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.
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_______________________
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