United States Trustee v. First Jersey Securities, Inc.

Opinions of the United

1999 Decisions States Court of Appeals

for the Third Circuit

6-10-1999

US Trustee v. First Jersey Sec.

Precedential or Non-Precedential:

Docket 98-5236,98-5290

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Filed June 10, 1999

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

Nos. 98-5236 and 98-5290

IN RE: FIRST JERSEY SECURITIES, INC.,

Debtor

UNITED STATES TRUSTEE; SECURITIES

& EXCHANGE COMMISSION

v.

FIRST JERSEY SECURITIES, INC.

(D.C. Civil No. 95-5455)

IN RE: FIRST JERSEY SECURITIES, INC.,

Debtor

SECURITIES & EXCHANGE COMMISSION

v.

FIRST JERSEY SECURITIES, INC.

(D.C. Civil No. 95-5456)

Securities & Exchange Commission,

Appellant, No. 98-5236

United States Trustee,

Appellant, No. 98-5290

Appeal from the United States District Court

For the District of New Jersey

(D.C. Civil Nos. 95-5455 and 95-5456)

District Judge: Honorable Mary Little Cooper

Argued March 1, 1999

BEFORE: ALITO and McKEE, Circuit Judges,

and SCHWARTZ, District Judge*

(Opinion filed June 10, 1999)

Katharine B. Gresham (Argued)

Securities & Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549

Attorney for Appellant

No. 98-5236

Deborah R. Kant (Argued)

William Kanter

United States Department of Justice

Civil Division

10th & Pennsylvania Avenue, N.W.

Washington, D.C. 20530

Attorneys for Appellant

No. 98-5290

Walter J. Greenhalgh (Argued)

Duane, Morris & Heckscher

One Gateway Center, Suite 1210

Newark, New Jersey 07102

Attorney for Appellee

OPINION OF THE COURT

SCHWARTZ, Senior District Judge

This appeal addresses the propriety of the appointment of

counsel for a debtor in possession, where the debtor

transferred restricted securities to its counsel in payment

for pre-petition services on the eve of its filing for

bankruptcy. The United States Trustee ("Trustee") and the

_________________________________________________________________

*Hon. Murray M. Schwartz, Senior United States District Judge for the

District of Delaware, sitting by designation.

2

Securities and Exchange Commission ("SEC") contend the

law firm of Robinson, St. John, & Wayne ("RSW") was

disqualified from serving as counsel for the debtor, First

Jersey Securities, because it held an interest adverse to the

debtor's estate by reason of the transfer to it of the

restricted securities. The Bankruptcy Court and the United

States District Court for the District of New Jersey held the

debtor could retain RSW as counsel. Because counsel

received a preference under Section 547 of the Bankruptcy

Code, 11 U.S.C. S 547, we will reverse and remand.

I.

First Jersey Securities, Inc.1 (the "debtor" or "First

Jersey") filed a voluntary petition for relief under Chapter

11 of the Bankruptcy Code on August 7, 1995. 11 U.S.C.

S 101 et seq. This action was prompted after the SEC

prevailed in a securities fraud action against First Jersey

and its 100% shareholder, Robert Brennan, and obtained

an order for them to disgorge $75 million in illegal

proceeds. S.E.C. v. First Jersey Securities, Inc., 890 F. Supp.

1185 (S.D.N.Y. 1995), aff 'd in part, rev'd in part, 101 F.3d

1450 (2d Cir. 1996). Obtaining that order left the SEC as

the largest unsecured creditor of the debtor.

Concurrent with the filing of the petition, the debtor filed

an application pursuant to S 327(a) of the Bankruptcy Code

to retain RSW as its counsel. First Jersey owed thefirm

approximately $389,000 for legal services rendered prior to

the filing for bankruptcy primarily for work performed in

the securities fraud litigation.2 On the same day of its

_________________________________________________________________

1. First Jersey was a discount broker-dealer specializing in the

underwriting, trading, and distribution of low-priced securities. The

company was found to have committed securities fraud by selling

securities to its customers at prices that included excessive markups,

and by failing to disclose to its customers thefirm's control over the

respective securities' trading markets.

