During the last week of October, the liquidating trustee of the Radio Shack liquidating trust filed lawsuits in the United States Bankruptcy Court for the District of Delaware. The lawsuits were seeking to avoid “preferential” payments made by Radio Shack to its creditors within 90 days of the filing of its bankruptcy petition (the “Preference Period”), which took place on February 15, 2015.

There were approximately 200 creditors sued for allegedly being “preferred” by Radio Shack, including commercial landlords, utility providers, banks, logistics companies and providers of electronic goods, among other trade creditors. It is important that the creditors receiving these complaints understand that there are defenses to these actions.

One of the strongest defenses for a creditor being sued is the ordinary course of business defense. To prove this defense, evidence of business custom and practice is considered. Under 11 U.S.C. 547(c)(2), the obligation being paid must be incurred in the ordinary course of business or financial affairs of the debtor, and the payment must have been made in the ordinary course of business of both the debtor and creditor (subjective test) or the payment was made under “ordinary business terms” (objective test). Thus, there are two standards that can be proved by a creditor to successfully defend a preference action under this defense. Providing either one will allow the creditor to prevail in its defense.

Subjective Test – We Always Did Business This Way

The Subjective test considers the consistency of transactions between the debtor and creditor during the preference period. The court looks at factors such as:

  • The length of time parties have engaged in the type of dealing at issue;
  • Whether the transfer was in an amount greater than what is usually paid;
  • Whether payments were tendered in a manner different from prior payments;
  • Whether there appears 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 view of the debtor’s deteriorating financial condition.

For example, if a creditor received a payment from Radio Shack of $5,000 on the same day every month for at least one year and this conduct continued during the Preference Period, the creditor would have a strong defense under the subjective prong of the ordinary course of business defense. However, if the debtor, whose financial condition weakened in the months leading up to the Preference Period, became sporadic in making payments or the payment sums began to vary, the defense would be weakened.

Objective Test – The Industry Conducts Business This Way

The Objective test looks at the way in which companies that are similar to the debtor engage in business. Only unusual dealings that fall outside of the broad industry standards should be considered extraordinary and outside of the ordinary course of business among the industry. This test is often more difficult to prove than the subjective test because the creditor has to rely on industry data from experts to show that payment terms were consistent within the industry, and industry practices and expert analysis may vary.

Other Defenses

There are several other defenses that a creditor being sued in a preference case may rely on, like the “new value” and “substantially contemporaneous exchange” defenses, which may be available to defend a preference action.

If your company is being sued by the liquidating trustee, it is important that you promptly discuss the lawsuit with counsel. For more information on defending a preference action, or other bankruptcy issues, please feel free to contact Stark & Stark’s Bankruptcy & Creditor’s Rights Group to discuss your situation.