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In re Molded Acoustical Products

filed: March 11, 1994.


On Appeal From the United States District Court For the Eastern District of Pennsylvania. (D.C. Civ. No. 92-03700).

Before: Becker, Nygaard, and Alito, Circuit Judges.

Author: Becker


BECKER, Circuit Judge.


When a debtor makes a payment to an ordinary unsecured creditor within 90 days before declaring bankruptcy, assuming that a number of other statutory elements are met, the payment will be stigmatized as an avoidable "preference." See 11 U.S.C.A. §§ 547(b), (f) (1993). If so, the debtor's estate will be able to recoup the payment, forcing the erstwhile preferred creditor to fend for the remnants of the estate as an equal alongside the rest of the unsecured creditors. A creditor may sidestep that unhappy contingency and bring itself within one of the unavoidable exceptions to the preference statute, however, if it can show that the transfer was (A) incurred in the ordinary course of both the debtor's and the creditor's business; (B) made and received in the ordinary course of their respective businesses; and (C) "made according to ordinary business terms." 11 U.S.C.A. § 547(c)(2) (1993).

In this appeal the parties ask us to decide the meaning of the last of these three elements -- that the transfer must have been "made according to ordinary business terms." Almost all courts of appeals to have explored its meaning have read the phrase broadly to refer to what is ordinary in the trade or business in which the creditor and debtor operate; just one court of appeals has read the term more narrowly, giving the term a construction that refers exclusively to what is "ordinary" between the involved creditor and debtor.*fn1 The question is, for us, one of first impression.*fn2 It is also one of great importance, as the requirement at issue strikes a balance between two conflicting policies, each central to the effectuation of the purposes underpinning the preference rule.

On the one hand the preference rule aims to ensure that creditors are treated equitably, both by deterring the failing debtor from treating preferentially its most obstreperous or demanding creditors in an effort to stave off a hard ride into bankruptcy, and by discouraging the creditors from racing to dismember the debtor. On the other hand, the ordinary course exception to the preference rule is formulated to induce creditors to continue dealing with a distressed debtor so as to kindle its chances of survival without a costly detour through, or a humbling ending in, the sticky web of bankruptcy. See H.R. REP. No. 595, 95th Cong., 1st Sess. 177-78 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6138; Union Bank v. Wolas, U.S. , 112 S. Ct. 527, 533, 116 L. Ed. 2d 514 (1991).

We believe that the Court of Appeals for the Seventh Circuit delivered the best rendering of the text of § 547(c)(2)(C) when it held that "'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 range should be deemed extraordinary and therefore outside the scope of subsection C." In re Tolona Pizza Prods. Corp., 3 F.3d 1029, 1033 (7th Cir. 1993) (emphasis in original). We will embellish the Seventh Circuit test, however, with a rule that subsection C countenances a greater departure from that range of terms the longer the pre-insolvency relationship between the debtor and creditor was solidified.

In this case the bankruptcy court rejected creditor/appellant Fiber Lite Corporation's ("Fiber Lite" or "the creditor") claim that it fit within the § 547(c)(2) exception and instead entered judgment in favor of the debtor/appellee Molded Acoustical Products, Inc. ("the debtor") in the amount of the preference adjusted downward by the amount of "new value" Fiber Lite provided the debtor during the preference period, and the district court affirmed the bankruptcy court's order in all respects. But neither court applied the interpretation of subsection C which we announce today. We will nonetheless affirm the district court's order, as, upon review of the record developed in the bankruptcy court, it is clear beyond cavil that Fiber Lite did not sustain its burden of showing that the transfers at stake were made according to ordinary business terms, even under our moderated interpretation of that phrase. That is to say, we are satisfied that even had the bankruptcy court applied the proper standard in its determination of whether the third prong of § 547(c)(2) was met, it would have had to reach the same result as it did using the standard it in fact applied.


a. Background

Fiber Lite sells, among other things, uncured fiberglass, a product that the debtor, itself a supplier of molded fiberglass products to the automotive industry, purchased for use in its fiberglass molding processes. Fiber Lite and the debtor had been conducting business for about twenty-one months prior to May 26, 1989, the day when the debtor voluntarily filed a petition for reorganization under Chapter 11 of the Bankruptcy Code (the "Code"), 11 U.S.C.A. §§ 101-1330 (1993).*fn3 Six months into the bankruptcy, the debtor instituted an adversary proceeding against Fiber Lite pursuant to sections 547(b) and 550(a)(1) of the Code, 11 U.S.C.A. §§ 547(b), 550(a)(1) (1993), in an effort to avoid and recover allegedly preferential transfers made by it during the 90-day pre-petition preference period.

The complaint alleged that during that time period the debtor had transferred to Fiber Lite payments in the amount of $552,389.44, and further alleged that all of that amount constituted an avoidable preference. Throughout the 90-day period preceding the debtor's filing of its bankruptcy petition, however, Fiber Lite had continued to supply the debtor with fiberglass products on open account. But the debtor had caught up on its overdue payments during this critical period: the parties stipulated (at trial) that the debtor had transferred $451,224.64 to Fiber Lite during the pre-petition preference period, whereas Fiber Lite had provided the debtor with only $269,328.04 in new goods. See In re Molded Acoustical Prods., No. 89-20868T, Order at 3 (Bankr. E.D. Pa. 1992) (Adv. No. 89-1077).

Following a bench trial, the bankruptcy court entered judgment in favor of the debtor and against Fiber Lite, finding inter alia that the debtor was insolvent at the time of the transfers*fn4 and that Fiber Lite had failed to bring itself within the safe harbor § 547(c)(2) affords. Although the bankruptcy court found that Fiber Lite had met, according to § 547(g),*fn5 its burden of proving that the transfers in question were made in the ordinary course of each party's business and in the ordinary course of dealings between the two parties, see § 547(c)(2)(A), (B), the court held that they were not made according to the ordinary terms in the industry generally, see § 547(c)(2)(C). In reaching this Conclusion, the court stressed that Fiber Lite's "industry terms" evidence, which consisted solely of its separate dealings with one other company and that company's wholly-owned subsidiary, constituted ...

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