Opinion
Case Nos. 98-12547 through 98-12570-PHX-CGC Jointly administered, Adversary 00-00648.
February 28, 2008
UNDER ADVISEMENT DECISION
I. Introduction
In 1997, a special committee of the Board of Directors of Boston Chicken, Inc. ("BCI") engaged Shearman Sterling ("Shearman") to advise it in connection with a proposed merger and roll up transaction. The transaction closed July 15, 1998. BCI filed for Chapter 11 relief on October 5, 1998. During the ninety days prior to the filing, BCI paid Shearman three checks for legal fees in the total amount of $582,832.54. The Trustee has sued Shearman to recover these amounts as preferential. The parties agree that all five subsections of § 547(b) have been satisfied. Shearman asserts that the payments may not be avoided because they were made in the ordinary course of business under § 547(c)(2). As a result of previous decisions by the Court, the remaining and determinative issue is whether the payments were made in the ordinary course of business or financial affairs of BCI and Shearman.
The Court rules that they were so made and therefore will grant judgment to the defendant.
II. Facts
The key facts in this matter are undisputed and are set forth in the Joint Pretrial Statement filed January 26, 2007, which is incorporated herein by reference. Key to the Court's analysis is when the bills were sent and when the bills were paid. During the course of representing BCI, Shearman sent BCI the eight separate bills. The table below summarizes the bills sent and the payments made: Bill # Date Sent Date Paid Amount Paid Days Outstanding
See Docket #121.
Trial was held on January 31, 2007. During the trial Thomas Novak, Shearman's Manager of Revenue Administration, testified to the following:
— Bills were paid on average within 72 days of billing;
— 92% of bills were paid between 0-179 days of billing;
— Clients regularly paid bills at the closing of financing or at the completion of a project;
— Bills covering 60 days, 45 days and 20 days of work were normal within the practice;
— Payment of multiple invoices with one check was ordinary;
— There was no policy regarding engagement letters; and
— That payment of Bills #3, #4, #5, #6, #7, and #8 were within the ordinary course of Shearman's business.
Additionally, the January 25, 2007 Deposition of Michael Daigle, BCI's general counsel at the time payments were made was admitted into evidence at the trial. Mr. Daigle testified that professionals, such as Shearman, were paid as a priority so that BCI could avoid bankruptcy. III. Analysis
See Deposition of Michael Daigle, January 25, 2007 at p. 9, ll. 8-21 and p. 11, l. 24 — p. 12, l. 18.
Pursuant to 11 § 547(c)(2)(B) a trustee may not avoid a transfer to the extent that such transfer was, "made in the ordinary course of business or financial affairs of the debtor and the transferee." To show that a transfer was made in the ordinary course of business, "a creditor must prove by a preponderance of the evidence that `. . . the debt and its payment are ordinary in relation to past practices between the debtor and the creditor.'" Sulmeyer v. Suzuki (In re Grand Chevrolet Inc., 25 F.3d 728, 732 (9th Cir. 1994) (citing In re Food Catering Housing Inc., 971 F.2d 396, 398 (9th Cir. 1992)). The court in Grand Chevrolet set out the following factors to consider in determining whether transfers are ordinary in relation to past practices:
1) the length of time the parties were engaged in the transactions at issue;
2) whether the amount or form of tender differed from past practices;
3) whether the debtor or creditor engaged in any unusual collection or payment activity; and,
4) whether the creditor took advantage of the debtor's deteriorating financial condition.
Id. F.3d 728 at 732. These factors are not exclusive. Schoenmannn v. BCCI Constr. Co. (In re NorthPoint Commc'ns Group, Inc.), 361 Br. 149, 157 (N.D.Cal. 2007). Instead, "all evidence shedding light on the practices between the parties, past and present, should be considered." Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com), 504.F.3d 775, 791 (9th Cir. 2007) (citing NorthPoint Commc'ns).
