IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
__________________________
No. 01-60265
__________________________
In The Matter Of: GULF CITY SEAFOODS, INC.,
Debtor,
GULF CITY SEAFOODS, INC.,
Appellant,
versus
LUDWIG SHRIMP CO., INC.,
Appellee.
_________________________________________________________________
Appeal from the United States District Court for the
Southern District of Mississippi
July 11, 2002
Before GARWOOD, JOLLY and DAVIS, Circuit Judges.
E. GRADY JOLLY, Circuit Judge:
This bankruptcy case deals with the interpretation and
application of the “ordinary course of business” defense for a
preferential transfer of funds. During the preference period, the
debtor, Gulf City Seafoods (“Gulf City”), made numerous payments to
one of its suppliers, Ludwig Shrimp Company (“Ludwig”). The
bankruptcy court found that Gulf City had made most of these
payments in the ordinary course of business and therefore refused
to avoid those payments. The district court agreed and affirmed
the judgment of the bankruptcy court. Gulf City now appeals.
Gulf City argues that Ludwig failed to show that the payments
in question were made “according to ordinary business terms” -- a
necessary showing to establish the “ordinary course of business”
defense. 11 U.S.C. § 547(c)(2). Following other circuits, we hold
that a party claiming that payments were made “according to
ordinary business terms” must show that the payments in question
fall somewhere in the range of payment practices of the relevant
industry. See, e.g., In re Tolona Pizza Prods. Corp., 3 F.3d 1029,
1032-33 (7th Cir. 1993). In this case, the record reflects that
Ludwig offered no such evidence. Accordingly, we reverse the
judgment of the district court with instructions to remand this
case to the bankruptcy court for further proceedings not
inconsistent with this opinion.
I
Gulf City was in the business of purchasing, processing, and
reselling seafood products. Ludwig supplied Gulf City with
seafood. The two parties had a longstanding business relationship.
A peculiar feature of their relationship was Gulf City’s method of
paying Ludwig for its seafood. Gulf City would take delivery of
seafood and write Ludwig one or more checks for that delivery.
Ludwig would not cash the checks right away. Instead, Ludwig would
cash the checks when Gulf City indicated that it had sufficient
2
funds in its account to cover the amount due on each respective
check. Before Gulf City filed for bankruptcy, on average, 40 to 45
days elapsed between the delivery of seafood and the date that the
check (or checks) paying for that delivery cleared the bank.
On October 11, 1996, Gulf City filed for bankruptcy. During
the preference period -- which ran from July 13, 1996 through
October 11, 1996 -- twenty-four checks payable to Ludwig cleared
Gulf City’s account. Of these checks, seventeen cleared Gulf
City’s account within 40 to 45 days after their receipt.1 The
remaining seven checks, totaling $86,113,2 cleared Gulf City’s
account within ten to eighteen days after their receipt.
The bankruptcy court found, on the basis of past practices,
that the checks that cleared Gulf City’s account within 40 to 45
days after their receipt represented payments made in the ordinary
course of business between Gulf City and Ludwig. It therefore
denied Gulf City’s request to have the payments on these checks
avoided.3 Gulf City appealed. After reviewing this finding under
1
Typically, there was a four-day lag between the date that
Ludwig deposited a check and the date that the check cleared Gulf
City’s account.
2
The bankruptcy court erroneously found that these checks
totaled $86,313.
3
In contrast, the bankruptcy court found that the seven checks
that cleared Gulf City’s account between ten to eighteen days after
their receipt did not represent payments made in the ordinary
course of business. Accordingly, the bankruptcy court avoided
these payments as preferential. The district court affirmed this
finding by the bankruptcy court. Neither party appeals this part
of the district court’s judgment.
3
the clearly erroneous standard, the district court affirmed. Gulf
City now appeals. “We review the decision of the district court by
applying the same standards of review to the bankruptcy court's
findings of fact and conclusions of law as applied by the district
court." Kennard v. MBank Waco, N.A. (Matter of Kennard), 970 F.2d
1455, 1457 (5th Cir. 1992).
II
The bankruptcy code disfavors the transfer of the debtor’s
property in the ninety days before bankruptcy. Accordingly, the
bankruptcy code allows the trustee to avoid such transfers. See 11
U.S.C. §§ 547(b)(1)-(5). The policy reasons underlying this
statutory provision have been stated thusly:
[T]o prevent the debtor during his slide toward
bankruptcy from trying to stave off the evil day by
giving preferential treatment to his most importunate
creditors, who may sometimes be those who have been
waiting longest to be paid. Unless the favoring of
particular creditors is outlawed, the mass of creditors
of a shaky firm will be nervous, fearing that one or a
few of their number are going to walk away with all the
firm’s assets; and this fear may precipitate debtors into
bankruptcy earlier than is socially desirable.
