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Limitations on the Deprizio Doctrine.

In Levit v. Ingersoll Rand Financial Corp., (7th Cir. 1989), the "Deprizio" case, the Court held that a payment to a non-insider creditor of a bankruptcy debtor may be preferential if the creditor received the payment within a year of the filing of the bankruptcy petition and the debt was guaranteed by an insider of the debtor. On March 10, 1993, the "Bankruptcy Amendments Act of 1993" (S.540) was introduced in Congress. One provision of S.540, which is slowly moving through Congress, is the legislative reversal of Deprizio. However, unless and until S.540 is enacted, Deprizio remains the law in many areas. In the interim, there have been two significant developments affecting its reach.

Deprizio Waiver Can Be Used In Guaranty Agreement

A preference is a transfer of the debtor's property "to or for the benefit" of a creditor on an antecedent debt while the debtor is insolvent within 90 days of bankruptcy, which allows the creditor to receive more than it would in a Chapter 7 liquidation. If the creditor is an insider, the "preference window" increases from 90 days to one year.

The key to Deprizio liability is a guarantor's subrogation rights. Subrogation is the right of a guarantor to be reimbursed for making a payment on the guaranty. Subrogation rights give the guarantor a contingent claim against the debtor.

In the typical case, the guarantor of a debt is an insider of the debtor (the Insider) and the creditor is not an insider (the Creditor) and, therefore, would not normally be subject to the one-year preference window. Payment to the Creditor reduces the Insider's exposure. In Deprizio, the Court held that a payment to the Creditor also reduced the Insider's contingent claim against the debtor within the meaning of the preference laws because the payment to the Insider is also for the benefit of the Insider, and subjects the Creditor to the Insider's one-year preference window.

Conversely, if the Insider has no subrogation rights, the payment to the Creditor does not reduce the Insider's claim against the debtor for subrogation. Therefore, in In re Fastrans, Inc., (Bankr. E.D. Tenn. 1992), the Court held that the following language constituted a waiver of subrogation rights and effectively defeated a Deprizio claim:

"Each guarantor also hereby waives any claim, right, or remedy which such guarantor may now have or hereafter acquire against the [debtor] . . . that arises hereunder and/or from the performance by any guarantor hereunder including, without limitation, any claim, remedy, or right of subrogation, reimbursement, exoneration, contribution, [or] indemnification . . ."

There Must Be an "Insider" Claim

The facts of this decision merit special attention. Although the Insider held other claims against the debtor unrelated to the Creditor's claims, these other claims were inadequate to subject the Creditor to the one-year preference period. The Court held that "it is not enough that an insider be a creditor of the debtor in a general sense; the insider must have 'claim' against the debtor attributable to the specific debt he or she guaranteed in order to render transfers made by the debtor on account of that debt to the non-insider transferee avoidable under Code 547(b)." In other words, to establish Deprizio liability, the trustee must prove that the Insider has a claim against the debtor arising from the guaranty and not from some unrelated reason.

Similarly, in in re XTI Xonix International, Inc., (Bankr. D. Ore. 1993), the court cited Fastrans as controlling authority and shielded a vendor with a subrogation waiver in its guaranty from the extended preference period. However, in In re Helen Gallagher Enterprises, (Bankr. C.D. Ill. 1991), the Court held that the following language was not adequate to defeat a Deprizio claim:

"The undersigned shall have no right of subrogation whatsoever with respect to the liabilities or the collateral unless or until the lender shall have received full payment of all liabilities."

This provision, unlike the one in Fastrans, did not waive the Insider's subrogation rights; instead, the provision merely postponed the exercise of the right until the Creditor was paid in full. To be effective, the Insider's waiver of his subrogation rights must be absolute.

Protection Is Not A Sure Thing

There is no assurance that a Fastrans-type Deprizio waiver will protect a creditor in every case. Some commentators have suggested that a waiver might constitute a fraudulent transfer but no court has taken such a position. In fact, no published decision has rejected Fastrans. Therefore, until Congress acts, a Deprizio waiver should be a useful provision in a personal guaranty.

Guaranty Agreements May Be Limited

The other potential limitation on Deprizio derives from the decision of the United States Court of Appeals for the First Circuit. In In re Erin Food Services, Inc., (First Cir. 1992), the First Circuit assumed, without deciding, that Deprizio is the correct state of the law. However, the Court limited its effect based on the facts of the case. In that case, the Insider essentially guaranteed only a part of the Creditor's claim.

However, at all times relevant, the Creditor's claim against the debtor totalled more than the maximum amount of the Insider's guaranty. Because the total claim exceeded the amount of the guaranty at all times, the debtor's payments to the Creditor never reduced the Creditor's claim against the Insider. Since Deprizio is based on a theory that the Insider's subrogation claim is reduced by the payment to the Creditor, if the claim is not reduced, there is no Deprizio claim.

Make Use of "Fastrans"

Erin Food has not been widely accepted; however, the decision may be helpful to those creditors who use limited guaranties. There are, of course, practical problems with a limited guaranty that cause many creditors to avoid them. Therefore, the better way to minimize risk until Congress acts may be to use a Deprizio waiver similar to that used in Fastrans and XTI Xonix.

K. Todd Phillips is the head of the bankruptcy practice group of Waggoner, Hamrick, Hasty, Monteith and Kratt of Charlotte, North Carolina.
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Author:Phillips, K. Todd
Publication:Business Credit
Date:Jul 1, 1994
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