Recent growth in the use of artificial intelligence (“AI”) is changing business processes at a rapid pace, and the management of credit relationships is not immune from this influence. Indeed, AI can use machine learning and predictive analytics to better identify customers at risk of non-payment and to communicate effectively with those customers to optimize collection. Used correctly, these tools can be a valuable part of credit management and may enhance the ability to get payments in the door. But if the customer making those payments is insolvent and ends up in bankruptcy, the use of AI may impact a creditor’s ability to keep those payments and create exposure to preference liability under section 547(b) of the United States Bankruptcy Code (11 U.S.C. §§ 101 et seq., hereinafter, the “Bankruptcy Code”).
Preferential Transfers and Defenses
We begin with a quick primer on preference liability under section 547(b). Subject to a few enumerated affirmative defenses, a debtor or trustee in bankruptcy may generally avoid and recover as “preferential” a transfer of an insolvent debtor’s property (over a threshold amount) made on account of an unsecured antecedent debt within the 90 days prior to bankruptcy.
While this definition of “preferential transfer” seems to capture virtually every payment made by a debtor to its unsecured creditors during the 90 days before its bankruptcy filing, section 547(c) of the Bankruptcy Code provides affirmative defenses that can shield a creditor from liability. The two most commonly used defenses are:
(i) the “subsequent new value” defense under section 547(c)(4), providing a dollar-for-dollar reduction of preference liability for additional unpaid goods or services provided after payment of one or more of the alleged preferential transfers; and
(ii) the ordinary course of business defense under section 547(c)(2), protecting payments made consistent with either the prior history of the parties’ credit practices, or the “ordinary business terms” of the creditor’s industry. These alternative criteria are presented disjunctively in section 547(c)(2). However, some courts have suggested that intensified collection efforts could invalidate a defense under both alternative prongs of section 547(c)(2). See In re: Lyondell Chemical Company, 2015 WL 5560283, at *9 (Bkrtcy.S.D.N.Y., 2015) (“the Court notes that there is nothing in the record indicating that LR2 took any ‘extraordinary collection efforts’ that could jeopardize the . . . satisfaction of the elements of the ordinary business terms defense). Furthermore, to prevail on an ordinary course of business defense based on ordinary business terms, a creditor “must provide admissible non-hearsay testimony related to industry credit payment, and general business terms in order to support its position.” FBI Wind Down, Inc. Liquidating Tr. v. CareersUSA, Inc. (In re FBI Wind Down, Inc.), 614 B.R. 460, 495 (Bankr. D. Del. 2020). Where a defendant presents only its own practices without any general industry standards for comparison, it has not met its burden. Id.
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