Lenders and Vendors Beware: Deprizio can Spoil Your Insider Guarantees – but a Waiver may Protect You
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Lenders and trade vendors often sagely require personal guarantees from the insiders of their debtor. In the event of debtor bankruptcy, a creditor may look to the insider-guarantor to satisfy the debt. The creditor’s ability to be made whole, then, is directly related to the financial position of the insider-guarantor. There is a problem: the Deprizio doctrine can erode the insider-guarantor’s financial position. Under the doctrine, the bankruptcy Trustee may disgorge assets from the guarantor that could otherwise satisfy the debt. Luckily, there is a solution to the Deprizio problem: a carefully crafted guaranty agreement that waives the guarantor’s claim against the bankruptcy debtor. This blog post explains the problem and clarifies the solution.
The Deprizio Problem
The court in Levit v. Ingersoll Rand Fin. Corp. (In re Deprizio), 874 F.2d 1186 (7th Cir. 1989) held that a payment to the creditor, by the debtor, may be a preferential transfer to a guarantor of the principal debt. Guarantors are generally considered to be creditors of the debtor for preference purposes where the debtor has agreed to indemnify the guarantor for any payments made by the guarantor to the creditor under the guaranty. In re Wesley Indus., Inc., 30 F.3d 1438, 1441 (11th Cir. 1994); id. (explaining that guarantor on a lender’s debt is a ‘creditor’ under 11 U.S.C. § 101(10) (2010) because he has a contingent right to payment from the debtor. This is because the guarantor succeeds to the lender’s entitlement and would look to the debtor for recourse if the lender collected from the guarantor.) When the debt to the creditor is reduced, the contingent liability of the guarantor is also reduced, thus reducing the contingent claim of the guarantor against the debtor.
Since Deprizio, an insider-guarantor may have to pay to the bankruptcy estate the total amount of payments that lender/vendor creditor received during the one year prior to debtor filing bankruptcy. Making these payments decreases the guarantor’s assets from which he can satisfy his obligation to the creditor; it shrinks his or her financial position. Because the unsecured (under-secured) creditor receives pennies on the dollar in a typical bankruptcy, the increase in the bankruptcy estate pool does little to help the creditor. Therein lays the problem. Less money is available to the lenders/vendors when they call on their guarantees.
The Waiver Solution
In reaction to Deprizio, some suggested, and still suggest, that an insider-guarantor could avoid exposure by waiving all rights of indemnification, subrogation, contribution, and exoneration against the debtor in the guaranty document. The rationale is that the waiver eliminates the creditor status of the insider-guarantor, such that there may be no voidable preference under 11 U.S.C. § 547. See In re M2Direct, Inc., 282 B.R. 60, 64 (Bankr. N.D. Ga. 2002). To apply this solution, lenders or vendors who are taking a guaranty by an insider of the debtor should obtain a waiver by the guarantor waiving any right that the guarantor might have, such as the right of reimbursement or subrogation, to recover from the debtor.
But courts have split on whether the waiver solution works. Ogier v. Steele (In re Buckhead Oil Co.), 454 B.R. 242 (Bankr. N.D. Ga. 2011). The waiver solution was successful in some cases. See e.g. In re Ne. Contracting Co., 187 B.R. 420, 423 (Bankr. D. Conn. 1995); In re XTI Xonix Technologies Inc., 156 B.R. 821, 827 (Bankr. D. Or. 1993); In re Fastrans, Inc., 142 B.R. 241, 245 (Bankr. E.D. Tenn. 1992). However, it failed in others. See e.g. In re Telesphere Communications, Inc., 229 B.R. 173, 176 n.3 (Bankr. N.D. Ill. 1999); In re USA Detergents, Inc., 418 B.R. 533, 542 (Bankr. D. Del. 2009).
As shown by the cases, the courts look to the contracts under applicable state law to determine whether it was the intent of the guarantor to fully waive its rights against the debtor. Thus, the validity of waivers will depend on the jurisdiction and, critically, the language of the waivers themselves. Moreover, these waivers are to be strictly construed. The courts examine closely the language in the guaranty to ascertain whether any claims, either legal or equitable, may survive the waiver. In re Buckhead Oil Co., Inc., 454 B.R. at 249.
Under Florida law, the following waiver was enforced: “Guarantor further expressly waives to the extent permitted by law any and all rights and defenses, including without limitation any rights of subrogation, reimbursement, indemnification and contribution.” Wells Fargo Bank, N.A. v. Osprey Commerce Ctr., LLC, 8:13-CV-1738-T-27MAP, 2014 WL 1271460 (M.D. Fla. 2014). Under Georgia law, the following language was enforced: “The undersigned agrees that he shall have no right of subrogation, reimbursement or indemnity whatsoever and no ‘claim’ against Borrower in any proceeding under Title 11 of the United States Code, as amended (the ‘Bankruptcy Code’) and no right of recourse to or with respect to any assets or property of Borrower or to any collateral for the Obligations, even upon payment in full of the Obligations.” In re Buckhead Oil Co., Inc., 454 B.R. at 249.
In conclusion, wise lenders and vendors will study the law in their jurisdiction and carefully craft appropriate Deprizio waivers into their guarantees to protect their guarantor’s financial position.