Preferential Transfers to Noninsider Creditors
| Jurisdiction | United States,Federal |
| Citation | Vol. 20 No. 4 Pg. 699 |
| Pages | 699 |
| Publication year | 1991 |
1991, April, Pg. 699. Preferential Transfers to Noninsider Creditors
In 1986, The Colorado Lawyer published a prescient article(fn1) in the "Business Law Newsletter" predicting that §§ 547(b) and 550(a)(1) of the Bankruptcy Code(fn2) ("Code") could be interpreted to require an unsecured or undersecured creditor to disgorge up to one year's worth of payments it received from a debtor in satisfaction of an antecedent debt guaranteed by an insider(fn3) of the debtor. Levit v. Ingersol Rand Fin. Corp. (In re V.N. Deprizio Constr. Co.)(fn4) is a landmark case which concluded that a trustee may recover payments from a noninsider creditor that were made by the debtor between ninety days and one year before the bankruptcy filing date (the "extended reachback period") if those payments were guaranteed by an insider.
Deprizio has been followed by the Tenth Circuit(fn5) and numerous other courts.(fn6) This article updates the 1986 article and discusses creditor strategies in response to Deprizio.
A trustee may avoid a transfer of an interest of the debtor under Code § 547(b) to the extent the transfer (1) was made to or for the benefit of a creditor; (2) was made for or on account of an antecedent debt; (3) was made while the debtor was insolvent; (4) was made during the extended reachback period, if such creditor at the time of the transfer was an insider; and (5) enables the creditor to receive more than it would receive in a Chapter 7 liquidation case.(fn7) If all the elements of § 547(b) are met with respect to an insider,(fn8) Code § 550(a)(1) permits the trustee to recover the property or its value for the extended reachback period, either from the initial transferee or the insider for whose benefit the transfer was made.
A literal reading of §§ 547(b) and 550(a)(1) would permit recovery against the noninsider creditor for the extended reachback period under the following reasoning: a guarantor is a contingent creditor(fn9) of the borrower under the Code. Accordingly, payments by the borrower to the creditor provide a "benefit" to the guarantor in the form of reduced contingent liability. If the other elements of § 547(b) are present, the year's worth of payments would constitute a voidable preference that could be recovered under § 550(a)(1), either from the creditor as the "initial transferee" or from the insider guarantor as the entity for whose benefit the transfer was made.(fn10)
While recognizing that the result described above could be obtained from a literal reading of Code §§ 547(b) and 550 (a)(1), pre-Deprizio bankruptcy courts generally permitted recovery against the insider guarantor but not against the creditor.(fn11) This result was justified on the equitable ground that a noninsider creditor who prudently obtains a guaranty should not in fairness be treated differently than a noninsider creditor who does not.(fn12)
To implement this equitable result, bankruptcy courts devised the "two transfer" theory, a legal fiction by which a debtor's payment is deemed to create two separate transfers. One is an indirect initial transfer to the insider guarantor in the form of reduced contingent liability that could be avoided for the one-year reachback period. The other is a direct second transfer to the noninsider creditor that could be avoided for the ninety-day reachback period, but not for the extended reachback period.(fn13)
In Deprizio, the Seventh Circuit concluded that the "two transfer" theory finds no support in the language of the Code. The court refused to apply its equitable authority to alter a result compelled by a literal reading of §§ 547(b) and 550(a)(1). As a result, the trustee was permitted to maintain his insider preference claim against the creditor for the extended reachback period.(fn14)
Five responses are available to creditors to avoid Deprizio liability. They are as follows: (1) the fully...
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