G.H. Leidenheimer Baking Co. v. Sharp

United States Court of Appeals
Fifth Circuit
F I L E D
REVISED FEBRUARY 8, 2006
UNITED STATES COURT OF APPEALS February 6, 2006
FOR THE FIFTH CIRCUIT
Charles R. Fulbruge III
_______________________ Clerk

No. 05-30445
_______________________

IN THE MATTER OF: SGSM ACQUISITION COMPANY, LLC,

Debtor.

-------------------------

G.H. LEIDENHEIMER BAKING COMPANY, LTD.,
Appellant,

versus

R. PATRICK SHARP, III,
Appellee.

*****************************************************************

_______________________

No. 05-30455
_______________________

In the Matter of: SGSM Acquisition Company, LLC,

Debtor.

--------------------------

PATTON SAUSAGE COMPANY, INC.; A.T. PATTON COMPANY, INC.,
Appellants,

versus

R. PATRICK SHARP, III,
Appellee.
 On Appeal from the United States District Court
for the Eastern District of Louisiana
Docket Nos. 2:04-CV-352 and 2:04-CV-360

Before JONES, Chief Judge, and DeMOSS and CLEMENT, Circuit
Judges.

EDITH H. JONES, Chief Judge:

Appellants G.H. Leidenheimer Baking Company, Ltd.

(“Leidenheimer”) and Patton Sausage Company (“Patton”) bring this

consolidated appeal, challenging the lower courts’ treatment of

preference payments each received from a grocery store chain before

it filed bankruptcy. See 11 U.S.C. § 547(b). Because none of the

payments at issue qualified for the ordinary course of business

defense,1 and the subsequent advance defense was properly applied

to both appellants, we AFFIRM as to Patton and AFFIRM AS MODIFIED

with respect to Leidenheimer.

I. Background

Debtor SGSM, which operated a chain of grocery stores,

continued to pay many suppliers during the ninety-day preference

period prior to its filing for Chapter 11 bankruptcy relief.

Leidenheimer and Patton, in turn, continued to supply SGSM stores

with bakery goods and meats and were paid accordingly. The

preference period lasted from December 25, 1998, to March 25, 1999.

1
On October 17, 2005, the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005 (“BAPCPA”) became effective, including a substantial
broadening of the ordinary course of business defense. See 11 U.S.C.
§ 547(c)(2). This opinion deals with the pre-amendment defense under the same
statutory reference.

2
At issue in this appeal are two suppliers’ defenses based upon

11 U.S.C. § 547(c)(2) (ordinary course of business) and 11 U.S.C.

§ 547(c)(4) (subsequent advances). Absent such defenses, the

payments are voidable as preferences under 11 U.S.C. § 547(b).

SGSM made six payments totaling $49,246.78 to Leiden-

heimer during the preference period. In an adversary proceeding

brought by SGSM’s liquidation agent, Leidenheimer asserted that the

payments were subject to both the subsequent advance and ordinary

course of business defenses. The bankruptcy court allowed only the

subsequent advance defense as to all six payments. After deducting

subsequent new value from each SGSM payment, $8,014.09 remained

avoidable by the trustee as a preference.2

Patton received eight payments for a total of $140,162.56

during the preference period. The bankruptcy court, in another

adversary proceeding, accorded these payments the same legal status

as those to Leidenheimer. After the court allowed only a

subsequent advance defense as to all eight payments, Patton was

ordered to return $47,437.31 as a preference.

The district court affirmed the bankruptcy court in both

cases, rejecting the ordinary course defense as to all payments and

further holding that Leidenheimer and Patton were prohibited by law

2
The parties dispute this amount as well. The $8,014.09 figure
includes $352.59 in negative transfers, representing product that SGSM returned
to Leidenheimer. Leidenheimer contends that these returns did not constitute
transfer, and that the district court erred in construing them as such.

3
from applying two preference defenses in tandem to the same

payment. The parties appealed pursuant to 28 U.S.C. § 158(d).

II. Discussion

The preference provision of the Bankruptcy Code furthers

the purpose of equitable distribution among creditors by authoriz-

ing the trustee (or debtor-in-possession) to recover most payments

made by the debtor on account of antecedent debt within ninety days

before bankruptcy. The theory is that when the preferential pay-

ments are returned, all creditors can share ratably in the debtors’

assets, and the race to the courthouse, or the race to receive

payment from a dwindling prebankruptcy estate, will be averted.

Because some creditors, however, receive payments for shipping

supplies that enable the debtor to continue doing business, to that

extent they act to forestall an ultimate bankruptcy filing.

Congress enacted several affirmative defenses against preference

recovery in order to balance the competing interests. Two of the

most important defenses are at issue in the case: that for

payments in the ordinary course of business and that for subsequent

advances given the debtor.

