Stanziale v. Industrial Specialists Inc. (In re Conex Holdings, LLC)

Chapter 7

OPINION1

INTRODUCTION

Before the Court is a motion for summary judgment filed by the defendant in a preference action seeking to recover transfers, pursuant to 11 U.S.C. sections 547 and 550. Defendant seeks summary judgment determining that the preferential transfers, if any, are not avoidable because they (i) were made in the ordinary course of business under section 547(c)(2)(A); and/or (ii) are barred by the Texas Construction Trust Fund Act. For the reasons set forth below, the Court will grant the motion for summary judgment on the basis that the preferential transfers, if any, were made in the ordinary course of business. As the transfers are not avoidable based on section 547(c)(2)(A), the Court need not rule on whether the action is barred under the Texas Construction Trust Fund Act.

JURISDICTION

This Court has jurisdiction over this matter pursuant to 28 U.S.C. sections 157 and 1384. Venue is proper in this District pursuant to 28 U.S.C. sections 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. section 157(b)(2) and this Court has the judicial power to enter a final order.

STATEMENT OF FACTS

A. Background and Procedural History

On February 21, 2011 (the “Petition Date”), involuntary petitions for relief under chapter 11 of title 11 of the United States Code were filed against Conex International, LLC (“Conex”), formerly known as Conex International Corporation; Conex Holdings, LLC; and Advance Blasting & Coating (collectively, the “Debtors”). On February 24, 2011, the Debtors’ involuntary chapter 11 cases were consensually converted to voluntary cases under Chapter 7 of the Bankruptcy Code, and the Office of the United States Trustee appointed Charles A. Stanziale, Jr. as trustee for the Debtors’ estates (the “Trustee” or “Plaintiff’).

In December 2012, Plaintiff commenced this proceeding by filing a complaint against defendant, Industrial Specialists Inc. a/k/a Industrial Specialists, LLC (“Industrial Specialists” or “Defendant”), seeking to avoid and recover $1,181,583.84 in allegedly preferential transfers made by the Debtors to Industrial Specialists in the *48390 days preceding the filing of the chapter 7 cases. The parties have completed discovery.

Defendant has filed a motion for summary judgment (the “Motion”), which Plaintiff opposes.2 This matter is fully briefed and is ripe for the Court’s consideration.

B. Relevant Facts

In 2007, Brand Industrial was formed as a Delaware Limited Liability Company. That same year, Brand International acquired Industrial Specialists. Industrial Specialists was the successor to Industrial Specialists of LA (“ISLA”), which had a Master Service Agreement with Debtors. When'Brand Industrial acquired Industrial Specialists, the Debtors consented to the assignment of the Master Service Agreement between ISLA and Debtors to Brand Industrial. On December 16, 2009, Brand Industrial filed a Certificate of Amendment with the Delaware Secretary of State’s Office, which amended its Certificate of Formation to change the name of the limited liability company to Industrial Specialists, LLC, effective as of January 1; 2010. Defendants claim that Brand Industrial and Industrial Specialists are the same limited liability company that contracted with the Debtors.

Conex was a general mechanical contracting and industrial services firm. Industrial Specialists (and formerly Brand Industrial) were subcontractors to the Debtors in construction projects for oil refineries located in Texas. The Debtors contracted with various owners of real property located in Texas to perform certain labor and furnish certain materials in connection with the construction and completion of the oil refineries. In turn, the Debtors subcontracted with Industrial Specialists to furnish certain labor and/or material in connection with these projects.

In the 90 days prior to the bankruptcy (the “Preference Period”), Conex made seven transfers (collectively, the “Transfers”) to Defendant:

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The Trustee seeks to recover these Transfers as preferential. Defendant asserts that each of the Transfers were made in the ordinary course of the relationship between Conex and Defendant.3

STANDARD OF REVIEW

Federal Rule of Civil Procedure 56(c), made applicable to these proceedings pursuant to Federal Rule of Bankruptcy Procedure 7056, provides that summary judg-*484raent should be granted if the movant shows that “there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law,”4 after considering the “pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits.” 5

In deciding a motion for summary judgment, all factual inferences must be viewed in the light most favorable to the nonmov-ing party.6 After sufficient proof has been presented to support the motion, the burden shifts to the nonmoving party to show that genuine issues of material fact still exist and that summary judgment is not appropriate.7 A genuine issue of material fact is present when “the evidence is such that a reasonable jury could return a verdict for the nonmoving party.”8

