Information on bankruptcy preference and trade creditors' defenses.

1. Adding Insult to Injury: Bankruptcy Preference & Trade Creditors’ Defenses Presented by DORMAN WOOD, CEW, CCE July 23, 2009 DORMAN WOOD associates, LLC (c) 2009

2. DORMAN WOOD associates, LLC (c) 2009 YOU WANT ME TO PAY BACK HOW MUCH?!!!!!!!!@@@@####$$$%%%%&

3. DORMAN WOOD associates, LLC (c) 2009 TOTAL PAYMENTS LISTED = $17,821,740.18 , COMPLAINT FILED IN COURT ADDED $6,278,812.54 FOR A TOTAL CLAIM OF $24,100,552.72

4. WHAT IS A PREFERENCE? DORMAN WOOD associates, LLC (c) 2009 A preference or preferential transfer is any transfer of property, including money, made by an entity to a creditor of that entity within 90 days prior (including filing date) to the entity’s filing for bankruptcy United States Bankruptcy Code §547(b), 11 U.S.C. The trustee may avoid any transfer of an interest in the debtor in property – (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made [a] on or within 90 days before the date of the filing of the petition; or [b] between 90 days and one year before the date of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if – [a] the case were a case under Chapter 7 of this title; [b] the transfer had not been made; and [c] such creditor received payment of such debt to the extent provide by the provisions of this title

5. WHO CAN AVOID A TRANSFER? DORMAN WOOD associates, LLC (c) 2009 A bankruptcy trustee or debtor in possession (the unsecured trade creditors’ committee can act on behalf of the DIP) has the power to “avoid” a transfer and recover the property transferred. The property recovered (less the trustee’s fees and legal expenses) is shared with all of the entities creditors. The end result being that companies can be forced to return payments they received within 90 days of their customer’s bankruptcy. A preference claim is intended to discourage unusual action during a debtor’s slide into bankruptcy and to promote equality of treatment among creditors (whether paid or not).

6. DORMAN WOOD associates, LLC (c) 2009 I GOT PAID WITHIN 90 DAYS OF MY CUSTOMER’S BANKRUPTCY, DO I HAVE TO GIVE THE MONEY BACK? NOT NECESSARILY! Some transfers are protected from avoidance by “Affirmative Defenses” set forth in the Bankruptcy Code. “Affirmative” means that the defendant (YOU) will have the burden of proof. DOES THE TRANSFER QUALIFY FOR AN AFFIRMATIVE DEFENSE? Affirmative defenses include: 1) the transfer was made in a contemporaneous exchange for new value to the debtor; 2) the transfer was made in the ordinary course of business; 3) the transfer was a security interest in property securing new value for the debtor; 4) the transfer was made after the creditor provided new value; 5) the transfer was of property with an aggregate value of less than $5,475. CONTEMPORANEOUS EXCHANGE: Payments received as ‘cash on delivery’ (COD) and that result in the immediate shipment to the debtor is described as a contemporaneous exchange and is not recoverable.

8. DORMAN WOOD associates, LLC (c) 2009 ORDINARY COURSE OF BUSINESS CONT’D: After October 2005 , the Code Required a creditor to only prove 2 components or prongs of “ordinary course” §547 (c)(2)(b) : (a) the debt was incurred by the debtor in the ordinary course of business between the debtor and transferee (creditor); (b) the payment was made in the ordinary course of the business or financial affairs of the debtor and transferee; OR (c) the payment was made according to ordinary business terms used in the industry in which the debtor and transferee operate Components (a) and (b) are considered the “subjective test” and requires testimony from company representatives about the way the two parties had historically conducted business with each other. The transferee (creditor) must Prove that the subject transfer(s) was/were consistent with the past practice between the two parties.

11. DORMAN WOOD associates, LLC (c) 2009 HISTORICAL PAYMENT ANALYSIS A payment history analysis should extend beyond the 90 day preference period. A payment history analysis should also include at least one year period prior to the beginning of the 90 day preference period. Two years if it is to your advantage. The payment history analysis is used to establish and compare several facts of the relationship between the parties: • DSO – time between invoice date and payment date; the creditor must establish that the range of DSO’s in the preference period is well within the range of DSO’s in the pre-preference period. • Range of Payments – the difference between the shortest payment time and the longest payment time (the low and the high) • Courts have often compared the range of payments between the preference period and the pre-preference period.