2. Lead counsel for RSW was Walter Greenhalgh. RSW subsequently

disbanded, and its successor firm, St. John & Wayne was substituted as

counsel. Later, Duane, Morris & Heckscher was substituted as counsel

when Greenhalgh joined that firm. At all times, Greenhalgh has been

lead counsel for the debtor in possession.

3

Chapter 11 filing, the debtor transferred 200,001 shares of

unregistered restricted stock in International Thoroughbred

Breeders, Inc. ("ITB") to RSW.3 This stock was to be

liquidated by RSW, with payments to be made in the

following manner: $200,000 as a retainer for representation

in the bankruptcy proceedings; $250,000 for payment on

firm invoices for representation in the securities fraud

litigation, with any excess to be returned to the debtor. The

$250,000 was to be considered full payment for the

$389,327 due for pre-petition services. The firm waived the

remaining pre-petition balance, thereby eliminating itself as

a creditor of the debtor. Apparently, shares in ITB were the

debtor's only meaningful resource, as its bankruptcy

petition listed only $22,367 in other assets. Ultimately,

RSW found a buyer for the shares, and transferred all of

the ITB stock for $600,003. RSW kept $450,000 and

returned the remainder to the debtor. While the transfer of

stock was noted in both the debtor's petition and counsel's

petition to be retained as counsel, neither party disclosed

the payment was made within 90 days of the debtor filing

for bankruptcy.

On August 11, 1995, four days after the filing of the

petition, the Trustee, joined by the SEC three days later,

objected to the appointment of RSW as counsel, arguing the

firm was not "disinterested" as is required by the

Bankruptcy Code. 11 U.S.C. S 327(a). The Trustee and the

SEC (collectively referred to as "SEC") maintained the

transfer of ITB restricted stock was a preferential payment,

thereby disqualifying RSW from acting as counsel for the

debtor because it held an interest adverse to the estate.

RSW, in response, submitted a certification asserting the

payment was made in the ordinary course of business, was

not preferential, and was deemed timely payment. It did not

disclose the date of the stock transfer. What occurred in the

Bankruptcy Court and District Court is set forth below.

_________________________________________________________________

3. Because the ITB shares were unregistered, they could only be sold

under an exemption provided by Section 4 of the Securities Act. 15

U.S.C. S 77d.

4

A. Bankruptcy Court

On August 24, 1995, the Bankruptcy Court held a

hearing on the debtor's application to retain RSW as its

counsel. The SEC contended the payment of RSW's pre-

petition claim was a voidable preference under the

Bankruptcy Code, 11 U.S.C. S 547(b),4 which is a cause for

disqualification under Section 327(a).5 During the hearing,

RSW acknowledged the stock transfer took place within the

90 day preference period, but contended it was made in the

ordinary course of business, and not made in exchange for

an "antecedent debt". Counsel explained the $250,000

payment was for a series of invoices from January through

May 1995, as well as for work done in June and July of

that year. He stated,

[T]he normal course of doing business with the debtor

for at least the past 12 months and probably going

back a year and a half or two years, would be a method

where we would generate an invoice, we would then

submit a group of invoices after several months, . ..

submit that to the debtor, discuss with the debtor a

method of payment, and the debtor would make

payment on those groups of invoices.

Bankruptcy Docket No. 30, August 24, 1995 Hearing at 31.

The Bankruptcy Court approved the debtor's application

to retain RSW from the bench on August 24, 1995 and

subsequently issued a written opinion. In re Brennan, 187

_________________________________________________________________

4. Section 547(b) of the Code permits a trustee to avoid certain pre-

bankruptcy transfers as "preferences" where the debtor transfers

property to a creditor for an antecedent debt made within 90 days before

filing for bankruptcy. In re Molded Acoustical Products, Inc., 18 F.3d

217,

217 (3d Cir. 1994).

