Preference Analysis – The Pillowtex Decision

Demystifying Valuation, Economic Damages + Forensic Accounting

On April 14, 2010, Judge Kevin J. Carey, Chief Judge of the United States Bankruptcy Court for the District of Delaware, issued a decision in the Pillowtex bankruptcy case that has significant implications with respect to the ordinary course of business (“OCB”) defense.

Pillowtex filed for bankruptcy prior to the 2005 expansion of the preference defense standard at SS547(c)(2) to prohibit avoidance of transfers made in the ordinary course of business between the parties or ordinary business terms in the industry of the debtor or creditor.  However, this ruling once again highlights the importance of determining a supportable baseline of the typical payment history between the debtor and creditor in analyzing preference claims.

According to the Pillowtex ruling, to determine whether transactions between the creditor and debtor are consistent before and during the 90 day preference period, courts consider the following:

1. the length of time the parties have engaged in the type of dealing at issue;
2. whether the subject transfer was in an amount more than usually paid;
3. whether the payments were tendered in a manner different from the previous payments;
4. whether there appears any unusual action by either the debtor or the creditor to collect or pay on the debt; and
5. whether the creditor did anything to gain an advantage (such as gain additional security) in light of the debtor’s deteriorating financial condition.

In addition to an analysis of these factors, the Court also considered factual information regarding the historical payment data between the debtor and the creditor in the period prior to the 90 day preference period.  While Judge Carey was ruling on a Motion for Summary Judgment, and was, therefore, not considering the credibility of each party’s argument, he did rule that he “could not conclude that the transfers were made within the ordinary course of business between the parties.”

Judge Cary’s decision was based, in part, upon data provided by the debtor that indicated that the number of days to pay had dropped significantly during the preference period.  The creditor did not dispute this, but rather argued that the reduction in the number of days to pay was due to the Company’s desire to receive a cash discount.  Based on this ruling, it appears that a proper statistical analysis of the “ordinary course” of payment history between the parties prior to the preference period will continue to be a key battleground in preference actions.

The next part in this series will show how financial experts can utilize the median absolute deviation to determine a range of ordinary course in the pre-preference period.

By Henry & Horne