In order to demonstrate the existence of a genuine issue of material fact in a jury trial, the nonmovant must supply sufficient evidence (not mere allegations) for a reasonable jury to find for the nonmovant.9 The same principles apply in a bench trial where the judge is the ultimate trier of fact; the nonmovant must obviate an adequate showing.to the judge to find for the nonmovant.10 In a situation where there is a complete failure of proof concerning an essential element of the nonmoving party’s case, Rule 56(c) necessarily renders all other facts immaterial and mandates a ruling in favor of the moving party.11

DISCUSSION

A. Preferential Transfer

“A preference, in simplest terms, is an eve-of-bankruptcy transfer to a creditor. The creditor that receives a preferential payment recovers 100% on its claim where, in all likelihood, other unsecured creditors receive less.”12 The six requirements that the Trustee must establish to make a preference voidable are: (1) a transfer is made; (2) on account of antecedent debt; (3) to or for the benefit of the creditor; (4) while the debtor was insolvent; (5) within 90 days of the filing of the petition; (6) that left the creditor better off than it would have been if the transfer had not been made and it had asserted its claim in a chapter 7 liquidation.13

If Defendant has a complete defense to the Trustee’s claim for preferential transfers then the above factors do not have to be considered. As such, the Court will turn to Defendant’s defenses to these claims.

*485B. The Preferential Transfers, If Any, Are Not Avoidable As They Were Made In The Ordinary Course Of Business Between The Debtor And Defendant.

Section 547(c)(2) permits a “safe harbor” for a transferee of a preferential payment if “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 the transferee; or (B) made according to ordinary business terms.” 14 Accordingly, the Court is left to determine whether any or all of the transfers were made in the ordinary course of business of the Debtor and Defendant, or made according to “ordinary business terms.”

i. Parties’ Arguments

Defendant asserts that in the pre-pref-erence period payments (the “Historical Period”) were generally received between 41 and 70 days after invoice, excluding various outliers. In comparison, during the Preference Period, all payments were received between 41 and 68 days. Thus, Defendant claims that each transfer in the Preference Period was (i) received squarely within the historic range of days after invoice and is consistent with the parties’ prior course of dealings; (ii) was made on account of debts incurred by the parties in the ordinary course of business; and (iii) was a continuation of normal financial relations between the Debtors and Defendant. Defendant argues that this is proved by the following:

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In its analysis, Defendant asserts that the Court should exclude four (4) payments made over 70 days after the invoice date in the Historical Period. Without the outliers, Defendant argues that the course of business between the Debtors and Defendant was the same in the Historical Period and the Preference Period.

The Trustee responds that the above data is skewed, arguing that 12 out of 14 invoices (86%) paid in the Preference Period were paid within 55 days of the date of invoice. In contrast, only 8 out of 20 invoices (40%) paid in the Historical Period were paid within 55 days of the invoice date. The Trustee argues that this drastic change (the percentage of invoices paid within 55 days of the invoice date more than doubled) shows that the payments of invoices accelerated in the Preference Period. The Trustee’s analysis is as follows:

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The Trustee continues that comparing the actual Historical Period to the Preference Period using Defendant’s methodology also shows that the payments in the Preference Period were paid, on average, one week earlier in the Preference Period. The Trustee also argues that there is no “principled basis” for removing the outliers (20% of the payments in the historic period) from the analysis, i.e., Defendant includes historical payments made 70 days after invoice as “ordinary” by Defendant but not payments made 77 and 78 days after invoice. The Trustee asserts that Defendant removed unfavorable payments to create a “skewed ordinary course analysis.” The Trustee’s last argument is that the payee in the Historical Period was, in some instances, Brand Industrial, rather than Industrial Specialists; and in attempting to establish its historical course of business, Defendant bears the burden of showing that the payments were actually made payable to it (as opposed to some other entity).

ii. Discussion

Under 11 U.S.C. § 547(c)(2), the “ordinary course of business exception” permits a creditor to retain transfers made by a debtor to a creditor during the 90 days before the petition date if such transfers were made for a debt incurred in the “ordinary course of business” of the parties; and either (1) the transfers were made in the “ordinary course of business” of the parties; or (2) the transfers were made in accordance with “ordinary business terms.”15

