mor e than
such creditor would receive if --

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

B) the transfer had not been made; and

C) such creditor received payment of such de bt to the extent provided by the provisions of thi s title

11 U.S.C. S 547(c)(2). The Bankruptcy Court and Dis trict Court held the SEC did not make a prima facie showi ng the stock transfer likely satisfied the requirement tha t the

transfer be "for or on account of an antecedent deb t owed by the debtor before such transfer was made." 11 U. S.C. S 547(b)(2). The Courts below found all other eleme nts of Section 547(b) were established, a conclusion with which
we are in accord.

The Bankruptcy Court reasoned that not only must th e debt be antecedent, but also the payment of a debt must be past due, as a prerequisite for establishing a void able preference under S 547(b)(2). RSW certified the tra nsfer of the securities was in the ordinary course of busine ss dealings between the two parties, and was deemed ti mely payment. It further represented the invoices submit ted by
the firm did not constitute a final bill of an amou nt owed to the firm. Rather, the firm would negotiate with the debtor over several months worth of invoices, and adjust t he bill accordingly. An invoice was not finalized until aft er negotiations. With respect to the final bill with F irst Jersey, the debtor agreed to pay $250,000 for legal service s rendered from January to July 1995 almost simultane ously with the conclusion of negotiations over the final bill. The parties agreed the $250,000 was in settlement of th e invoices presented by RSW for legal work performed from January to May 1995 (which totaled $314,327), as we ll as for work performed in June and July 1995 for which RSW had not yet generated an invoice ($75,000). RSW thu s argues the payment was made before the debt was act ually past due. The Bankruptcy Court agreed, reasoning th e debt was not due prior to the time the payment was made. The

10District 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 J ersey must have owed an antecedent "debt" to RSW, and tha t
debt must have been incurred "before the transfer w as made." 11 U.S.C. S 547(b)(2). The Bankruptcy Code d efines 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" m eans: (A) right to payment, whether or not such right is redu ced to judgment, liquidated, unliquidated, fixed, continge nt, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. 11 U.S.C. S 101(5 ). Under this broad definition of claim, "all legal obligati ons of the debtor, no matter how remote or contingent, will be able to be dealt with in the bankruptcy case." Senate Repor t at 22, 1978 U.S. Code Cong. & Admin. News 5787, 5808. In addition, as debt is defined as a liability on a cl aim, it is coextensive with the definition of a claim, and bot h are construed broadly. Pennsylvania Dep't of Pub. Welfa re v. Davenport, 495 U.S. 552, 110 S.Ct. 2126, 109 L.Ed.2 d 588 (1990). It follows "when a creditor has a claim aga inst a debtor -- even if the claim is unliquidated, unfixe d, 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 RS W when the law firm performed legal services on the d ebtor's behalf. We agree. Courts which have considered this issue have concluded, consistent with the statutory defin itions, that an antecedent debt owed by the debtor occurs w hen 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 previous ly obtained a property interest in the consideration p rovided by the creditor that gave rise to the debt"). The r ight to payment generally arises when the debtor obtains th e 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.

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

performed legal services for First Jersey. Its clai m was "antecedent" for purposes of Section 547(b)(2). The payment of $250,000 from the sale of ITB stock was to settl e the debt owed by First Jersey for past legal services r endered between January and July 1995. We agree with our si ster circuits and other courts that legal claims arise w hen the legal services are performed, not when the bill its elf is presented to the client. See, e.g., In re Florence Tanners, Inc., 209 B.R. 439, 447 (Bankr. E.D. Mich. 1997); I n re Investment Bankers, Inc., 136 B.R. 1008, 1018 (D. C olo. 1989), aff'd, 4 F.3d 1556 (10th Cir. 1993).

In In re Florence Tanners, an attorney claimed he d id 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 aris es 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 leg al 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 t he 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 enactin gS 547(b) was to promote equal distribution among a debtor's creditors. The preference section discourages credi tors from racing to the courthouse to dismember the debtor du ring its slide into bankruptcy, and it furthers the poli cy 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 conclusio ns were permitted to stand, the preference provision o f the

12Bankruptcy Code would be largely vitiated. The Bank ruptcy

Court's judicial gloss would allow creditors to ret ain a prepetition payment simply by asserting that the payme nt was "timely," as was done by RSW. Pronouncing a payment is "timely" does not make it so. Moreover, such an app roach would lead to inequality among similarly situated c reditors, 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 ineq uality of treatment of similarly-situated creditors (dependin g on the vagaries of their billing practices), but also the opportunity for a particular creditor, who foresees that his de btor is approaching bankruptcy, to secure preferential trea tment for himself by the timing of the bill." Matter of E merald Oil Co., 695 F.2d 833, 837 (5th Cir. 1983).

In this case, the stock transfer resulted in a larg e diminution of the value of the debtor's estate, and a serious depletion of assets of the estate available to othe r creditors. Similarly situated creditors were not treated equal ly. Moreover, RSW, as the debtor's counsel, was in a un ique position to secure preferential treatment for itsel f-- as it knew the debtor was going to file for bankruptcy in the imminent future. First Jersey's payment to RSW depl eted 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 pref erence under Section 547 of the Bankruptcy Code. As such, RSW
had an actual conflict with the debtor and was ther efore disqualified from serving as counsel under S 327, u nless payment to it was in the ordinary course of busines s.