5. Section 327(a) provides: "[T]he trustee, with the court's approval, may

employ one or more attorneys . . . that do not hold or represent an

interest adverse to the estate, and that are disinterested persons, to

represent or assist the trustee in carrying out the trustee's duties under

this title." 11 U.S.C. S 327(a). Pursuant to 11 U.S.C. S 1107, the debtor

in possession has the right to seek the employment of professionals

subject to S 327(a). If, in fact, the $250,000 payment for pre-petition

services was a preference, RSW would not be a "disinterested person"

within the meaning of the statute.

5

B.R. 135 (Bankr. D. N.J. 1995). That Court held the SEC

did not present a prima facie case that RSW received a

voidable preference under Section 547(b) of the Bankruptcy

Code. Specifically, the Bankruptcy Court found there was

no prima facie showing of a transfer to "satisfy an

antecedent debt owed by the debtor before such transfer

was made", as is required under S 547(b)(2).6 In re Brennan,

187 B.R. at 153. The Court reasoned a debt is not"owed"

within the meaning of the statute until payment is past

due, even if the debt is antecedent. It accepted RSW's

assertion that the debtor's financial obligation to the firm

was not past due, and consequently the payment was

deemed timely.

In the alternative, the Court found the transfer of stock,

even if a preference, was not a voidable preference because

it was a payment made in the ordinary course of business

under Section 547(c). If the transfer was incurred and made

in the ordinary course of business between the parties, and

made according to ordinary business terms, then the

transfer cannot be avoided by the debtor's estate. 11 U.S.C.

S 547(c)(2).7 In addition, the Court dismissed the SEC's

claim that the debtor and counsel failed to disclose

adequately the details of the pre-petition transfer of the

stock. The Bankruptcy Court concluded, "The U.S. Trustee

and the SEC therefore failed to establish that the payment

in question is probably an avoidable preference. The mere

accusation that it could be avoidable is not sufficient to

disqualify Robinson." In re Brennan, 187 B.R. at 154.

B. District Court

The SEC and Trustee appealed the decision of the

Bankruptcy Court to the United States District Court for

_________________________________________________________________

6. Section 547(b)(2) provides that "the trustee may avoid any transfer of

an interest of the debtor in property . . . for or on account of an

antecedent debt owed by the debtor before such transfer was made."

7. Section 547(c)(2) provides that a "trustee may not avoid under this

section a transfer . . . to the extent that such transfer was -- (A) in

payment of a debt incurred by the debtor in the ordinary course of

business or financial affairs of the debtor and the transferee; (B) made

in the ordinary course of business or financial affairs of the debtor and

the transferee; and (C) made according to ordinary business terms."

6

the District of New Jersey, contending the Bankruptcy

Court erred in finding the law firm was not disqualified

under S 327(a). The District Court filed a memorandum and

order affirming the Bankruptcy Court's decision. In re First

Jersey Securities, Inc., No. 95-5455 (D. N.J.filed April 9,

1998).

The Court agreed with the Bankruptcy Court that the

transfer of ITB stock did not constitute a preference under

S 547(b), and therefore, RSW should not be disqualified.

The District Court also concluded the stock transfer was

not made on account of an antecedent debt owed by the

debtor before the transfer was made. Finally, the Court

declined to address the Bankruptcy Court's conclusion that

the stock transfer payment was made in the ordinary

course of business.

II.

The District Court exercised jurisdiction under 28 U.S.C.

S 158(a) to review the Bankruptcy Court'sfinal order

approving the debtor's application for retention of counsel.

This Court has jurisdiction under 28 U.S.C. S 158(d) to

review the District Court's final order. United States Trustee

v. Price Waterhouse, 19 F.3d 138 (3d Cir. 1994).

Our standard of review of a District Court's

determination on appeal from a Bankruptcy Court decision

has been articulated on numerous occasions. "As an

appellate court twice removed from the primary tribunal,

we review both the factual and legal determinations of the

district court for error." Universal Minerals, Inc. v. C.A.

