Chapter 4 The Data-Gathering Process and Assessing "Reasonably Certain"

• Jurisdiction: United States

Chapter 4 The Data-Gathering Process and Assessing "Reasonably Certain"

Chapter 3 discussed the billing and payment processes, how billing and payment information is recorded and gathered, and how it can be utilized for analysis. Whether it is the subjective or objective test,⁹⁵the intent of the effort is to compare the activity in one period to the activity in another period. Once an understanding of billing and payment processes is achieved, the next step is to gather sufficient relevant data to perform an analysis of the preference period transfers. Ultimately, analyses under both the subjective and objective tests rely on the information or data that is utilized. As such, to create a reasonably reliable analysis, the data-gathering and verification process is a vital component of any preference analysis. If proper actions are taken as part of the data-gathering and verification process, the end conclusions will be reasonably certain with much greater probability.

Establishing the Time Period for Analysis

The first step in gathering sufficient relevant data is often to identify the appropriate time periods to analyze, particularly with respect to the pre-preference period. To determine whether preference period transfers were ordinary under either the subjective or objective tests, it is necessary to compare the transfers in question to transfers occurring during an appropriate date range prior to the preference period.

The "preference period" is well defined as being the 90 days prior to the bankruptcy filing (or the one year prior to the bankruptcy filing for matters involving "insiders" as defined by the Bankruptcy Code). However, the pre-preference period does not necessarily have the same clarity. Courts have provided some guidance as to the duration of time that is relevant to consider. Stated another way, courts have provided guidance as to how much time is insufficient from which to draw conclusions. Provided below are excerpts from select cases in which the courts have discussed the topic of the time period of pre-preference analysis for the objective and subjective tests.

• The court in In re Archway Cookies provided in a footnote a description of several cases that it considered. The complete footnote is provided in the footnote to this paragraph below. In short, the court found examples of other courts utilizing a baseline of dealings from relationships of 18 months, 15 months, two years and three years. It also noted that one court found that a year-long relationship was not long enough.⁹⁶
• "Where parties have no extensive history of credit transactions to which a disputed payment can be related, their express agreement furnishes 'the most informative evidence left to consider' of the ordinariness of a transaction from the parties' perspective."⁹⁷
• "In this case, the parties' relationship was established over a two-year period and during their relationship there were 117 transactions between the parties. Based on the length of their business relationship and the numerous transactions between the parties, the Court finds that this relationship was of sufficient length to establish an ordinary course of dealing between the parties."⁹⁸
• In In re American Camshaft Specialties Inc., both experts utilized a period of one year prior to the preference period for purposes of their analyses.⁹⁹
• In In re T.B. Home Sewing Enterprises Inc., the court discusses that a "baseline of dealings" should be established that must be:

fixed at least in part during a time in which [debtor's] day-to-day operations were 'ordinary' in the laymen's sense of the word. Preferably, the material period should extend back into the time before the debtor became financially distressed.¹⁰⁰
In that case, the court reviewed the parties' payment history for the two years prior to the preference period.

• In In re Circuit City Stores Inc., the court was not persuaded that a one-year period prior to the preference period, as applied by certain other courts, should be utilized. Rather, the court considered that the analysis of ordinary between the parties should begin at a time prior to a "liquidity event" that caused the debtor to alter payment terms to vendors as it attempted to manage its cash. The period of time prior to the "liquidity event" was considered based on the facts of the case. In this case, the court found it was relevant to evaluate a period that reached back to the beginning of the parties' relationship. The court noted:

Artificially limiting a court from reviewing the full course of conduct between two parties would unnecessarily hamstring a court's ability to determine the true ordinary course of conduct. Each case must be viewed and judged according to its peculiar factors....¹⁰¹

• In In re Arch Aluminum & Glass Co. Inc., the court reviewed both payment information (timing) as well as activity (collection calls) for a period of "over a year preceding the Debtor's bankruptcy filing." The comparison of timing and activity was between the preference period and a period prior to the preference period, which the court found sufficient and reasonable.¹⁰²

For the subjective test (between the parties), there may be limitations regarding the duration of time for which an applicable analysis can be performed. That is, the parties may not have had a longstanding relationship or may have changed their relationship in a significant manner (as it pertains to the types of products sold, for example). The objective test may not be bound by such restrictions.

In other instances, the parties may have limitations on the availability of information. This could result from a sale of the business in which accounting platforms were no longer maintained. Alternatively, accounting platforms may have been updated, modified or superseded, making access to prior information exceedingly difficult. There are also circumstances in which an accounting platform, company server or other IT component may have failed, in which case electronic records of these prior transactions are no longer available.

Without such constraints, the period of analysis should be one of sufficient duration to facilitate a reasonably certain conclusion. There is no specific formula, algorithm or checklist to determine what the duration of this period should be. Rather, it is driven by the facts and circumstances of each matter. For example, in certain cases there may be a significant number of transactions between the parties on a daily basis. This may justify the use of a shorter time period, provided a sufficient number of transactions are being analyzed. Alternatively, there may be other situations in which a company only ships goods to a buyer once per month. As such, a more extended analysis may be appropriate to consider.

Another consideration may be the variability of historical transactions. If transactions between the parties show a very consistent trend, even if over a relatively shorter period, it may be reasonable to rely on this shorter period. However, if there is greater variability, consideration of a longer time period may be prudent in order to establish the reasons for such variation and to be able to complete a more robust statistical analysis of payment practices.

Extracting Information from Accounting Platforms

There are a wide variety of accounting platforms in use today that can range from very simple (Microsoft Excel spreadsheets or QuickBooks) to very complex ERP systems (such as integrated SAP systems) and many gradients of sophistication in between. For both the subjective and objective tests, it is important to understand how the data is stored in these systems, how it is extracted and how to interpret the results. The content of this chapter, and this book, cannot possibly cover all of the accounting systems and the varied fields of data collected and data-exporting mechanisms. However, provided below is a listing of certain items that may be important to consider:

• Which accounting platform is being used?
• Has it been replaced, changed, updated or modified over time?
• Does the company utilize outside consultants or representatives to assist in structuring and updating the accounting platform?
• Who are the people responsible for inputting information into the system?
• Are the people inputting information employees of the company, temporary employees or consultants?
• Are there periodic (weekly, monthly, annual) reviews of the information that result in changes or modifications?
• Do outside accountants or auditors review sales, purchases, accounts receivable or accounts payable information for accuracy?
• Are there required fields of entry for accounts receivable and payable information?
• Are there optional fields of entry for accounts receivable and payable information, such as "Notes" or "Comments," that would allow the user to record additional information?
• Are there calculations or settings utilized by the accounting system such as pre-defined automatic payment periods?
• Is the accounting system connected to electronic data interfaces or exchanges with customers or vendors?
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