On June 4, 1999, the U.S. Bankruptcy Court for the District of Oregon in In re Williams, 234 B.R. 801 (Bankr. D. Ore. 1999), upheld the claim of the trustee that an alleged preferential transfer (involving the security interest of the defendant in the debtor's mobile home) was for the benefit of the debtor's wife, an insider, and that the trustee could avoid the perfection of the security interest under the "DePrizio rationale."

The facts in this case were undisputed. On June 7, 1996, the debtor and his wife signed a note for $59,671 to finance the purchase of the couple's mobile home. To secure the note, they entered into a security agreement that constituted a pledge of the mobile home and the real property upon which the mobile home was situated. This security interest was not perfected until July 29, 1996, which occurred more than 90 days but less than one year prior to the debtor's chapter 7 filing on Dec. 12, 1996.

The sole issue presented to the court was whether the trustee's claim was barred by the 1994 Amendments to 11 U.S.C. §550. The defendant argued that the 1994 Amendments prevented the trustee from recovering the transferred property from a "non-insider creditor," and that the adversary proceeding brought by the trustee should be dismissed.

The DePrizio Doctrine

Section 202 of the Bankruptcy Reform Act of 1994 amended §550 of the Bankruptcy Code and was intended to effectively overrule Levit v. Ingersoll Rand Finance Corp. (In re V.N. DePrizio Constr. Co.), 874 F.2d 1186 (7th Cir. 1989), and its progeny. Under DePrizio, courts have extended the preference avoidance period from 90 days to a full year for non-insider creditors when the transfers in question nevertheless benefited an insider. In particular, DePrizio permitted a bankruptcy trustee to recover preferential payments under §§547 and 550 of the Code, which consisted of loan payments made to non-insider lenders during this extended one-year preference period when the debt was guaranteed by insiders (the controlling shareholders) of the debtor. An insider is one who is a principal of, related to or affiliated with the debtor. 11 U.S.C. §101(31). The Seventh Circuit reasoned in DePrizio that even though the preferential payments were not made to the insiders, they were for the benefit of the insider creditors, because each payment made to the lenders reduced, on a dollar-for-dollar basis, the liability of the guarantors to the lenders. (The parties in Williams had acknowledged that the perfection of the security was at least "of some potential benefit" to the debtor's wife, the insider).

Section 202 of the 1994 Reform Act expressly intended to overrule DePrizio by stating that payments to a non-insider lender may only be recovered if they were made during the 90-day period following such payments. Section 202 added the following subsection (c) to §550:

If a transfer made between 90 days and one year before the filing of the petition is avoided under §547(b) of this title, and was made for the benefit of a creditor that at the time of such transfer was an insider, the trustee may not recover under subsection (a) from a transferee that is not an insider.

The trustee in Williams relied on the DePrizio decision, and a line of subsequent court decisions have adopted the DePrizio reasoning, such as the Ninth Circuit's holding in Official Unsecured Creditors Comm. v. United States Nat'l Bank (In re Suffola Inc.), 2 F.3d 977 (9th Cir. 1993). As the court in Williams noted, every court of appeals to consider the application of the DePrizio doctrine has adopted it. See Galloway v. First Ala. Bank (In re Wesley Indus. Inc.), 30 F.3d 1438 (11th Cir. 1994); Southmark Corp. v. Southmark Personal Storage Inc.), 993 F.2d 117 (5th Cir. 1993); In re C-L Cartage Co., 899 F.2d 1490 (6th Cir. 1990); Manufacturers Hanover Leasing Corp. v. Lowrey (In re Robinson Bros. Drilling Inc.), 892 F.2d 850 (10th Cir. 1989); In re Erin Food Svcs., 980 F.2d 792, 798-99 (1st Cir. 1992); T-B Westex Foods Inc. v. FDIC, 950 F.2d 1187 (5th Cir. 1992); Ray v. City Bank & Trust Co., 899 F.2d 1490 (6th Cir. 1990).

In a recent bankruptcy decision that considered the DePrizio doctrine, O'Neill v. Orix Credit Alliance Inc. (In re Northeastern Contracting Inc.), 233 B.R. 15 (D. Conn 1999), the court held that the doctrine would also be applied in the Second Circuit in a case filed prior to the 1994 Reform Act, to the extent that the debtor's payments to a non-insider creditor benefited an insider-guarantor. The court stated that "the code that existed prior to the [1994 Bankruptcy Code] amendments lent itself to the interpretation enunciated in DePrizio." Id. at 19. However, the court also stated that "the DePrizio line of cases was effectively overruled by the 1994 congressional amendments to the Bankruptcy Act [sic]." Id. at 17 n. 2. All of the federal circuit court cases upholding the DePrizio doctrine were decided prior to the passage of the 1994 Reform Act (or, in the case of Northeastern, applied to a case that was filed prior to Oct. 22, 1994, the effective date of the 1994 Reform Act). The court in Northeastern noted that other courts in the Second Circuit have criticized, questioned or rejected the DePrizio doctrine, often based on the argument that the doctrine unfairly penalizes diligent creditors and may have a "chilling effect" on the ability of a company to secure favorable corporate credit terms by offering guarantees from insiders as additional security. See In re Frank Santora Equipment Corp., 213 B.R 420, 424 (E.D.N.Y. 1992); In re Wedtech Corp., 187 B.R. 105, 110 (S.D.N.Y. 1995); Pereira v. Lehigh Sav. Bank (In re Artha Management Inc.), 174 B.R. 671, 677 (Bankr. S.D.N.Y. 1994); Weiskopf v. New York Job Devpmt. Auth., 145 B.R. 3, 4 (Bankr. N.D.N.Y. 1992).