Hughes & Co., 669 F.2d 98, 101-2 (3d Cir. 1981). Our

vantage point is identical to that of the District Court, "so

we review the bankruptcy court's findings by the standards

the district court should employ to determine whether the

district court erred in its review." Id. at 102. Accordingly,

the Bankruptcy Court's findings of fact are reviewable for

clear error. In re Continental Airlines, 125 F.3d 120, 128 (3d

Cir. 1997). Legal determinations are subject to plenary

review. Id. The Bankruptcy Court's exercise of discretion is

reviewed for abuse thereof. In re Engel, 124 F.3d 567, 571

(3d Cir. 1997).

7

III.

The SEC urges this Court to reverse the District Court's

decision approving the retention of RSW as counsel for the

debtor. It argues the Court erred in finding the stock

transfer was not a voidable preference under 11 U.S.C.

S 547, and that error led it to conclude RSW was qualified

to serve as counsel to the debtor under 11 U.S.C.S 327.

The SEC also urges the transfer of the ITB restricted stock

was not made in the ordinary course of business as

outlined in 11 U.S.C. S 547(c)(2). Finally, the SEC asserts

the District Court erred in finding RSW's disclosures

concerning the stock transfer payments were sufficient

under S 327(a). Because we conclude the stock transfer was

a preferential payment not made in the ordinary course of

business, we need not address whether RSW adequately

disclosed the stock payments to the Bankruptcy Court.

A. Stock Transfer as Preferential Payment

Section 327(a) of the Bankruptcy Code provides for the

trustee (or the debtor in possession), with the Court's

approval, to employ attorneys "that do not hold or represent

an interest adverse to the estate," and that are

"disinterested persons." 11 U.S.C. S 327(a); 11 U.S.C.

S1107. In order for counsel to be retained, "counsel must

`not hold or represent an interest adverse to the estate' and

must be a `disinterested person.' " In re BH&P Inc., 949

F.2d 1300, 1314 (3d Cir. 1991) (citing In re Star

Broadcasting, Inc., 81 B.R. 835, 838 (Bankr. D. N.J. 1988)).

A "disinterested person" is defined as one who does not

have an interest materially adverse to the interest of the

estate, by reason of any direct or indirect relationship with

the debtor, or for any other reason. 11 U.S.C. S 101(14)(e).

The standards regarding adverse interests underS 327(a)

are outlined in In Re Marvel Entertainment Group, Inc., 140

F.3d 463, 476 (3d Cir. 1998). In that case, we held:

(1) Section 327(a), as well as 327(c), imposes a per se

disqualification as trustee's counsel of any attorney

who has an actual conflict of interest;

(2) the district court may within its discretion--

pursuant to S 327(a) and consistent with 327(c) --

8

disqualify an attorney who has a potential conflict of

interest and

(3) the district court may not disqualify an attorney on

the appearance of conflict alone.

Id. A Court may consider an interest adverse to the estate

when counsel has "a competing economic interest tending

to diminish estate values or to create a potential or actual

dispute in which the estate is a rival claimant." In re

Caldor, Inc., 193 B.R. 165, 171 (Bankr. S.D.N.Y. 1996)

(where Trustee objected to retention of counsel by official

committee of unsecured creditors in Chapter 11 case); In re

Star Broadcasting, Inc., 81 B.R. 835, 838 (Bank. D.N.J.

1988) (where Bankruptcy Court held law firm held actual

conflict of interest in representing both debtors in

possession).

In summary, S 327(a) mandates disqualification when

there is an actual conflict of interest, allows for it when

there is a potential conflict, and precludes it based solely

on an appearance of conflict. In the situation where the

debtor in possession seeks to retain counsel, as is the case

here, the Code provides, "[A] person is not disqualified for

employment under S 327 of this title by a debtor in

possession solely because of such person's employment by

representation of the debtor before the commencement of

the case." 11 U.S.C. S 1107(b). Where there is an actual

conflict of interest, however, disqualification is mandatory.

In re Marvel Entertainment Group, 140 F.3d at 476. A

preferential transfer to RSW would constitute an actual

conflict of interest between counsel and the debtor, and

would require the firm's disqualification. In re BH&P, 949

F.2d at 1316-1317.

