A preferential transfer is one made by an insolvent debtor within the 90-day period before filing a bankruptcy petition. An indirect preference can occur when a creditor indirectly benefits from a transfer of the debtor’s property to another entity. An insider receiving a preference, such as payments to a lender on an insider-guaranteed loan, raises special issues. These issues were at the heart of the leading case of Levit v. Ingersoll Rand Financial Corp. (In re Deprizio Construction Co.). The outcome of the Deprizio case triggered amendments to the Bankruptcy Code and the use of waivers to insulate insider guarantors from preference liabilities, which are called Deprizio waivers.
A threshold question here is: who can be characterized as an insider? An insider of a debtor corporation is:
- a director,
- an officer,
- a person serving in a managerial role,
- a partnership in which the debtor is the general partner,
- and a relative of a general partner.
This list is non-exhaustive and comprised of “statutory” insiders. Non-statutory insiders that fall within the Bankruptcy Code’s definition of “insider,” but outside the enumerated categories, include entities that exert excessive control over the debtor or conduct dealings that cannot be considered at arm’s-length.
Insider guarantees raise unique preference issues when an insider of the debtor, who guaranteed a financial obligation, receives an indirect preference by a payment made to the lender. This is because that payment effectively reduces the insider-guarantor’s liability on the loan. If the payment is made within 90 days of the filing, it is recoverable from both the transferee (i.e., the lender receiving the payment) as well as the guarantor, although only one recovery is permitted. If the payment occurred between 90 days and one year of the filing, the transfer is only recoverable from the guarantor.
In response to Deprizio, several lenders impose Deprizio waivers in the guaranties signed by insider-guarantors. Using these waivers, insiders eliminate their status as creditors by waiving all reimbursement, indemnification, and subrogation rights against the debtor. Accordingly, the preference payments would be subject only to the 90-day look-back, rather than the one-year look-back. These waivers are still in use, even after Congress amended the Bankruptcy Code to address these issues.
The Bankruptcy Code amendments enacted in 1997 added sections 550(c) and 574(i) which, together, abrogated Deprizio waivers. Bankruptcy Code Section 550(c) prevents recovery of the property (or the value thereof) from a non-insider and excludes recoveries from non-insider transferees when the transfer is made in the 90-day to one-year period prior to filings. Bankruptcy Code Section 547(i) addresses avoidance, which 550(c) does not; Section 547(i) provides that these transfers are only avoidable as to the insider.
Despite the amendments, Deprizio waivers can still be useful. Parties using these waivers should be prepared to prove their validity and confirm that they took no subsequent actions that would negate the financial impact of the waivers, such as filing a proof of claim.
For more information on Deprizio waivers, preferential transfers, or how your bankruptcy case may be affected, contact KI Legal’s experienced Bankruptcy and Restructuring attorneys. Call (212) 404-8644 or email firstname.lastname@example.org to discuss.
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