12. DORMAN WOOD associates, LLC (c) 2009 PAYMENT ANALYSIS EXAMPLE Check Num Amt Paid Paymt Rec Dt Inv Number Inv Date # Days 1400551920 21970.8 02/05/01 794299683 12/13/00 54 1400553795 46235.8 02/14/01 794317034 02/09/01 5 1400553795 24070 02/14/01 794317035 02/09/01 5 1400553795 138788.01 02/14/01 794317036 02/09/01 5 1400553881 676.6 02/15/01 794251802 10/09/00 129 1400553881 23231.7 02/15/01 794261267 10/20/00 118 1400553881 1250 02/15/01 794264175 10/25/00 113 1400553881 4103.09 02/15/01 794277461 11/09/00 98 1400553881 250 02/15/01 794282675 11/16/00 91 1400553881 48438.8 02/15/01 794299080 12/12/00 65 1400553881 9482.75 02/15/01 794299081 12/12/00 65 1400553881 270063.5 02/15/01 794299082 12/12/00 65 1400553881 153281.75 02/15/01 794299684 12/13/00 64 1400553881 3942.5 02/15/01 794299687 12/13/00 64 1400553881 88989.3 02/15/01 794299688 12/13/00 64 1400553881 20480.28 02/15/01 794299690 12/13/00 64 1400553881 10387 02/15/01 794301155 12/14/00 63 1400553881 207.5 02/15/01 794301156 12/14/00 63 1400553881 4807.6 02/15/01 794301157 12/14/00 63

13. DORMAN WOOD associates, LLC (c) 2009 OVERALL DSO COMPARISON 1999 2000 2001 DSO AVERAGE VENTURE LINE DSO HISTORY: 73.6 71.1 73.8 72.8 INDUSTRY DSO HISTORY: 63.3 68 58.5 67.3 DSO BRIDGE V MERISEL: 63.7 OVERALL AVERAGE DSO: 67.9

14. DORMAN WOOD associates, LLC (c) 2009 THE MEAN The Mean is the average – it is computed by adding the DSO’s and dividing by the number of invoices. Courts have often considered the Mean as a measure of whether the payment practices during the preference period were ordinary in relation to the payment practices in the pre-preference period. See Official Unsecured Creditors Committee v. Ford Motor Credit Company (In re Ed Jefferson Contracting, Inc.), Bankr. E.D. Mo PAYMENT CONSISTENCY Historical data must establish not only that the payments were within the creditors’ usual payment experience with the debtor, but that the method of payment (i.e., standard company check v cashier’s check or wire transfer) did not change in any manner during the preference period.

15. DORMAN WOOD associates, LLC (c) 2009 ORDINARY BUSINESS TERMS Generally, the harder prong to prove is that payment of the debt was ordinary in the relevant industry . This usually requires expert testimony and external evidence from the creditor’s competitors. Testimony from the creditor’s own employees may be considered self-serving and given little weight by the courts. Sourcing this information can be problematic, as it is often considered proprietary in a competitive industry. Outside experts attempt to confirm this type of information from a variety of sources; i.e., NAICS/SIC, credit reporting agencies, industry credit group statistics and industry trade associations. See In re Bridge Information Systems, Inc. vs Gulfcoast Workstation Corp., Bankr. E.D. Mo 2006

16. DORMAN WOOD associates, LLC (c) 2009 WHAT IS AN INDUSTRY? The case most referred to with respect to establishing what an industry is, is Tolana Pizza Products in which the court stated: “… the most important thing is not that the dealings between the debtor and the allegedly favored creditor conform to some industry norm but that they conform to the norm established by the debtor and the creditor in the period before, preferably well before, the preference period. That condition is satisfied here—if anything……” “ We conclude that “ordinary business terms” refers to the range of terms that encompasses the practices in which firms similar in some general way to the creditor in question engage, and that only dealings so idiosyncratic as to fall outside that broad range should be deemed extraordinary...” See Tolona Pizza Products Corp., U.S. Court of Appeals, 7 th Circuit No. 92-3386, August 19, 1993