The Bankruptcy Code's avoidable preference provision,

11 U.S.C. S 547(b), allows a bankruptcy trustee to recover

certain transfers a debtor made prior to filing a petition in

bankruptcy. The trustee must show that the transfer was:

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;

9

4) made -- on or within 90 days before the date of the

filing of the petition; . . .

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 ti tle;

B) the transfer had not been made; and

C) such creditor received payment of such debt to

the extent provided by the provisions of this title

11 U.S.C. S 547(c)(2). The Bankruptcy Court and District

Court held the SEC did not make a prima facie showing the

stock transfer likely satisfied the requirement that the

transfer be "for or on account of an antecedent debt owed

by the debtor before such transfer was made." 11 U.S.C.

S 547(b)(2). The Courts below found all other elements of

Section 547(b) were established, a conclusion with which

we are in accord.

The Bankruptcy Court reasoned that not only must the

debt be antecedent, but also the payment of a debt must be

past due, as a prerequisite for establishing a voidable

preference under S 547(b)(2). RSW certified the transfer of

the securities was in the ordinary course of business

dealings between the two parties, and was deemed timely

payment. It further represented the invoices submitted by

the firm did not constitute a final bill of an amount owed to

the firm. Rather, the firm would negotiate with the debtor

over several months worth of invoices, and adjust the bill

accordingly. An invoice was not finalized until after

negotiations. With respect to the final bill with First Jersey,

the debtor agreed to pay $250,000 for legal services

rendered from January to July 1995 almost simultaneously

with the conclusion of negotiations over the final bill. The

parties agreed the $250,000 was in settlement of the

invoices presented by RSW for legal work performed from

January to May 1995 (which totaled $314,327), as well as

for work performed in June and July 1995 for which RSW

had not yet generated an invoice ($75,000). RSW thus

argues the payment was made before the debt was actually

past due. The Bankruptcy Court agreed, reasoning the debt

was not due prior to the time the payment was made. The

10

District Court concurred with this conclusion under the

same legal reasoning.

The District Court's legal interpretation of S 547(b)(2) is

reviewed de novo. Under the language of the statute, in

order to constitute a preferential payment, First Jersey

must have owed an antecedent "debt" to RSW, and that

debt must have been incurred "before the transfer was

made." 11 U.S.C. S 547(b)(2). The Bankruptcy Code defines

a debt as a "liability on a claim." 11 U.S.C.S 101(12). In

turn, the Code defines a claim broadly. A "claim" means: (A)

right to payment, whether or not such right is reduced to

judgment, liquidated, unliquidated, fixed, contingent,

matured, unmatured, disputed, undisputed, legal,

equitable, secured, or unsecured. 11 U.S.C. S 101(5). Under

this broad definition of claim, "all legal obligations of the

debtor, no matter how remote or contingent, will be able to

be dealt with in the bankruptcy case." Senate Report at 22,

1978 U.S. Code Cong. & Admin. News 5787, 5808. In

addition, as debt is defined as a liability on a claim, it is

coextensive with the definition of a claim, and both are

construed broadly. Pennsylvania Dep't of Pub. Welfare v.

Davenport, 495 U.S. 552, 110 S.Ct. 2126, 109 L.Ed.2d 588

(1990). It follows "when a creditor has a claim against a

debtor -- even if the claim is unliquidated, unfixed, or

contingent -- the debtor has incurred a debt to the

creditor." In re Energy Cooperative, Inc., 832 F.2d 997, 1001

(7th Cir. 1987).

The SEC contends First Jersey incurred a debt to RSW

when the law firm performed legal services on the debtor's

behalf. We agree. Courts which have considered this issue

have concluded, consistent with the statutory definitions,

that an antecedent debt owed by the debtor occurs when a

right to payment arises -- even if the claim is not fixed,

liquidated, or matured. See 11 U.S.C. S 101(5); In re

Bennett Funding Group, Inc., 220 B.R. 739, 742 (2d Cir.

