Deprizio Cant Be Invoked to Apply the Insider Preference Period to Outside Creditors Period

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Oct 2003

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Who would have thought that bankruptcy practitioners would still be tormented by
the Seventh Circuit's decision in Deprizio, a case decided nearly 15 years ago and supposedly overruled by
Congress through the 1994 Bankruptcy Act? See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
re V.N. Deprizio Constr., 874 F.2d 1186,
1200-01 (7th Cir. 1989)</a>. In Deprizio, the Seventh Circuit held, among other things, that
the preference-recovery period for outside creditors, usually a commercial
lender, is one year when payment produces a benefit for an inside creditor,
including a guarantor. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; The chapter 7 trustee sought to avoid certain
payments to pension and welfare trusts as preferential transfers. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 1188</a>. The Deprizio holding was based on the fact that the guarantor had
subrogation rights that permitted the guarantor to demand repayment from the
borrower-debtor for amounts the guarantors paid to the lender. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 1191</a>.

In response to Deprizio, Congress passed
§202 of the Bankruptcy Reform Act of 1994. Through Bankruptcy Code
§550(c), Congress precluded a trustee's ability to recover from a
non-insider creditor transfers made more than 90 days before filing.<a href="#1" name="1a">1</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §550(c)</a>. The legislative history to §550(c)
indicates that Congress added §550(c) to "overrule the Deprizio line of cases and clarify that non-insider
transferees should not be subject to the insider preference provisions of the
Bankruptcy Code beyond the 90-day statutory period." Legislative History
to §550; 140 Cong. Rec. H:10, 752-01, H:10,767 (daily ed. Oct. 4, 1994)
(submission of Rep. Brooks).

Courts and commentators acknowledge congressional intent, but disagree over whether
§550(c) precludes a trustee from invoking the Deprizio doctrine to avoid, rather than recover, a
creditor's lien perfected within the year-long insider preference period
under Bankruptcy Code §547(b). One camp believes that §550(c) does
not prevent a court from applying the insider preference period under
§547(b) to an outside creditor to avoid a lien, and that the lien is
automatically preserved for the benefit of the estate under §551, without
the aid of §550 recovery provisions. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Williams, 234 B.R. 801, 804-05 (Bankr. D.
Or. 1999)</a>; Josephson, Richard C., "The Deprizio Override, Don't Kiss the Waivers Goodbye
Yet," 4-Jun Bus. L. Today 40 (1995); Carlson, David Gray,
"Tripartite Voidable Preferences," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Bankr. Dev. J. 219, 303 (1995)</a>.

The other view is that Deprizio was wrongly
decided and that the 1994 Act confirms congressional intent to free
non-insiders from the effects of the extended preference period under
§547(b) for avoidance and recovery actions. At least two commentors adopt
this view. See Lawniczak, James
M., "Did Congress Always Say What It Meant in the Bankruptcy Reform Act
of 1994?" <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Com. L. J. 372, 383 (1996)</a> (asserting that §547 does not allow
for the Deprizio court's
application of the insider preference period to outside creditors); Lewis, Adam
A., "Did It or Didn't It? The Deprizio Dilemma," Am. Bankr. Inst. J. 20, 42 (1995)
(arguing that the legislative history to §550 and policy confirm that a
non-insider creditor should not be at risk for insider preference period
transfers). Lewis and Lawniczak present the better view for at least two
reasons.

First, a literal reading of §547 invalidates the rationale underlying the Deprizio decision. The Supreme Court held that, when faced
with a question of statutory interpretation, the plain meaning of an
unambiguous statute is to be given effect. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…
States v. Ron Pair Enterprises Inc., 489 U.S.
235, 242 (1989)</a>. In the context of Deprizio, there is no debate that §547 is unambiguous,
and that the plain meaning of §547 should be given effect. Nevertheless,
the Deprizio court relied on an
unnatural reading of §547 to apply the insider preference period to
outside creditors. As Lawniczak correctly reasons, it is impossible for the
lien transfer (i.e., the
perfection of a lien) to meet all of the elements of a §547 preferential
transfer. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…,
101 Com. L. J. at 372, 382</a>. Section 547 does not allow "the
creditor" in §547(b)(1) to be a different creditor than "such
creditor" in §547(b)(4) or (5), which requires that the creditor
receive something. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; Instead, §547(b) only examines one creditor at
a time and further requires that such creditor be an insider and receive more
than it would receive in a chapter 7 case. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; Therefore, the grant of a lien or another transfer
to a creditor with an insider guaranty is not avoidable under §547(b) if
made within the insider preference period. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…;

In addition, the §550(c) amendment further dismantles the basis of the Deprizio decision. Deprizio was based on the language of §550(a)(1).
Specifically, alongside the unnatural reading of §547(b), the Deprizio court relied heavily on §550 to explain why the
transfer to the outside creditor should be subject to the insider preference
period. See, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Re V.N. Deprizio Constr., 874 F.2d. at
1195-1196, 1197 n.9</a> ("It is not the "benefit"
language of §547(b)(1)...that makes the change; it is the novel text of
§550(a)(1), allowing recovery from either transferee or beneficiary, that
underlies the trustee's claim"); see, also, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…,
101 Com. L. J. at 372, 382</a> (identifying Deprizio's reliance on §550(a)(1)).
Congress's amendment to §550 makes it clear that the trustee can no
longer recover from a non-insider transferee. Therefore, the Deprizio court's rationale based on §550 crumbles.

As a final note, the shaky rationale of Deprizio provides courts with ample grounds to decline to avoid an outside
creditor's lien perfected within the insider preference period.
Nevertheless, the legislative history subsequent to the 1994 Act reveals that a
stalemate over the consumer amendments of the Bankruptcy Code have allowed the Deprizio decision to continue to fester. Congress has sought
twice unsuccessfully to pass legislation amending §547 to clearly indicate
that the Deprizio doctrine should
not be applied in avoidance actions. See H.R. 833, 106th Cong. §1116 (1999); S. 625, 106th Cong.
§1114 (1999); H.R. Rep. No. 107-617, §1213 (2002). Unsurprisingly,
Congress is awed that Deprizio
still haunts creditors.

<h3>Conclusion</h3>

The Deprizio court's unnatural reading of §547(b) does not reconcile with the rules of statutory interpretation espoused by the Supreme Court. Moreover, Congress's amendment to §550 is enough to shred the rationale underlying the Deprizio doctrine. Therefore, even in light of perceived inadequacies of the 1994 Act and the current political law jam, the Deprizio doctrine can be laid to rest.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> All section references are to the U.S. Bankruptcy Code. <a href="#1a">Return to article</a>

Journal Authors

John R. Clemency

LaShawn D. Jenkins

Journal Date

Wednesday, October 1, 2003 - 12:00

Bankruptcy Rule

2003