The Trustee argues that to meet its burden of proof regarding past practices, Shearman must show either a baseline of dealing between the parties or if there is insufficient history to establish a baseline, the Court must look only to the parties' agreements to define the baseline. The Trustee suggests that the Court should rely on Chocolat, Inc. v. Fisher Development, Inc. (In re Chocolat, Inc.), 176 B.R. 540 (N.D.Cal. 1995) for the proposition that a sole payment may definitively establish a payment history. However, the sole payment by the debtor in In re Chocolat was just one of the factors the court looked to in its decision. As stated in Chocolat, the court must decide whether "the parties themselves considered the transaction ordinary . . . based on the facts of the particular case." Id. at 549.
The Court rejects the approach suggested by the Trustee. Instead, the Court adopts the all encompassing approach as suggested by Wood v. Stratos Product Development, LLC (In re Ahaza Systems, Inc.), 482 F.3d 1118 (9th Cir. 2007). The 9th Circuit in In re Ahaza determined that despite a lack of history between parties, a creditor could establish ordinary business relationship under § 547(c)(2)(A) when there was a first-time debt between the parties. The 9th Circuit held in such a circumstance the "debt should be compared to the debt agreements into which we would expect the debtor and creditor to enter as part of their ordinary business operations." Id. at 1126. Accordingly, "a first time debt must be ordinary in relation to this debtor's and this creditor's past practices when dealing with other similarly situated parties." Id. Importantly, the 9th Circuit agreed with and cited the language in Kleven v. Household Bank F.S.B., 334 F.3d 638 (7th Cir. 2003) which analyzed first time transfers under § 547(c)(2)(B). This strongly suggests that the Ahaza analysis is applicable to both § 547(c)(2)(A) and (B).
Accordingly, the Court will adopt the approach outlined in Ahaza. Rather than looking solely at Bills #1 and #2 to establish a baseline and in the absence of an explicit agreement between the parties, the Court will look to BCI's and Shearman's "past practices when dealing with other similarly situated parties." The quoted wording from Kleven in Ahaza is instructive in this matter:
When there are no prior transactions with which to compare, the court may analyze other indicia, including whether the transaction is out of the ordinary for a person in the debtor's position, or whether the debtor complied with the terms of the contractual arrangement, generally looking to the conduct of the parties, or to the parties' ordinary course of dealing in other business transactions.
Ahaza at 1126 (quoting Kleven at 334 F.3d 638, 642).
It is undisputed that "[t]he timing and manner of [BCI]'s payment of [Shearman]'s bills was consistent with the timing and manner of [BCI]'s payments to its other professional service providers, including law firms." Accordingly, the Court must determine if the timing and payment of the bills were consistent with Shearman's past practices with other similarly situated clients.
Joint Pre-Trial Statement, Statement of Uncontested Facts, Fact #40.
To prove its past practices, Shearman presented Thomas Novak, Shearman's Manager of Revenue Administration, to testify regarding Shearman's historic billing practices. Through this testimony, the Court learned that bills for other clients were paid on average within 72 days of billing and that 92% of bills were paid between 0-179 days of billing. In the BCI matter, Bills #3 through #8 were paid on average within 61 days of billing and between 2 and 121 days of billing. This payment pattern falls within the standard range for client payments at Shearman. The wide range of dates is also explainable because, according to Mr. Novak, clients regularly paid bills at the closing of financing or at the completion of a project. The BCI case was no different. Additionally, Bills #3 through #8 covered an ever decreasing number of days. Again, according to Mr. Novak, it was typical to send bills covering, 60 days, 45 days and 20 days of work. Mr Novak also testified that payment of multiple invoices with one check was ordinary at Shearman. Accordingly, BCI's "batch payment", as termed by the Trustee, was a standard course of dealing. Mr. Novak also explained the lack of a written agreement between the parties, stating that there was no policy regarding engagement letters. In the end, Mr. Novak concluded that payment of Bills #3, #4, #5, #6, #7, and #8 were within the ordinary course of business for Shearman. Based on the testimony of Mr. Novak, Shearman has established to the Court's satisfaction that the timing and payment of bills by BCI was an ordinary business practice between the parties.
Also instructive to the Court's decision is the testimony of Michael Daigle, BCI's general counsel at the time of payment, in his January 25, 2007 Deposition. Mr. Daigel testified that professionals, including Shearman, that were involved in obtaining financing were paid as soon as possible. When asked why these professional were given priority, Mr. Daigle answered, "we felt that there was a lot that had to happen in order to keep the company out of bankruptcy, and we couldn't get that done unless the professionals were working." When asked what would have happened if the merger transaction was not completed, Mr. Daigle responded, "if the bank financing did not happen [BCI] was out of money . . . [BCI] was effectively out of business." Through this testimony, Shearman has established that BCI's payments to Shearman were ordinary in the eyes of BCI.