B.A.P. 1998) (debt occurs "when the debtor previously

obtained a property interest in the consideration provided

by the creditor that gave rise to the debt"). The right to

payment generally arises when the debtor obtains the goods

or services. See, e.g., Id; In re Futoran, 76 F.3d 265, 267

(9th Cir. 1996); In re Cybermech, Inc., 13 F.3d 818, 821

(4th Cir. 1994); In re Energy Co-op, Inc., 832 F.2d at 1001.

11

Under this reasoning, RSW had a claim at the time it

performed legal services for First Jersey. Its claim was

"antecedent" for purposes of Section 547(b)(2). The payment

of $250,000 from the sale of ITB stock was to settle the

debt owed by First Jersey for past legal services rendered

between January and July 1995. We agree with our sister

circuits and other courts that legal claims arise when the

legal services are performed, not when the bill itself is

presented to the client. See, e.g., In re Florence Tanners,

Inc., 209 B.R. 439, 447 (Bankr. E.D. Mich. 1997); In re

Investment Bankers, Inc., 136 B.R. 1008, 1018 (D. Colo.

1989), aff'd, 4 F.3d 1556 (10th Cir. 1993).

In In re Florence Tanners, an attorney claimed he did not

receive a preferential transfer because he received payment

before he had sent an invoice for his services. The Court

disagreed, and held "a debt for legal services arises when

the services are performed, not when the subsequent

invoice is issued." 209 B.R. at 447. Similarly, the

Bankruptcy Appellate Panel in In re Bennett Funding Group

concluded that, since a law firm which provided legal

services "had a claim, mature or unmatured, that it could

then assert against a debtor's bankruptcy estate if payment

was not made at the time a petition was filed . . . the debt

was `antecedent' for purposes of Section 547(b)(2)." 220

B.R. 739, 742 (B.A.P. 2d Cir. 1998).

The policies underlying the preference section in the

bankruptcy statute cry out for the conclusion that a debt

arises when legal services are provided, not when a law firm

issues an invoice. The overriding intent in enactingS 547(b)

was to promote equal distribution among a debtor's

creditors. The preference section discourages creditors from

racing to the courthouse to dismember the debtor during

its slide into bankruptcy, and it furthers the policy of equal

distribution among similarly situated creditors. 5 Collier on

Bankruptcy, S 547-9; 1978 Code Cong. & Admin. News

5787, 6138.

The Bankruptcy Court's reasoning that a debt is not

owed until payment is past due is not found in the

preference statute, 11 U.S.C. S 547. Its absence is readily

understandable. If the Bankruptcy Court's conclusions

were permitted to stand, the preference provision of the

12

Bankruptcy Code would be largely vitiated. The Bankruptcy

Court's judicial gloss would allow creditors to retain a pre-

petition payment simply by asserting that the payment was

"timely," as was done by RSW. Pronouncing a payment is

"timely" does not make it so. Moreover, such an approach

would lead to inequality among similarly situated creditors,

and allow for both strategic behavior and collusion by

creditors to secure preferential treatment prior to a debtor

filing its petition. This approach would "leave to the creditor

the discretion to determine the date the obligation was

incurred, creating the possibility not only of inequality of

treatment of similarly-situated creditors (depending on the

vagaries of their billing practices), but also the opportunity

for a particular creditor, who foresees that his debtor is

approaching bankruptcy, to secure preferential treatment

for himself by the timing of the bill." Matter of Emerald Oil

Co., 695 F.2d 833, 837 (5th Cir. 1983).

In this case, the stock transfer resulted in a large

diminution of the value of the debtor's estate, and a serious

depletion of assets of the estate available to other creditors.

Similarly situated creditors were not treated equally.

Moreover, RSW, as the debtor's counsel, was in a unique

position to secure preferential treatment for itself-- as it

knew the debtor was going to file for bankruptcy in the

imminent future. First Jersey's payment to RSW depleted

the estate of its only significant asset that would have been

available to its other creditors. This is the type of payment

Congress intended the preference section to reach. We have

no trouble concluding the stock transfer was a preference

under Section 547 of the Bankruptcy Code. As such, RSW

had an actual conflict with the debtor and was therefore

disqualified from serving as counsel under S 327, unless

payment to it was in the ordinary course of business.