17. DORMAN WOOD associates, LLC (c) 2009 BAPCPA RESTRICTIONS SMALL PREFERENCE CLAIMS – No preference claim can be filed unless the total of all alleged preferential transfers received by a particular creditor total at least $5,000. VENUE – Preference claims of less than $10,000 can only be filed in the jurisdiction where the defendant resides ( a corporate creditor ‘resides’ in any district where it has sufficient contacts to subject itself to jurisdiction, so there may be multiple districts where a corporate defendant may be sued)

18. PREFERENCE SUITS AND PRACTICAL DEFENSE STRATEGIES DORMAN WOOD associates, LLC (c) 2009

19. KNOW YOUR ENEMY – Who can collect preference claims DORMAN WOOD associates, LLC (c) 2009 The strategies for defending against a preference claim are clearer if you understand who your opponent is and what his/her incentives are. Preference claims may be brought by any of several parties. These include attorneys representing: • the debtor • court appointed trustee • the unsecured trade creditors committee • bankruptcy plan administrator • collection agency “ Keep your friends close – hold your enemies closer”…An Arabian proverb

36. DORMAN WOOD associates, LLC (c) 2009 CASES OF INTEREST Bridge Information Systems v Merisel/MOCA - $24.1m preference claim , Bankr. E.D. Mo Plaintiff alleged that certain practices between the parties were not ‘ordinary course’ of business: 1) Use of bank lockbox system for collection of customer payments; 2) Use of remittance advice for payment application; 3) Monthly calls by creditor to debtor regarding payments; 4) Creditor extended greater credit limit and longer terms than competitors; 5) Terms listed on creditor’s web page were not the terms extended to debtor; 6) Terms listed on creditor’s web page were not normal for the industry; 7) Product sold by creditor could have been purchased from other sources by debtor; 8) Original invoices issued to debtor by creditor could not be reproduced; 9) Accuracy or validity of reprinted invoices could not be verified due to a computer system conversion. Bridge Information Systems v Gulfcoast Workstation Corp. - $2.2m preference claim – appeal of previous decision , Bankr. E.D. Mo Gulfcoast Workstation Corp. filed an appeal in an effort to have an earlier court decision against their ordinary course of business defense overturned. In the original suit, the plaintiff alleged that business transactions between the parties were not in the ordinary course of business and that defendant had failed to prove their new value defense. In the original suit, plaintiff had alleged that the use of remittance advice by Bridge and payment application by Gulfcoast in accordance with the remittance advice was not ordinary. Gulfcoast offered no evidence to support their defense other than the testimony of their controller and general manager, which the court found insufficient. The appellate court upheld the district court’s original decision. Hardwood P-G, Inc/Custom Forest Products v Columbia Forest Products - $3.1m preference claim, Bankr. W. D. Texas Plaintiff alleged that certain practices between parties were not ‘ordinary course’ of business: 1) Changed credit terms; 2) Stopped selling certain products to debtor; 3) Did not adhere to corporate credit/collection policy; 4) calling customer regarding late payments; 5) No written document retention policy

37. DORMAN WOOD associates, LLC (c) 2009 SUGGESTED BOOKS FOR YOUR LIBRARY Bankruptcy In Practice, 4 th Edition , American Bankruptcy Institute, $125. www.abiworld.org/publications/bookstore Preference Handbook, 2 nd Edition , American Bankruptcy Institute, $45.www.abiworld.org/publications/bookstore The Electronic Evidence and Discovery Handbook , American Bar Association, $129.95 www.abanet.org/ababookstore NOTE: None of the information contained in or discussed during this presentation should be considered as legal advice. Advice of competent legal counsel should always be sought in bankruptcy and other creditors’ rights matters.

38. DORMAN WOOD associates, LLC (c) 2009 Th-Th-Th-Th-Th-Th-Th-Th-Th-That's all folks! www.witness4u.com [email_address] V. 719-641-0169 F. 623-584-6041