The party contending that the transfer falls under one of the exemptions bears the burden of proving that assertion by a preponderance of the evidence.16 In the context of a motion for summary judgment, the burden of proof remains with the party asserting the nonavoidability of the transfer, i.e., Defendant. The Trustee simply needs to point to the absence of such proof to make its case.17

Here, the parties do not dispute that the debt was incurred in the ordinary course of business. The Debtor operated as a general industrial contractor, and Defendant was a subcontractor employed to assist on a construction project. In addition, Defendant has not sought a determination in the Motion that the payments were made in accordance with ordinary business terms.

Rather, the only question before the Court is whether the payments made to Defendant occurred in the ordinary course of business. The determination of whether a creditor has met its burden under section 547(c)(2)(A) is a subjective test, “calling for the Court to consider whether the transfer was ordinary as be*487tween the' debtor and the creditor.”18 Courts have considered a myriad of factors in this test, including: (1) the length of time the parties engaged in the type of dealing at issue; (2) whether the subject transfers were in an amount more than usually paid; (3) whether the payments at issue were tendered in a manner different from previous payments; (4) whether there appears to have been an unusual action by the debtor or creditor to collect on or pay the debt; and (5) whether the creditor did anything to gain an advantage (such as additional security) in light of the debtor’s deteriorating financial condition.19 No one factor is determinative.20 To determine whether transfers were in the ordinary course of business the Court must first determine what the ordinary course of business was and then compare the preferential transfers to it.21

In situations where the parties have a long history of dealings, the focus in determining the ordinary course of the parties’ business is on those dealings. The Third Circuit has stated:

when the relationship in question has been cemented long before the onset of insolvency-up through and including the preference period-we should pause and consider carefully before further impairing a creditor whose confident, consistent, ordinary extension of trade credit has given the straitened debtor a fighting chance of sidestepping bankruptcy and continuing in business. 'Bankruptcy policy, as evidenced by the very existence of § 547(c)(2), is to promote such continuing relationships on level terms, relationships which if encouraged will often help businesses fend off an unwelcome voyage into the labyrinths of a bankruptcy. On the other hand, where the relationship is of recent origin, a significant departure from credit terms normal to the trade bears the earmarks of favoritism and/or exploitation, and to countenance such behavior could be unfair (or could appear unfair) to the remaining creditors who exhibit the virtue of patience.22

*488Here, the Debtor and Defendant had been doing business for approximately 16 months, which is of sufficient duration for the Court to determine the ordinary course of business between them.23

Next, the Court must compare transfers made within the Preference Period to those made in the course of dealings between the parties prior to the Preference Period. Courts place particular importance on the timing of payment in determining the ordinary course of business between parties.24 Small deviations in timing might not preclude a finding of ordinariness, while greater deviations in timing are more likely to preclude a finding of ordinariness.25 Overall, this inquiry is intensely fact specific.26

The Court will begin with the Trustee’s asserted dollar-weighted days (“DSO”) analysis argument. The Trustee relies on In re Hechinger Inc. Co. of Delaware, Inc.27 in support of the DSO argument. In Hechinger, a few months prior to the debtors’ bankruptcy, the defendant changed the debtors’ credit terms from “1% 10 days, net 30, with a 7-day mail float” to “1% 7 days, net 8.” Under the former terms, the debtors could earn a 1% price reduction for invoices paid within the “discount period,” or, in other words, ten days plus a seven-day grace period for payments made by mail; furthermore, the debtors had up to 30 days to pay in order for the payment to be considered prompt.28 The later terms contained a $1 million credit limit for future purchases, a 1% price reduction for invoices paid within the seven day “discount period” and had up to eight days to pay in order for the payment to be considered prompt, among other restrictions.29 The defendant argued that as the alleged preference payments were made within the credit terms they were presumptively in the ordinary course. The bankruptcy court determined that the payments made by the debtors to the defendant during the preference period were not “ ‘made in the ordinary course of business or financial affairs of the debtor and the transferee’ within the meaning of § 547(c)(2)(B) because the changes ... [the defendant] had imposed on ... [the debtors] were ‘so extreme, and so out of character with the long historical relation*489ship between these parties.’ ”30

