APPELLATE COURT EXPANDS TRUSTEE'S AVOIDANCE POWER ON INSIDER PREFERENCES

The Bankruptcy code Amendments of 1984 made major changes in the law of debtor-creditor rights. Most of us have become accustomed to living with those changes. A change that was one of the most difficult to live with was the preference provisions of the code.

It's always difficult to tell a client that their claim is uncollectible. It became all but impossible to tell a client that, while we had collected their account for them, because payment by the debtor was made within 90 days of the debtor's bankruptcy filing, they would have to return the recovery. The trustee had sued to avoid that payment as a preferential transfer and the recovery may have to be repaid to the estate. We all came to be able to live with this problem. Luckily, a lot of trustees were not especially diligent or knowledgeable so preference recoveries didn't happen too often.

Now we are faced with an extension of the preference action to cover certain payments made to creditors within not just 90 days of the bankruptcy filing but within one year of the filing. The problem arises from the DePrizio case, [Louis W. Levit, Trustee of V. N. DePrizio Construction Co. v. Ingersoll Rand Commercial Financial corporation, U.S.D.C., Seventh Circuit, decided May 12,1989]. The DePrizio decision was handed down by the United States DistrictCourt of Appeals for the Seventh Circuit sitting at Chicago and has been the subject of discussion at bankruptcy seminars all over the country.

Let's look at the following example: In January of 1988 we receive a claim against ABC Corporation for $10,000.00. The account is guaranteed by John Smith, President of ABC. We make demand and the claim is paid in February of 1988. Time passes, ABC's situation deteriorates and in November of 1988, ABC files a Chapter 7. The payment to our client was made more than 90 days before the filing so it's not a voidable preference under Section 547(4) (a) [90 day avoidance]. DePrizio stands for the principal that our client's recovery is a voidable preference under Section 547(4) (b) relating to insider transactions, [one year avoidance]

Simply put, because the payment to the creditor by ABC reduced the liability of the guarantor who was an insider, the trustee can go back, up to one year prior to the filing and recover those payments. Of course, the guarantee would be reinstated, but as a practical matter, the creditor has probably made a substantial change of position due to the recovery.

What does all this mean to those of us collecting commercial accounts? The basic rule of collection is still in effect; in other words, collect a claim as quickly as possible. Enhance the claim by a meaningful personal guarantee where possible. Even if the recovery, for some reason, is avoided the guarantee is still in force.

There are other considerations. Will a debtor corporation, which has paid loans guaranteed by officers, try to delay filing of a bankruptcy until at least one year has passed so that the officers won't have their personal debt revived? Should we take a personal guarantee from officers of corporations where we know that the guarantor really is giving us nothing by that guarantee and where we have some belief the corporation might go into bankruptcy in the near future. If we are representing creditors in an involuntary petition we must be careful to check if any have personal guarantees and if they may have received a payment out of the ordinary course of business within one year and not just 90 days of the filing of the petition.

If any of you would like a copy of the DePrizio decision, which for now is the law in the states covered by the Seventh Circuit, just drop me a line. I am certain that this case is going to be appealed to the United States Supreme Court and other circuits might come to a different conclusion.

What really bothers me about the decision is the Court's gratuitous statement that those creditors who somehow assert their rights aggressively against a commercial debtor, "make off with. ..assets" or are "asset grabbing". The common law and statutory law in virtually every state mandate that creditors will be rewarded only if they act aggressively and that the creditor who does act aggressively and gets there first has the right to priority. Every creditor's lawyer has that duty, notwithstanding the fact that there are times when it is in client's interest to join with other creditors in effecting a moratorium or composition.

The whole sense of the DePrizio opinion is that there is something sinister about the creditor who gets a personal guarantee and uses it. When the Court says that "all creditors gain from a rule of law that induces each to hold back", I think the Court misconstrues the interrelationship between state debtor-creditor law and the Bankruptcy code and penalizes those creditors astute enough to obtain personal guarantees.

One would hope that the Commercial Law League of America of which many lawyers and agencies are members would take a position supporting legislation that would set aside the rule of DePrizio. There will be instances where creditors who are paid at the same time for the same reason will be treated differently in that the creditor holding a personal guarantee will be a preferred creditor under the Bankruptcy Code and others paid at the same time and for the same reason will be able to retain the proceeds of the recovery. This is an unfair and paradoxical result. This is a wrong that needs to be set right. I am certain that we will all be hearing more about DePrizio in the months and years ahead.

The material contained herein is not to be relied upon as a substitute for consultation with your attorney.