Kilpatrick Stockton LLP; Atlanta
This article addresses potential preference exposure for workout payments made pursuant to restructuring agreements between a creditor and debtor. Specifically, this article will address whether these payments are free from avoidance under the “ordinary course of business” defense.
The Ordinary Course of Business Defense in General
The “ordinary course of business” defense set forth in §547(c)(2) of the Bankruptcy Code provides:
(c) The trustee may not avoid under this section a transfer--
(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was--
(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or
(B) made according to ordinary business terms.
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St. John's University School of Law; Jamaica, N.Y.
Commercial real estate projects are typically financed with non-recourse mortgage loans for tax reasons. If the borrower defaults, the lender’s sole recourse is to foreclose on the mortgaged property to recover on any balance owed under the loan; it may not recover against the other assets of the borrower or its principals. This financing arrangement may create uncertainty for lenders, who are understandably concerned that the borrower and its principals may misuse the loan proceeds, thereby jeopardizing the lender’s full recovery in a foreclosure. This concern, coupled with rating agency pressures resulting from the increased securitization of commercial real estate loans, has led to the widespread use of non-recourse carve-outs, also known as “bad boy” guaranties. Generally, a “bad boy” guaranty provides for full-recourse liability against the guarantor if the borrowers, their principals or both commit certain “bad” acts that threaten the value of the mortgaged property. Examples of non-recourse carve-outs include:
- losses for fraud or intentional misrepresentation;
- losses from the misappropriation of rents;
- losses from the failure to pay taxes;
- allowing further encumbrance of the mortgaged property without the lender’s consent;
- transfers of secured property without the lender’s consent; and
- the borrower filing a voluntary bankruptcy petition.
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The Young and New Members Committee and the Secured Credit Committee will be hosting a joint panel discussion at the Annual Spring Meeting titled Practice Tips, Pitfalls and Recent Trends When Bankruptcy and the Uniform Commercial Code Collide. This program will review recent decisions involving Uniform Commercial Code issues that have arisen in bankruptcy cases, including, but not limited to, perfection and priority disputes between and among debtors, secured creditors and other parties. The presentation will also cover §503(b)(9) reclamation disputes and various other issues. The panelists will be Hon. Mary Grace Diehl, U.S. Bankruptcy Judge (N.D. Ga.); Ingrid Michelsen Hillinger, a professor of law at Boston College Law School; Carl N. Kunz, III, a partner in the Bankruptcy and Creditors’ Rights Group of Morris James LLP in Wilmington, Del.; and Stephen V. Falanga, the head of the Bankruptcy, Reorganization and Creditors' Rights group of Connell Foley LLP in Roseland, N.J. Young and new members attending the Annual Spring Meeting are encouraged to attend the presentation. Register today!
The New & Young Member Committee is a great way to meet other new members and to learn how ABI committees work. Have you ever considered getting involved in one or more of the other 21 topic committees? Joining a topic committee is a great way to connect with colleagues in your practice area and begin to develop professional relationships that will benefit you for years to come. Like the Young and New Members Committee, each ABI committee has a newsletter, listserve and committee sessions at ABI meetings. Click here to learn more about the other 21 active ABI committees!