B. Payment in the Ordinary Course of Business

Even if a payment is considered a preference under

Section 547(b), it may not be subject to avoidance if it was

made in the ordinary course of business, as defined in 11

U.S.C. S 547(c). The purpose of Section 547(c) is to leave

undisturbed normal financial relations between a debtor

and its creditors, even as a company approaches

bankruptcy. It protects "recurring, customary credit

13

transactions that are incurred and paid in the ordinary

course of business of the debtor and the debtor's

transferee." 5 Collier on Bankruptcy, 547-47. We conclude,

however, that the debtor's stock transfer to RSW in this

case was not made in the ordinary course of business

dealings between the two parties, nor was it made

according to ordinary business terms.

In reaching the opposite conclusion, the Bankruptcy

Court concluded the stock transfer was made in the

ordinary course of business, and was thus acceptable even

if one concluded the payment constituted a preferential

transfer under S 547(b). The Court accepted RSW's

assertion that its ordinary billing procedure with First

Jersey was to submit a number of invoices after several

months, and then negotiate the amount and method of

payment. Counsel explained, "we would go to the debtor

with the invoices in hand, submit them to the client,

discuss with the client whether the bills should be

adjusted, and in most cases they were adjusted downward,

and then work out some sort of a payment on that

particular group of invoices." Bankruptcy Docket No. 30 at

32.

A trustee may not avoid a preferential transfer to the

extent such transfer was: "(A) in payment of a debt incurred

by the debtor in the ordinary course of business or

financial affairs of the debtor and transferee; (B) made in

the ordinary course of business or financial affairs of the

debtor and transferee; and (C) made according to ordinary

business terms." 11 U.S.C. S 547(c)(2). The burden is on the

transferee to satisfy each statutory element by a

preponderance of the evidence. 11 U.S.C. S 547(g); J.P. Fyfe,

Inc. of Florida v. Bradco Supply Corp., 891 F.2d 66, 69-70

(3d Cir. 1989).

It is undisputed the transfer of stock satisfies

S 547(c)(2)(A) -- the debt was incurred for legal services

provided by RSW to First Jersey in the normal course of

business. The conflict arises as to the other two elements.

The term "ordinary" is not defined in the bankruptcy

statute. J.P. Fyfe teaches the determination of what is "in

the ordinary course of business" is subjective, calling for

the Court to consider whether the transfer was ordinary as

14

between the debtor and the creditor. Factors such as

timing, the amount and manner in which a transaction was

paid are considered relevant. In re Yurika Foods Corp., 888

F.2d 42, 45 (6th Cir. 1989).

Employing these criteria, we conclude the payment was

not made in the ordinary course of business. The timing of

the payment to RSW is clearly suspect. The transfer of

stock was made on the day the debtor filed its petition for

bankruptcy. RSW did not show that the payment date fit a

particular practice between the parties. Rather, all the

record shows is that First Jersey made periodic payments

during 1994 and 1995. These payments consisted of:

10/28/94 $300,000

12/07/94 $150,000

12/22/94 $150,000

02/10/95 $150,000

03/24/95 $150,000

05/31/95 $150,000

We merely note the payment of $250,000 on August 7,

1995 deviates from the pattern of $150,000 payments from

December 1994 to May 1995. However, we are very

troubled by the absence in the record of any explanation for

why the payment was made on the eve of the debtor'sfiling

for bankruptcy. As First Jersey's counsel in the securities

litigation, RSW had to know of the debtor's precarious

financial position when it accepted restricted securities in

lieu of cash payment because RSW prepared the

bankruptcy petition filed on the same day as the stock was

transferred to it.

The RSW firm also failed to produce any evidence that

the payment of legal bills by transfer of restricted stock was

in the ordinary course of business between the parties.