The lower courts’ treatment of these defenses will be

reviewed by our standard criteria. In bankruptcy cases, this court

“perform[s] the same function, as did the district court: Fact

findings of the bankruptcy court are reviewed under a clearly

erroneous standard and issues of law are reviewed de novo.”

4
Nationwide Mut. Ins. Co. v. Berryman Prods. (In re Berryman), 159

F.3d 941, 943 (5th Cir. 1998). A finding of fact is not clearly

erroneous “if it is plausible in the light of the record read as a

whole.” Baker Hughes Oilfield Operations, Inc. v. Cage (In re

Ramba), 416 F.3d 394, 402 (5th Cir. 2005).

Evidentiary rulings are reviewed under the abuse of

discretion standard. Pipitone v. Biomatrix, Inc., 288 F.3d 239,

243 (5th Cir. 2002). “A trial court abuses its discretion when its

ruling is based on an erroneous view of the law or a clearly

erroneous assessment of the evidence.” Bocanegra v. Vicmar Servs.,

Inc., 320 F.3d 581, 584 (5th Cir. 2003). We first address the

ordinary course of business defense asserted by both appellants.

A. Ordinary Course of Business Defense

The Bankruptcy Code states that a payment made during the

preference period need not be returned to the debtor’s estate

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 finan-
cial affairs of the debtor and the transferee; and
(C) made according to ordinary business terms.

11 U.S.C. § 547(c)(2). A creditor asserting an ordinary course of

business defense must prove all three statutory elements by a

preponderance of the evidence. Gulf City Seafoods, Inc. v. Ludwig

Shrimp Co. (In re Gulf City Seafoods), 296 F.3d 363, 367 (5th Cir.

5
2002). The first element is not at issue here, as the debts

incurred by SGSM to the appellants arose out of ordinary

transactions to keep its grocery stores supplied. Section

547(c)(2)(B), which asks whether the transfer was made according to

the ordinary business affairs of the parties, is the “subjective”

prong of the ordinary course defense. Finally, in examining

industry practice under § 547(c)(2)(C), the relevant inquiry is

“‘objective’; that is to say, we compare the credit arrangements

between other similarly situated debtors and creditors in the

industry.” Id. at 368. Some latitude exists under the objective

prong, as the court should not impose a single norm for credit

transactions within an industry; the inquiry is whether “a

particular arrangement is so out of line with what others do” that

it cannot be said to have been made in the ordinary course. Id. at

368-69. As to what constitutes the relevant industry, Gulf City

held that the term ordinarily encompasses “suppliers to whom [the

debtor] might reasonably turn for [similar supplies] and firms with

whom [the debtor] competes for customers.” Id. at 369. Each

appellant challenges the court’s application of the subjective and

objective elements of the defense.

There were no unusual features of SGSM’s payments, e.g.,

no extra charges or penalties, within the preference period other

than their being somewhat delayed. The dispute over the subjective

6
prong thus dealt with a comparison of the average invoice-to-

payment intervals before and during the preference period.

Leidenheimer asserted an ordinary course of business

defense to all six payments made by SGSM.3 The bankruptcy court

conducted its analysis according to Gulf City and determined that

the average time between invoice and payment during the pre-

preference period was twenty-one days and the median was seventeen

days. In the preference period, however, the average jumped to

38.67 days, with a median of 37. Leidenheimer makes much out of

the fact that the bankruptcy court averaged all payments, neglect-

ing to examine each payment “individually,” but this is not the

case. Indeed, the court examined each set of invoices and payments

individually and concluded that only the payment made on

February 19, 1999 (discharging invoices an average of 25.22 days

old), was made in the parties’ ordinary course of business. On

appeal, while still contending that all SGSM payments were made in

the ordinary course, Leidenheimer emphasizes the payments made on

February 12 and 19, 1999. The February 12 payment is difficult to

fit within the subjective prong; Leidenheimer itself states that

this payment discharged invoices 35.37 days old on average. Both

payments were made significantly later than those during the pre-

preference period. Based on these facts, it was not clearly

erroneous for the bankruptcy court to conclude that only the

3
This court’s review of the evidence is hampered by the failure of
appellants’ counsel to include record citations in their briefs.

7
February 19, 1999, payment satisfied the subjective prong of

ordinary course analysis.

Patton fares better on the subjective prong analysis. We

need not recount the evidence in detail to conclude that the lower

courts correctly found at least three payments to Patton, made on

February 19, March 9, and March 19, 1999, satisfied the subjective

prong.

The larger issue for both suppliers, however, is the

objective prong of ordinary course analysis.4 Whether a creditor

has met its burden in proving this prong “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.” Gulf

City, 296 F.3d at 369. The parties agreed that the relevant

industry is grocery DSD (direct store delivery). To prove that the

SGSM payments were made in the ordinary course for the industry,

Leidenheimer offered testimony from two experts: Nicholas Pyle and

John Stephens. Pyle is a lobbyist for a bakers’ trade group, and

Stephens is the president and owner of a seafood supply company.