On appeal, the Third Circuit found that the debtors were pressured to make accelerated payments during the preference period because of defendant’s enforcement of its credit limit.31 The Third Circuit pointed out the vigorous enforcement of the credit limit by comparing the timing in which the debtors paid the invoice to the defendant, i.e., in the preference period, the debtors paid 96.5% of its invoices within 0-10 days from the date of invoice; while, in the comparable period for the three preceding years, only 10% of invoices were paid within 0-10 days from the date of invoice.32 The Third Circuit went on to compare the debtors’ outstanding balance with the defendant, i.e., in the preference period, the debtors’ balance ranged from $1 million owed to a $1 million credit balance; while, in the historical period, the debtors’ daily balance was always greater than $1 million and was generally between $3-4 million.33 The Third Circuit also noted that the bankruptcy court did not find the credit limit to be the deciding factor.34 The bankruptcy court considered the newly imposed credit limit, the change in terms, the new requirement that payments needed to be made by wire transfer.35 As stated by the Third Circuit in affirming the bankruptcy court’s ruling:

The Bankruptcy Court also properly considered the length of time the parties had engaged in the type of dealing at issue, the way the payments were made, whether there appeared to be any unusual action by either the debtor or creditor to collect or pay on the debt, and whether the creditor did anything to gain an advantage in light of the debt- or’s deteriorating financial condition. Each of these factors weighed in favor of a finding that the disputed transfers were not “ordinary” under § 547(c)(2)(B).36

Although argued by the Trustee, the He-chinger Court did not use, nor mention, the DSO methodology in its analysis (or any other statistical calculation, for that matter) in determining whether preferential transfers were within the ordinary course. Nor will this Court.37

In the Historical Period, the Debt- or made 20 transfers to Defendant. It is notable that the parties do not dispute the invoice dates or the payment dates — they only dispute how to calculate the range of *490payments and their import. The range of payments was 41-95 days after invoice. Defendant argues that four (4) of these transfers should be excluded from consideration as they are “outliers” (made 95, 81, 78, and 77 days after invoice). The Trustee disagrees that the outliers should be disregarded.38 Here, the difference in average days to pay in the Historical Period and Preference Period, inclusive of outliers, is seven (7) days or, excluding the outliers, two (2). The Court does not find either difference to be problematic or to take the preferential transfers outside of the normal course of dealings between the Debtor and Defendant.39 Thus, even when including the outliers, the timing of the payments was in the ordinary course of business.

The Trustee also asserts that Defendant has not met its burden because it did not identify the payee. The Trustee asserts that any payments made out to “Brand Industrial Solutions, LLC” (or any other entity other than the named Defendant) should not be included in the historical period. However, Defendant submitted uncontroverted evidence to support the name change from Brand Industrial Solutions, LLC to Industrial Specialists, LLC (the named Defendant).40 Defendant’s evidence includes the State of Delaware Certificate of Amendment, Brand Industrial Solutions LLC Certificate of Formation *491and the certification of the Secretary of State of the State of Delaware certifying the aforementioned certificates. Based on these certificates, the Court concludes that the payments made by the Debtor to Brand Industrial Solutions, LLC and those made to Industrial Specialists, LLC are, in fact, payable to the same entity. As such, Defendant has met its burden in showing that the payments made in the Historic Period were made to the same entity as the payments made in the Preference Period.

Furthermore, there is no evidence of change in the amount of the subject transfers such that payments in the Preference Period were in an amount more than usually paid; nor that the payments were tendered in a different manner from previous payments; nor that Defendant took any unusual action to collect such debts from the Debtor; nor that Defendant did anything to gain an advantage as a result of the Debtor’s deteriorating financial condition. The Court finds that the evidence of the range of payments is adequate for Defendant to carry its burden that the payments made during the Preference Period were similar to those made during the Historical Period.

iii. Conclusion

Based on the length of relationship between the Debtor and Defendant, the timing of payments, and the historical billing practices, the Court finds that the Transfers were made in the ordinary course of business and are therefore not voidable pursuant to section 547(c)(2)(A).

CONCLUSION

For the foregoing reasons, the Court will grant the Motion and enter summary judgment in favor of Defendant by finding that the Transfers are not voidable as they are protected by the ordinary course defense set forth in section 547(c)(2)(A). An order will be issued.