RSW did not assert it had ever before received payment in

the form of restricted securities. The stock in question was

unregistered, and could not be sold publicly. In fact, RSW

needed to find a sophisticated buyer for the securities --

and the shares were not sold until October 19, 1995. It

defies reason that the Robinson firm would accept payment

in an illiquid asset unless it knew the debtor was in serious

financial difficulties and could not pay otherwise. The

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manner and timing of the payment in the currency of

restricted ITB stock suggests the transfer was not made in

the ordinary course of business between the parties.

Moreover, the payment was not made "according to

ordinary business terms", as is required by S 547(c)(2)(c).

This phrase has been interpreted as encompassing"the

practices in which firms similar in some general way to the

creditor in question engage." In re Molded Acoustical

Products, Inc., 18 F.3d 217, 224 (3d Cir. 1994)."Only

dealings so idiosyncratic as to fall outside that broad range

should be deemed extraordinary and therefore outside the

scope of subsection C." Id., (citing Matter of Tolona Pizza

Prods. Corp., 3 F.3d 1029, 1033 (7th Cir. 1993)). This Court

emphasized, moreover, that "the more cemented [as

measured by duration] the pre-insolvency relationship

between the debtor and the creditor, the more the creditor

will be allowed to vary its credit terms from the industry

norm yet remain within the safe harbor of S 547(c)(2)." Id.

at 225.

While this test is deferential, it is not non-existent. The

general practice of law firms is to receive cash in return for

services, not restricted securities. See, e.g., In re Florence

Tanners, Inc., 209 B.R. 439, 448 (Bankr. E.D. Mich 1997)

(questioning "whether in the ordinary course of the legal

business, clients pay lawyers with merchandise"). While law

firms have begun to accept equity positions as payment

from "start-up" companies with strong growth potential, the

reasoning in these situations is the expectation by the law

firm that the stock of the client will appreciate in value. In

contrast, here the restricted stock is not of a client with

growth potential, but of a third party. Moreover, the record

reflects it was common practice for First Jersey to pay RSW

only in cash. In fact, up until the day the Chapter 11

petition was filed, there is no evidence in the record that

First Jersey ever transferred securities, much less restricted

securities, to RSW as payment for legal services.

Finally, it very much appears that on August 7, 1997,

First Jersey recognized its need for counsel to shepherd it

through the chapter 11 proceedings. The obvious choice

was RSW since it had continuously represented First Jersey

as its legal troubles mounted. But there was a problem.

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First Jersey owed RSW a substantial amount of money.

Turning over the ITB stock to RSW was the only solution,

especially since RSW represented ITB in the past, and

presumably was familiar with the company. Be that as it

may, payment of legal bills in restricted stock as a prelude

to filing a bankruptcy Chapter 11 petition can hardly be

construed as a payment "made according to ordinary

business terms."

Viewed in its totality, it is clear this payment was not

made in the ordinary course of business. Accordingly, the

preferential payment was a preference, creating an actual

conflict of interest, and thus, disqualifying RSW as counsel

for the debtor.8

IV. Conclusion

For the reasons set forth above, we find the District

Court erred in holding that the stock transfer was not a

preference under 11 U.S.C. S 547. The stock transfer

created an actual conflict of interest, and therefore

disqualification is mandatory. In addition, wefind the

Bankruptcy Court erred in finding the transfer was exempt

under S 547(c)(2) as a payment made in the ordinary course

of business.

Accordingly, we will reverse the District Court's order and

direct the District Court to remand to the Bankruptcy

Court with instructions to disqualify RSW and successor

firms as counsel for First Jersey, and to take such further

action as is consistent with this opinion.9

_________________________________________________________________

8. Because we conclude the $250,000 payment constituted a preference,

and counsel is disqualified, we do not reach the question of whether the

debtor and RSW adequately disclosed information in RSW's application

for employment as required by Rule 2014(a) of the Federal Rules of

Bankruptcy Procedure and 11 U.S.C. S 327.

9. We note the Bankruptcy Court warned RSW at the hearing that if the

transfer is avoided as to the payment of the pre-petition debt, "[RSW] is

subject not only to disgorgement of the preference, but also to the

possible denial or reduction of compensation under Code section 328(c)

as well." In re Brennan, 187 B.R. at 154.

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A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

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