Contributed by Joshua Nemser.
An employer makes two payments to its health insurance provider on account of pre-existing debts. Less than 90 days after the date of the first payment, the employer files a voluntary petition under chapter 7 of the Bankruptcy Code. Avoidance actions ensue. What happens? Keep calm and read on: it’s time to discuss preferences.
Back to Basics: What Is a Preferential Payment?
The 90-day period prior to commencement of a bankruptcy case can be fraught with drama. Creditors that appreciate the imminence a filing might exert pressure on the would-be debtor to get paid first. In an attempt to keep their business afloat, executives of the would-be debtor might pick and choose the order in which they pay creditors. In short, there is temptation to override a fundamental principle of bankruptcy law: the egalitarian treatment of similarly situated creditors. To combat this temptation, the Bankruptcy Code generally prescribes that transfers made by a debtor to a creditor within that 90-day pre filing period — the preference period for non-insider creditors — may be avoided if that transfer was made on account of an antecedent debt and while the debtor was insolvent if that transfer enabled the creditor to receive more than it would receive under a chapter 7 liquidation.
Health Alliance provided individual and group health insurance services to debtor EIY Co., Inc. as of April 1, 2012. Health insurance premiums were due on the first of each month, subject to a 31-day grace period during which EIY could make the premium payment without penalty. On May 1, Health Alliance issued an invoice to EIY for its May group premium. This invoice was paid on June 15 (past the 31-day grace period). On June 1, Health Alliance issued another invoice to EIY for its June group premium. This invoice was paid on June 25 (within the 31-day grace period). EIY’s chapter 7 trustee commenced an adversary proceeding seeking to recover from Health Alliance these allegedly preferential payments. Health Alliance raised two affirmative defenses: (1) the transfers were made in the ordinary course of EIY’s business or according to ordinary business terms, and (2) alternatively, the transfers constituted contemporaneous exchanges for value.
Ordinary Course Defense
The ordinary course of business defense calls for a two-step analysis. The first step looks at the obligation itself: Was it incurred in the ordinary course of business of both the debtor and the creditor? If so, proceed to the second step, which asks: Was the transfer on account of the obligation (a) made in the ordinary course of business or financial affairs of the debtor and the creditor or (b) made according to ordinary business terms? If either prong (a) or prong (b) is satisfied, the transfer is not avoidable.
With respect to the first step, the EIY parties conceded that selling health insurance was an ordinary course business activity of Health Alliance and that obtaining health insurance was an ordinary business activity of EIY.
The case hinged upon the second step of the analysis.
With respect to prong (a), the court could not summarily determine that the transfers were made in the ordinary course of business of the parties. Because “the parties’ relationship was a scant three months,” Health Alliance was unable to establish any “consistency or pattern of payments whatsoever during its brief relationship with [EIY].”
In its analysis of prong (b), the court reviewed payment practices within the health insurance industry in general, as well as the actual terms of the policy between the parties. The court found that the policy “contains terms which are within industry standards and the range of terms commonly found in such policies.” The policy specifically contemplated a grace period for payment, and so, the court held that the transfer made within the grace period was made according to ordinary business terms. The transfer made outside of the grace period, however, “was not made according to the policy terms;” the court accordingly held that a trial would be necessary to determine whether that transfer was a preferential payment.
Contemporaneous Exchange Defense
To prevail on the affirmative defense of a contemporaneous exchange for value, a creditor “must establish that it provided new value to the [d]ebtor in exchange for payments that were intended to be contemporaneous with the receipt of new value and were, in fact, substantially contemporaneous.” Although Health Alliance generally raised this defense with respect to both transfers, it did not offer a developed supporting argument. The court did not analyze the transfer made within the grace period because it already had found it to be not avoidable. As far as the transfer made outside of the grace period, the court permitted Health Alliance to address this defense at trial.
EIY is a helpful Bankruptcy 101-level refresher on preference law. The more novel takeaway from EIY is that transfers made pursuant to contractual terms may be considered “made according to ordinary business terms.” Even if they are technically late.
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