The payment practice of BCI described by Mr. Daigle is similar to that in In re Healthcentral.com. There, the debtor began to experience cash flow problems. In response, the debtor adopted an "old school" approach to paying its creditors in which core staff would meet in person weekly and decide which creditor to pay. Based on the "old school" system, the debtor continued to pay an important creditor which received a preferential payment. The 9th Circuit determined that the "old school" system of paying creditors was not per se out of the ordinary and overturned summary judgment. This Court holds that this is exactly the type of situation where an "old school" approach is appropriate and ordinary under the circumstances.
The Trustee characterizes the transfers in question as "batch" payments. As such, the Trustee argues that they should be avoided because the "baseline" established during the during the pre-preference period was to pay one bill with one check. In support of this contention, the Trustee cites In re Food Catering and Moltech Power Systems, Inc. v. Tooh Dineh Industries, Inc. (In re Moltech Power Systems, Inc.), 327 B.R. 675 (Bankr. N.D.Fla 2005). The Court is not persuaded by these cases. First, in both cases, an increase in batch payments was not the sole basis for finding § 547(c)(2)(B) inapplicable. Second, the standard set forth in In re Moltech Power Systems, Inc. Is that "[a]n increase in batch size of only one or two invoices standing alone is probably not enough to constitute `substantial deviation.' However, the increase in batch size of roughly four here provides additional evidence that the payments made during the preference period were not ordinary." Id. at 684 (internal citations omitted). Here the alleged increase in batch size was one and three invoices respectively. On its face, the increase in batch size does not satisfy the standard set forth in Moltech.
As would be expected in a relationship based on the restructuring of a company, Shearman and BCI had a short relationship. It began in November of 1997 and was completed by July 1998. Of the eight bills sent during this time period only two were paid in the pre-preference period, Bill #1 and Bill #2. Bills #1 and #2 only covered one billing period, November 6, 1997 through January 21, 1998. Here, while one billing period may be instructive, it is not dispositive to establish the relationship between the parties.
Shearman has established that BCI paid pre-petition bills that were between 59-80 days old with the average number of days outstanding of 69.5 days via the payment of Bills #1 and #2. The Trustee argues that each of the post-petition transfers should be avoided because they fall outside of the payment range and the average number of days outstanding. The argument of the Trustee fails as to Bills #3, #5, #6 and Bill #7 (Part B) which were paid in 84, 54, 91 and 59 days respectively. Payments of these bills were generally within the range of payment of 59-80 days and approximated the average payment of 69.5 days. Even applying the Trustee's test, this leaves only Bill #4 (121 days), Bill #7 (Part A) (15 days) and Bill #8 (2 days) as potentially outside the baseline. However, as discussed above, the Court has already determined that the payments were in the ordinary course of business based on the relationship between the parties.
The Court is guided by the Supreme Court's decision in Barnhill v. Johnson, 503 U.S. 393, 402 (1992) which states that the purpose of § 547(c)(2) is "designed to encourage creditors to continue to deal with troubled debtors on normal business terms by obviating any worry that a subsequent bankruptcy filing might require the creditor to disgorge as a preference an earlier received payment." Here, Shearman was fulfilling the purpose espoused in Barnhill. To find otherwise would be counterintuitive. Harkening back to Justice Stewart's view of pornography, the court in McGranahan v. Fisher Nut Company (In re Central Valley Processing, Inc.), 360 B.R. 676, 676-77 (Bankr.E.D.Cal. 2007), observed that it knows the ordinary course of business when it sees it. Here, this Court sees an ordinary course of business between the parties. Accordingly, it finds in favor of Shearman.
IV. Conclusion
For the foregoing reasons, the Court concludes that the attorneys fees were incurred in the ordinary course of business and therefore judgment will be given to the defendant. Counsel for Shearman is to lodge a form of order consistent with this decision for the Court's signature.
So ordered.