Tolona Pizza, 3 F.3d at 1031 (Posner, J.) (citations omitted). If,
however, a preference period transfer was made “in the ordinary
course of business,” the bankruptcy code precludes the trustee from
avoiding the transfer. 11 U.S.C. § 547(c)(2). In other words, the
ordinary course of business defense provides a safe haven for a
creditor who continues to conduct normal business on normal terms.
Without this defense, the moment that a debtor faced financial
4
difficulties, creditors would have an incentive to discontinue all
dealings with that debtor and refuse to extend new credit. Lacking
credit, the debtor would face almost insurmountable odds in its
attempt to make its way back from the edge of bankruptcy.
Although the policy behind the “ordinary course of business
defense” is clear, the code recognizes that it may not always be
easy to discern the difference between (1) payments that are truly
“ordinary” between the debtor and the creditor and (2) payments
that represent collusive arrangements designed to favor the
particular creditor during the debtor’s slide into bankruptcy. To
address this practical problem, the bankruptcy code requires the
creditor to satisfy three elements: The creditor must prove that
the 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. 11 U.S.C. § 547(c)(2).
In sum, the creditor must show that as between it and the
debtor, the debt was both incurred and paid in the ordinary course
of their business dealings and that the transfer of the debtor’s
funds to the creditor was made in an arrangement that conforms with
ordinary business terms -– a determination that turns the focus
away from the parties to the practices followed in the industry.
5
Today, we focus on the third prong of the ordinary course of
business defense: Whether Gulf City’s payments to Ludwig were made
“according to ordinary business terms.”4 Nearly all other circuits
have held that a payment is “according to ordinary business terms”
if the payment practices at issue comport with the standard of the
industry. See Lawson v. Ford Motor Co. (In re Roblin Indus.,
Inc.), 78 F.3d 30, 39 (2d Cir. 1996); Fiber Lite Corp. v. Molded
Acoustical Prods., Inc. (In re Molded Acoustical Prods., Inc.), 18
F.3d 217, 223 (3d Cir. 1994); Advo-System, Inc. v. Maxway Corp., 37
F.3d 1044, 1050 (4th Cir. 1994); Logan v. Basic Distrib. Corp. (In
re Fred Hawes Org., Inc.), 957 F.2d 239, 243-44 (6th Cir. 1992); In
re Midway Airlines, Inc., 69 F.3d 792, 797 (7th Cir. 1995); Jones
v. United Sav. & Loan Ass’n. (In re U.S.A. Inns of Eureka Springs,
Ark., Inc.), 9 F.3d 680, 683-84 (8th Cir. 1993); Sulmeyer v. Suzuki
Pacific (In re Grand Chevrolet, Inc.), 25 F.3d 728, 733 (9th Cir.
1994); Clark v. Balcor Real Estate Finance, Inc. (In re Meridith
Hoffman Partners), 12 F.3d 1549, 1553 (10th Cir. 1993); In re A.W.
& Assocs., Inc., 136 F.3d 1439, 1442-43 (11th Cir. 1998). Under
the holdings of these cases, the relevant inquiry is “objective”;
that is to say, we compare the credit arrangements between other
4
Gulf City also argues that the payments at issue were not
incurred or paid in the ordinary course of business dealings
between Gulf City and Ludwig. We find no reversible error in the
bankruptcy court’s determination that these payments were
“ordinary” as between Gulf City and Ludwig and therefore satisfied
the first two prongs of the “ordinary course of business” defense.
See 11 U.S.C. §§ 547(c)(2)(A)&(B).
6
similarly situated debtors and creditors in the industry to see
whether the payment practices at issue are consistent with what
takes place in the industry.5 By consistent, we do not necessarily
mean identical. In In re Tolona Pizza Products Corp., 3 F.3d
1029, 1032-33 (7th Cir. 1993), Judge Posner recognized that strict
conformity to some industry standard may be inappropriate because
credit arrangements will not be identical for every debtor and
creditor in an industry. Importantly, the law “should not push
businessmen to agree upon a single set of billing practices.” Id.