The bankruptcy court refused to qualify Pyle as an expert and did

not permit him to testify. The court also refused to qualify

4
Under the BAPCPA, the second and third prongs of the ordinary course
defense have become disjunctive rather than, as here, conjunctive.

8
Stephens as an expert. None of these decisions represents an abuse

of discretion.

Pyle, a lobbyist for the bakery industry, had never

testified in court as an expert in any capacity, had no experience

with accounts receivable or accounts payable in a retail capacity,

had a limited accounting background, and had never worked for a DSD

vendor. The basis of his testimony derived largely from Internet

research and from speaking with members of other relevant trade

associations, not from any personal experience in the industry.

The evidentiary deficiencies of his qualifications speak for

themselves.

Stephens’s experience could also be considered

problematic. His background in DSD was as a vendor in the seafood

supply industry. The court concluded that this produced a too-

narrow and one-sided view of the grocery business. More important,

Stephens’s testimony concerning industry practices was vague at

best. In his deposition, Stephens alluded to the existence of

varying norms and terms among DSD vendors, and he could offer only

an “educated guess” as to what might constitute normal terms for

baked goods vendors. Proving industry practice should not be an

extraordinary burden for creditors, and it is certainly conceivable

that a fellow businessman and DSD supplier like Stephens could have

provided relevant testimony for Leidenheimer despite his lack of

personal involvement in the baked goods industry. His actual

9
testimony, however, evinced a lack of expert knowledge necessary to

establish DSD or baked goods industry credit terms favorable to

Leidenheimer. Consequently, the court did not clearly err in

holding that Leidenheimer failed to meet its burden of proof on the

objective prong of the ordinary course of business defense.5

As Stephens was the only witness utilized by Patton to

prove the objective prong, and his testimony was rejected by the

bankruptcy court for the same reasons pertinent to Leidenheimer,

the bankruptcy court did not abuse its discretion in refusing to

qualify Stephens.

B. Subsequent Advance Defense

Having failed to substantiate SGSM’s payments as within

the ordinary course of business defense, Leidenheimer and Patton

resort to the subsequent advance defense. This defense aims to

protect creditors who have furnished and been paid for ongoing

supplies or revolving credit to a debtor in distress, because such

transactions fortify the debtor’s business and may avert

bankruptcy. At worst, the extensions of new value do not harm

existing creditors. Accordingly, the trustee in bankruptcy may not

avoid a transfer:

5
The trustee relied upon Todd Brents as his expert witness. Brents
was qualified by the bankruptcy court as an expert in DSD and preference actions,
based upon his long record and personal experience in both areas. It appears
from the language in the bankruptcy court’s opinion that while a portion of
Brent’s testimony was rejected by the court, it accepted the majority of Brent’s
testimony.

10
 to or for the benefit of a creditor, to the extent that,
after such transfer, such creditor gave new value to or
for the benefit of the debtor — (A) not secured by an
otherwise unavoidable security interest; and (B) on
account of which new value the debtor did not make an
otherwise unavoidable transfer to or for the benefit of
such creditor.

11 U.S.C. § 547(c)(4). Interpreting this provision, the court in

Laker v. Vallette (In re Toyota of Jefferson, Inc.), 14 F.3d 1088

(5th Cir. 1994), rejected the pre-Code “net result” rule, whereby

all new value from subsequent advances was totaled and deducted

from all eligible preference payments. The court approved a

transfer-by-transfer approach that asks whether the “(1) new value

was extended after the preferential payment sought to be avoided,

(2) the new value is not secured with an otherwise unavoidable

security interest, and (3) the new value has not been repaid with

an otherwise unavoidable transfer.” Id. at 1093 n.2. Later, in

Williams v. Agama Sys., (In re Micro Innovations Corp.), 185 F.3d

329 (5th Cir. 1999), this court adopted the rule articulated in

In re Thomas Garland, 19 B.R. 920 (Bankr. E.D. Mo. 1982), which

“allows a given extension of new value to be applied against any

preceding preference.” In re Micro Innovations, 185 F.3d at 336.

Thus, as long as new value meets the Toyota of Jefferson test, it

can be applied against any preceding payment in the preference

period.

