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Seventh Circuit Refines the Standard for Calculating the Baseline of Payment History Between the Parties

Unsecured Creditors Comm. of Sparrer Sausage Co. v. Jason’s Foods, Inc., No. 15-2356, 2016 U.S. App. LEXIS 10569 (7th Cir. June 10, 2016)

Debtor Sparrer Sausage manufactures sausage products. Defendant Jason’s Foods, a wholesale meat supplier provided unprocessed meat products to the Debtor. During the relevant 90-day period, Sparrer paid 23 invoices to Jason’s, totaling nearly $590,000, which Sparrer’s creditors’ committee (exercising trustee avoidance powers) sought to recover. Conceding that the payments were otherwise avoidable preferences, Jason’s asserted that the payments had been made in the ordinary course of business between it and Sparrer.

The Bankruptcy Court determined that during the historical period, Sparrer generally paid invoices from Jason’s within 16 to 28 days and that 12 of the 23 invoices in the preference period, totaling about $280,000, were ordinary and unavoidable because they fell within that range. The remaining 11 invoices, totaling nearly $310,000, were not made in the ordinary course because they were made either too early (14 days) or too late (29, 31, 37, and 38 days) after the invoice date. The District Court affirmed the bankruptcy court’s decision. On further appeal to the Seventh Circuit, Jason’s challenged the bankruptcy court’s determination that Sparrer typically paid invoices within 16 to 28 days. The Defendant argued that bankruptcy court’s calculation of 16 to 28 days range for the baseline period was too-narrow and it did not accurately reflect the companies’ payment practices during that period.

The Seventh Circuit stated that the bankruptcy courts typically calculate the baseline payment practice between a creditor and debtor either by way of average-lateness method or the total-range method. In the case at bar, the bankruptcy judge used average lateness method (determining the average invoice date and adding some time to it in both directions) and his decision to use that method was within his discretion and there was no reason to disturb that. However, the Court pointed out that the problem was with the application of the method. The Seventh Circuit concluded that the bankruptcy judge did not apply the average lateness method appropriately and that the application was “flawed.”

The Court found that the bankruptcy court erroneously applied Quebecor World and its so-called bucketing analysis to arrive at 16 to 28 days baseline period. It calculated the average invoice age during the historical period (22 days) and added 6 days on both sides of that average to arrive at 16 to 28 days range. However, neither the facts nor the bankruptcy court’s analysis in that case had any resemblance to this case.
In re Quebecor World, the average invoice age during the historical period was 27.56 days, while the average invoice age during the preference period was 57.16 days – a difference of nearly 30 days. Given such a stark disparity, the bankruptcy court grouped historical-period invoices in buckets by age. That analysis revealed that the debtor paid 88% of invoices during the historical period within 11 to 40 days after the invoice date. Expanding this range by five days on the high end, the court determined that any invoices paid more than 45 days after the invoice date were outside the ordinary course.

However, in the case at bar, 16-to-28-day baseline range encompassed just 64% of the invoices that Sparrer paid during the historical period and the judge offered no explanation for the narrowness of this range. Thus, the Seventh Circuit questioned the basis on which the bankruptcy court excluded the invoices that Sparrer paid within 14 days or 29 days when these payments were among the most common during the historical period. The Court expanded the baseline period and stated that by indeed adding just two days to either end of the range, the analysis would capture 88% of the invoices paid during the historical period, a percentage much more in line with the Quebecor World analysis. Thus, a 16-to-28-day baseline appeared not only excessively narrow but also arbitrary.

Accordingly, the Seventh Circuit applied the broader range of baseline period and found that Sparrer paid 9 of the 11 alleged invoices within 14, 29, and 31 days of issuance and only two invoices were outside the 14-to-30 day expanded baseline. This limited Jason’s preference liability to just $60,679.00. Jason’s had also supplied new value worth $63,514.00 to Sparrer and Jason’s was entitled to a reduction of its preference liability in this amount. After the revised analysis, the new value that Jason’s supplied to Sparrer ($63,514.00) exceeded its remaining preference liability ($60,679.00). Thus, the preference liability was entirely offset and the Committee was not entitled to recover anything from Jason’s.