Law Offices of Nicholas Gebelt

What Are The Factors Considered By Courts In Determining Whether The Subjective Test Has Been Satisfied?

How Does A Defendant Satisfy The Subjective Test?

In determining whether the recipient of a prepetition payment can successfully use the “ordinary course of business” defense against a preference avoidance action, the Court may consider whether the payment was consistent with past practice of the parties. If the payment was consistent with the past practice of the parties, it may satisfy what is referred to as the subjective test.

For example, suppose a debtor makes mortgage payments of $3,000, just like clockwork on the first of every single month. If the debtor made the payment in question for the usual amount on the first of the month, then the subjective test for the ordinary course of business defense would be satisfied. However, if the debtor made a payment that was much larger than the usual payment — e.g., a mortgage payment of $12,000 instead of the usual $3,000 — the payment would not be consistent with prior payments, and therefore wouldn’t satisfy the subjective test.

How Does A Defendant Satisfy The Objective Test?

In contradistinction to the subjective test — which looks at the past relationship between the debtor and the defendant creditor — the objective test focuses on an industry standard.

Of course, if the defendant creditor provides highly specialized services that no one else does, then there probably isn’t an industry standard. Therefore, that defendant will not be able to satisfy the objective test and will have to appeal to the subjective test in mounting its defense.

However, if there are many entities engaged in the defendant’s kind of business, then the Court can consider the industry standard. For example, the Court may hear expert testimony, and consider trade journals that discuss standard industry practices between debtors and creditors. Once the Court determines what the industry standard is, it can compare that standard to the transaction between the debtor and creditor to determine if the payment followed the standard. If it was consonant with the industry standard, the Court may conclude that the payment was not a preference.

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