Opinion ID: 3011063
Heading Depth: 2
Heading Rank: 2

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

Text: 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 15 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 encompassingthe 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. 16 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