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 t o leave
undisturbed normal financial relations between a de btor and its creditors, even as a company approaches bankruptcy. It protects "recurring, customary credi t

13transactions that are incurred and paid in the ordi nary

course of business of the debtor and the debtor's transferee." 5 Collier on Bankruptcy, 547-47. We co nclude, however, that the debtor's stock transfer to RSW in this case was not made in the ordinary course of busines s 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 acceptabl e even if one concluded the payment constituted a preferen tial 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 sev eral months, and then negotiate the amount and method of payment. Counsel explained, "we would go to the deb tor with the invoices in hand, submit them to the clien t,
discuss with the client whether the bills should be adjusted, and in most cases they were adjusted down ward, 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 affair s of the debtor and transferee; and (C) made according to or dinary 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 s ervices provided by RSW to First Jersey in the normal cours e of
business. The conflict arises as to the other two e lements. The term "ordinary" is not defined in the bankruptc y statute. J.P. Fyfe teaches the determination of wha t is "in the ordinary course of business" is subjective, cal ling for
the Court to consider whether the transfer was ordi nary as

14between the debtor and the creditor. Factors such a s

timing, the amount and manner in which a transactio n was paid are considered relevant. In re Yurika Foods Co rp., 888 F.2d 42, 45 (6th Cir. 1989).

Employing these criteria, we conclude the payment w as not made in the ordinary course of business. The ti ming of the payment to RSW is clearly suspect. The transfer of stock was made on the day the debtor filed its peti tion for bankruptcy. RSW did not show that the payment date fit a particular practice between the parties. Rather, al l the record shows is that First Jersey made periodic pay ments 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 explan ation for why the payment was made on the eve of the debtor's filing for bankruptcy. As First Jersey's counsel in the se curities litigation, RSW had to know of the debtor's precari ous financial position when it accepted restricted secu rities in lieu of cash payment because RSW prepared the bankruptcy petition filed on the same day as the st ock was
transferred to it.

The RSW firm also failed to produce any evidence th at the payment of legal bills by transfer of restricte d stock was in the ordinary course of business between the part ies. RSW did not assert it had ever before received paym ent in the form of restricted securities. The stock in que stion was unregistered, and could not be sold publicly. In fa ct, RSW needed to find a sophisticated buyer for the securi ties -- and the shares were not sold until October 19, 1995 . It defies reason that the Robinson firm would accept p ayment in an illiquid asset unless it knew the debtor was in serious financial difficulties and could not pay otherwise. The

15manner 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"th e practices in which firms similar in some general wa y to the creditor in question engage." In re Molded Acoustic al Products, Inc., 18 F.3d 217, 224 (3d Cir. 1994)."On ly dealings so idiosyncratic as to fall outside that b road range should be deemed extraordinary and therefore outsid e the scope of subsection C." Id., (citing Matter of Tolo na Pizza Prods. Corp., 3 F.3d 1029, 1033 (7th Cir. 1993)). T his Court emphasized, moreover, that "the more cemented [as measured by duration] the pre-insolvency relationsh ip between the debtor and the creditor, the more the c reditor will be allowed to vary its credit terms from the i ndustry norm yet remain within the safe harbor of S 547(c)( 2)." Id.

at 225.

While this test is deferential, it is not non-exist ent. 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"). W hile law firms have begun to accept equity positions as paym ent from "start-up" companies with strong growth potent ial, the reasoning in these situations is the expectation by the law firm that the stock of the client will appreciate i n value. In contrast, here the restricted stock is not of a cli ent with growth potential, but of a third party. Moreover, t he 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 rec ord 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, 199 7, First Jersey recognized its need for counsel to she pherd it through the chapter 11 proceedings. The obvious cho ice was RSW since it had continuously represented First Jersey as its legal troubles mounted. But there was a prob lem.

16First Jersey owed RSW a substantial amount of money

.

Turning over the ITB stock to RSW was the only solu tion, especially since RSW represented ITB in the past, a nd presumably was familiar with the company. Be that a s it may, payment of legal bills in restricted stock as a prelude to filing a bankruptcy Chapter 11 petition can hard ly be construed as a payment "made according to ordinary
business terms."

Viewed in its totality, it is clear this payment wa s not made in the ordinary course of business. Accordingl y, the preferential payment was a preference, creating an actual conflict of interest, and thus, disqualifying RSW a s counsel
for the debtor.8

IV. Conclusion

For the reasons set forth above, we find the Distri ct Court erred in holding that the stock transfer was not a preference under 11 U.S.C. S 547. The stock transfe r created an actual conflict of interest, and therefo re 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 o rder and direct the District Court to remand to the Bankrupt cy Court with instructions to disqualify RSW and succe ssor 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 constit uted a preference, and counsel is disqualified, we do not reach the qu estion of whether the debtor and RSW adequately disclosed information in RSW's application for employment as required by Rule 2014(a) of the F ederal Rules of Bankruptcy Procedure and 11 U.S.C. S 327.

9. We note the Bankruptcy Court warned RSW at the h earing that if the transfer is avoided as to the payment of the pre-pe tition 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.

17A True Copy:

Teste:

Clerk of the United States Court of Appeals
for the Third Circuit

18