11
 This set of tables, based upon the evidence in the

record, illustrates how the new value defense was utilized by the

lower courts:6

Table 1: Leidenheimer

Date SGSM Subsequent Preference
Payment New Value Exposure
1/15/99 $8,472.22 $6,606.97 $1,865.25
1/27/99 11,924.52 9,256.63 4,533.14
2/12/99 16,007.70 4,063.65 16,477.19
2/19/99 5,518.73 3,867.45 18,128.47
2/26/99 2,886.81 10,307.73 10,707.55
3/12/99 4,228.04 6,921.50 8,014.09

Table 2: Patton

Date SGSM Subsequent Preference
Payment New Value Exposure
12/30/98 $13,098.00 >$13,098.00 $0
1/15/99 10,925.77 >10,925.77 0
1/27/99 9,281.42 6,812.03 2,469.39
2/3/99 34,975.45 8,458.06 28,986.78
2/11/99 22,955.68 13,650.01 38,292.45
2/19/99 15,074.62 22,927.33 30,439.74
3/9/99 18,295.89 6,452.97 42,282.66
3/15/99 15,555.73 10,404.08 47,434.31

In both cases, payments made by SGSM during the

preference period were followed by subsequent product deliveries.

The Garland approach, which allowed excess new value to cancel out

prior payments still exposed as preferences, was followed by the

6
On appeal to this court, Appellants submit slightly different
figures. It is unclear where Appellants get the figures cited in their briefs,
but this court “[c]an only take the record as it finds it, and cannot add
thereto, or go behind, beyond, or outside it.” Brookins v. United States, 397
F.2d 261, 262 (5th Cir. 1968).

12
lower courts and confirms that subsequent new value was applied to

each of the payments at issue. As the ordinary course of business

defense was inapplicable to the suppliers, the lower courts

properly applied the subsequent advances defense to Leidenheimer

and Patton.7

On a minor note, Leidenheimer asserts that $352.29

credited to SGSM for returned goods should be deducted from its

preference exposure as being a “negative transfer.” A bankruptcy

appellate panel for the Tenth Circuit held, in Gonzales v. Nabisco

Div. of Kraft Foods, Inc. (In re Furr’s Supermarkets, Inc.), 317

B.R. 423 (B.A.P. 10th Cir. 2004), that transfers of baked goods

7
Because we agree with the bankruptcy and district courts that the
ordinary course of business defense did not vindicate any of the payments at
issue in this case, Appellants’ theory that multiple § 547(c) defenses may be
applied together need not be addressed. Still, it is important to note that the
practice of “double dipping,” whereby a creditor attempts to apply a second
§ 547(c) defense to a particular payment after having successfully invoked the
subsequent advance defense as to the same payment, is prohibited in bankruptcy.
See IRFM, Inc. v. Ever-Fresh Food Co. (In re IRFM), 52 F.3d 228, 233 (9th Cir.
1995); In re Toyota of Jefferson,14 F.3d at 1092-93. Section 547(c)(4) only
applies to transfers where, after receiving subsequent new value from the
creditor, “the debtor did not make an otherwise unavoidable transfer to or for
the benefit of such creditor.” Id. A transfer defended by another § 547(c)
defense is an “otherwise unavoidable” transfer for the purposes of the subsequent
advance defense. As a result, “new value on account of which [otherwise
unavoidable] payments were made cannot be used by the [creditor] under
§ 547(c)(4).” Tenn. Valley Steel Corp. v. Rockwood Water, Wastewater, & Natural
Gas Sys. (In re Tenn. Valley Steel Corp.), 201 B.R. 927, 941 (Bankr. E.D. Tenn.
1996). Stated another way, if a payment is otherwise unavoidable under § 547(c),
then the new value immediately preceding that payment cannot be used anywhere for
the purposes of the subsequent advance defense; taking the subsequent new value
deduction prior to a transfer defended under § 547(c) is double dipping.
Appellants seemingly ignore this fact in arguing that they have no preference
exposure.
A creditor is allowed to assert alternative defenses in attempting to ward
off the bankruptcy trustee. However, with respect to an individual payment made
by the debtor during the preference period, a creditor can only benefit from one
§ 547(c) defense; if the subsequent advance defense is utilized, a creditor
cannot attempt to support part of the same payment as being in the ordinary
course of business.

13
which were “damaged, out of date, or were overstocked items” should

not be included in the new value calculation, because, lacking

value, they were not a potentially avoidable transfer. Id. at 425,

428-29. The return of worthless goods “does not dilute the new

value” provided by Leidenheimer. Id. at 429. The total exposure

of Leidenheimer should be decreased to $7,761.50.

III. Conclusion

Neither Leidenheimer nor Patton sufficiently proved that

the payments they received were entitled to the ordinary course of

business defense, and the subsequent advance defense was properly

calculated in both cases, with the exception of $352.29 worth of

goods returned to Leidenheimer. Therefore, with respect to Patton,

we AFFIRM the judgments of the bankruptcy and district courts, and

with respect to Leidenheimer, we AFFIRM AS MODIFIED, reducing the

judgment against Leidenheimer to $7,761.50.

14