Analysis of the Court's Decision

The lender in Williams argued that because the defendant was a non-insider creditor, the 1994 Reform Act amendment to §550 barred any recovery by the trustee. The trustee conceded that it could not "recover" any transferred property, but argued that no recovery was necessary in this case because the debtor's interest in the property (i.e., the mobile home) became property of the bankruptcy estate upon the filing of the debtor's bankruptcy petition. Therefore, the trustee asserted, there was nothing to recover and no need to seek the remedies provided by §550. The trustee maintained that the security interest of the defendant had been avoided pursuant to §547(b), and that such avoidance provides a remedy separate and distinct from the right to "recover" transferred property under §550. The trustee also argued that under §551 of the Code, the avoided lien was preserved for the benefit of all the creditors of the estate. This was not, the trustee noted, a situation where the property had been transferred to the creditor or a third party prior to the bankruptcy filing, in which event the trustee's remedy would be to seek recovery under §550. The trustee also pointed out that the debtor and his wife were in possession of the mobile home at the time of the filing of the debtor's bankruptcy petition, and had continuously remained in possession of the property.

The court noted that "[t]his appears to be a case of first impression in this district." Although acknowledging that there is a split of authority among commentators (and among the few bankruptcy courts that have dealt with the issue) as to whether §547 provides a separate remedy from the right to "recover" under §550, the court agreed with the trustee's position. The court cited with approval the decision of the bankruptcy court in In re Congress Credit Corp., 186 B.R. 555 (D. P.R. 1995). Congress held that by avoiding the lien under §547(b), the trustee held property, which had not previously been transferred, free and clear of the creditor's lien or other interest and had no need to resort to the recovery provisions of §550. The court acknowledged that a Wisconsin bankruptcy court in In re McLaughlin, 183 B.R. 171 (Bankr. W.D. Wis. 1995), held that where a security interest in property has been avoided under §547(b), the trustee's remedy is to seek recovery under §550. However, based on its review of the legislative history of §550 (including the 1994 Reform Act) and the fact that Congress saw fit only to amend §550 and not §547(c), the court in Williams determined that "the position taken by the court in In re Congress Credit Corp. has merit." 1999 WL 388210 at *4.

Commentators' Concerns

The decision in Williams confirms the belief of several commentators, as set forth in articles published after the enactment of the 1994 Reform Act, that negative consequences for lenders may still exist notwithstanding the addition of subsection (c) to §550. These commentators have expressed their concern that §202 of the 1994 Reform Act eliminated only the right to recover the preference and that the preference may still be avoidable, notwithstanding Congress' clear intention to overrule the DePrizio line of cases and to protect non-insider transferees for transfers received more than 90 days prior to the bankruptcy filing.¹

Conclusion

It will be interesting to see whether the Williams decision prompts another attempt by Congress to close the "loophole" in the existing language of §§547 and 550 exposed by the court in this case. If Congress's intention in enacting §202 of the 1994 Reform Act was truly to prevent recovery of all payments to non-insider creditors outside of the 90-day preference period, then Congress may need to specifically amend §547. As the court in Williams noted, "the most effective method would have been to add another defense or exception to avoidance in §547(c)." 1999 WL 388210 at *4. In the meantime, it may be prudent for lenders to continue to insist that guarantees of mortgage loans by insider guarantors contain language waiving any subrogation rights against the mortgagor. This strategy was commonly utilized after the holding in DePrizio, and prior to (and, by cautious lawyers, after) the enactment of the 1994 Reform Act. The theory behind the addition of such language in the guarantee is that the guarantor is thereby not a creditor at all because of the waiver of his or her right to collect against the mortgagor in the event the guarantor is subsequently required to pay the debt to the mortgagee. The bankruptcy court in Northeastern, supra, concurred with this reasoning, finding that one of the creditors had waived his subrogation rights and was therefore not a creditor, but holding that another guarantor was a creditor for purposes of the DePrizio doctrine because he had merely postponed (and not waived) his claims until all non-insider creditors were paid in full.

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Footnotes

¹ See Millner, Robert, "Is DePrizio Dead...or Just Wounded? Lien Avoidance as a Post-reform Act Remedy for Trilateral Preferences," Lender Liability News (LRP Publications), May 19, 1995, at 12-13; Ponoroff, Lawrence, "Now You See It, Now You Don't: An Unceremonious Encore for Two-transfer Thinking in the Analysis of Indirect Preferences," 69 Am. Bankr. L.J. 203 (1995); Josephson, Richard C., "The DePrizio Override: Don't Kiss Those Waivers Goodbye Yet," 4 Bus. L. Today 40 (1994) (cited by the court in Williams in support of its holding); Lewis, Adam A., "Did It or Didn't It? The DePrizio Dilemma," 10 ABI Journal, 20 (1995). Return to article