at 1033. In Judge Posner’s view, “‘ordinary business terms’ refers
to the range of terms that encompasses the practices in which firms
similar in some general way to the creditor in question engage, and
that only dealings so idiosyncratic as to fall outside that broad
5
In making this showing, Ludwig should provide some evidence
of credit arrangements of other creditors and debtors in the
industry. Following the Second, Sixth and Seventh Circuits, we
hold that Ludwig cannot meet its burden under this objective test
by simply showing that (1) its arrangement with Gulf City is
similar to the credit arrangements Ludwig has with other debtors,
or (2) the arrangement is similar to Gulf City’s arrangements with
other creditors. See In re Roblin, 78 F.3d at 43; In re Midway
Airlines, 69 F.3d at 797-98; In re Fred Hawes, 957 F.2d at 246 n.7
(“[I]n looking at industry standards, a court may also refer to the
manner in which the parties conduct their business with other,
unrelated parties. This evidence alone, however, is insufficient
to prove ‘ordinary business terms’ by a preponderance of the
evidence.”). Therefore, Ludwig did not meet its burden of proof
under § 547(c)(2)(C) by simply offering testimony that with its
other customers, 35 days, on average, elapsed between the shipment
of the seafood and payment. The creditor, however, may satisfy its
burden through testimony by its own company representatives about
the practices of other creditors and debtors in the industry,
subject of course to applicable evidentiary rules. Whether such
testimony is appropriately reliable is a matter best left to the
bankruptcy court.
7
range should be deemed extraordinary and therefore outside the
scope of subsection C.” Id. (first emphasis in original).
We are in general agreement with the view expressed by Judge
Posner, particularly that the statutory language should not be
construed to place businessmen in a straightjacket. In any event,
we will follow all the other circuits and adopt an “objective” test
for deciding whether a payment arrangement was made “according to
ordinary business terms”; that is, the question must be resolved by
consideration of the practices in the industry –- not by the
parties’ dealings with each other.6 Because “ordinary business
terms” sets an outer boundary to the parties’ practices, the
ultimate question is simply whether a particular arrangement is so
out of line with what others do that it fails to be “according to
ordinary business terms.” We leave this case by case determination
where it belongs –- with the bankruptcy judge. We only say that
the judge must satisfy himself or herself that there exists some
basis in the practices of the industry to authenticate the credit
arrangement at issue. Otherwise the practice cannot be considered
an “ordinary” way of dealing with debtors.
A question remains: How should the bankruptcy court go about
defining the relevant industry from which to draw the industry
standard for challenged credit arrangements?
6
This issue was left open by our decision in GasMark Ltd.
Liquidating Trust v. Louis Dreyfus Natural Gas Corp. (In re Gasmark
Ltd.), 158 F.3d 312, 318 (5th Cir. 1998).
8
Defining the industry whose standard should be used for
comparison is not always a simple task. See Tolona Pizza, 3 F.3d
at 1033 (questioning whether the appropriate industry included
“the [sellers] of sausages to makers of pizza? The [sellers] of
sausages to anyone? The [sellers] of anything to makers of
pizza?”). In our view, for an industry standard to be useful as a
rough benchmark, the creditor should provide evidence of credit
arrangements of other debtors and creditors in a similar market,
preferably both geographic and product.7 We think that the
industry benchmark inquiry is best illustrated by application: In
this case, Ludwig might provide evidence, to the extent that it is
reasonably available, of credit practices between suppliers to whom
Gulf City might reasonably turn for its seafood supply and firms
with whom Gulf City competes for consumers, from which a bankruptcy
judge can determine whether there is some basis to find that the
Ludwig-Gulf City arrangement is not a virtual stranger in the
industry.8
7
The Third Circuit has also suggested that the bankruptcy
court should look to market definition principles from antitrust
law to determine the relevant industry for comparison. See Molded
Acoustical, 18 F.3d at 227 n.12.
8
We recognize that there will be situations in which the
debtor has only one or two companies to which it can reasonably
turn for supplies or credit. In these cases, we are concerned that
a creditor might not be able to show that its payment practices are
“according to ordinary business terms” because the pool is too
small to make such a determination. In these small market cases,
the creditor may show similar credit arrangements in other local
industries with similar characteristics. We leave it in the first
instance to the bankruptcy court to decide whether a particular
9
Here, Ludwig offered no evidence of payment practices between
other creditors and debtors, much less evidence of payment
practices of other debtors and creditors in the same industry.
Accordingly, the bankruptcy court clearly erred in finding that the
seventeen payments at issue were made “in the ordinary course of
business.”9
III
For the aforementioned reasons, we reverse the judgment of the
district court and remand with instructions to remand to the
bankruptcy court for further proceedings not inconsistent with this
opinion.
REVERSED AND REMANDED.
industry standard benchmark offered by the creditor satisfies the
“objective” inquiry.
9
On appeal, Gulf City also argues that the bankruptcy court
incorrectly calculated the damages for the seven payments it found
were not in the ordinary course of business. This argument is
based on a misinterpretation of the bankruptcy court’s finding.
The bankruptcy court clearly concluded that seven specific
payments, and only those payments, were not made in the ordinary
course of business. In the light of this finding, the bankruptcy
court’s calculation of damages was clearly correct.
10