Preferential Transfers: Is the Deprizio Doctrine Dead?

by Jack Weinberg and John Greco

The Bankruptcy Strategist, Vol. XII, No. 12, Oct. 1995

THE DEPRIZIO DOCTRINE, which applied the extended one year preference period to outside creditors whose dealings with the debtor benefitted inside creditors, is alive and well — at least in bankruptcy cases commenced before October 22, 1994, the effective date of the Bankruptcy Reform Act of 1994 (the “1994 Act”). Although, as part of the 1994 Act, Congress amended Code § 550 to abolish the Deprizio Doctrine, several Bankruptcy Courts recently have expressed their willingness to continue to apply the one year preference period under the Deprizio Doctrine in bankrupt-cy cases commenced before October 22, 1994. Also, at least one Bankruptcy Court has indicated that it would be receptive to arguments that the Deprizio Doctrine may be applied to cases filed after the effective date of the 1994 Act.

The Deprizio Doctrine

In Levit v. Ingersoll Rand Financial Corporation (In re Deprizio), 874 F.2d 1186 (7th Cir. 1989), commonly referred to as Deprizio, the Seventh Circuit addressed an issue no other circuit court had addressed before:

whether payments to creditors who dealt at arms’ length with a debtor are subject to the year-long preference-recovery period that 11 U.S.C. § 547(b)(4)(B) provides for “inside” creditors, when the payments are “for the benefit of” insiders.

Id. at 1187.

The Court in Deprizio held that “the preference-recovery period for outside creditors [under § 547(b)] is one year when the payment produces a benefit for an inside creditor, including a guarantor”.

Id. at 1200-01.

In reaching this conclusion, the Deprizio Court reasoned: (i) the insider guarantor benefitted from payments the debtor made to a non-insider obligee because such payments reduced the insider’s obligation under the guaranty; and (ii) the insider guarantor was a creditor of the debtor, within the meaning of § 101(9),* since the insider had a contingent claim against the debtor for amounts which the insider may pay under the guaranty. The Court in Deprizio then concluded that the payments to the non-insider obligee benefitted the insider and, therefore, were subject to the one year preference avoidance period found in § 547(b)(4)(B).

The Court in Deprizio held also, under § 550(a)(1), that “the trustee [has] the option to collect [the avoided transfer] from Lender, Guarantor or both, subject only to the proviso in § 550(c) that there can be but one satisfaction.”** Id. at 1194.

Thus, the Court in Deprizio permitted a trustee to avoid, and recover, payments made to a non-insider during the year preceding the petition date, when such payments benefitted an insider.

The doctrine established by the Seventh Circuit in Deprizio has been adopted by each of the five other Circuit Courts that later addressed the issue.***

The 1994 Act Amended Code § 550 To Abolish the Deprizio Doctrine

As part of the 1994 Act, Congress sought to eliminate the Deprizio Doctrine by amending § 550 of the Code. As amended, § 550(c) provides:

(c) If a transfer made between 90 days and one year before the filing of the petition —

(1) is avoided under section 547(b) of this title; and

(2) was made for the benefit of a creditor that at the time of such transfer was an insider;

the trustee may not recover under subsection (a) from a transferee that is not an insider.

The commentary following § 547 states as follows:

Section 550(c) overrules the Deprizio decision (Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186, 22 C.B.C.2d 36 [7th Cir. 1989]), by providing that non-insider transferees do not have liability for preferential transfers made for the benefit of insiders during the period between 90 days and one year prior to the filing of the petition.

See 1995 Collier Pamphlet Edition, Part 1, Bankruptcy Code, pp. 594 and 620.

Thus, although a transfer to a non-insider made during the period between 90 days and one year before the filing may be considered a preference, amended Code § 550 would prevent the trustee from recovering the transferred amount from the non-insider. However, as discussed below, an issue remains with respect to the trustee’s

powers of avoidance under Code § 547.

The Deprizio Doctrine Continues to Be Applied

Since most of the 1994 Act, including amended Code § 550(c), does not apply in bankruptcy cases commenced before its effective date of October 22, 1994, the Deprizio Doctrine continues to be the rule in cases commenced before October 22, 1994.

For example, in Blevins Elec., Inc. v. First American Nat’l Bank (In re Blevins Elec., Inc.), 1995 Bankr. LEXIS 1111 (Bankr. E.D. Tenn. 1995), the petition was filed before October 22, 1994, but the adversary proceeding was commenced after October 22, 1994. The Bankruptcy Court in Blevins examined § 702 of the 1994 Act to determine whether the provisions of the 1994 Act should be applied to that case. Section 702 provides:

the amendments made by this Act shall not apply with respect to cases commenced under title 11 of the United States Code before the date of enactment of this Act.

The Court in Blevins held that the word “cases” in § 702 referred to the bankruptcy case as a whole (i.e., that which is commenced by filing a petition for relief), and not to individual adversary proceedings commenced within a bankruptcy case. Since the bankruptcy case in Blevins was commenced prior to October 22, 1994, the Court found that the 1994 Act was inapplicable.

The Court in Blevinsthen held that it was bound by precedent in the Sixth Circuit which required it to apply the Deprizio Doctrine. See also Loo v. Martinson (In re Skywalkers, Inc.) 49 F.3d 546 (9th Cir. 1995); Orix Credit Alliance, Inc. v. Harvey (In re Lamar Haddox Contractor, Inc.), 40 F.3d 118 (5th Cir. 1994); Rosen v. Air Forwarding Systems, Inc. (In re Air Forwarding Systems, Inc.), 176 B.R. 638 (Bankr. M.D. Fla. 1995)(bound by 11th Circuit authority to apply the Deprizio Doctrine).

In some circuits, such as the Second Circuit, which have not yet ruled on the validity or applicability of the Deprizio Doctrine, courts have reached different conclusions regarding the Doctrine. For example, in O’Neil v. John Deere Industrial Equipment Company, Inc. (In re Northeastern Contracting Co., Inc.), 182 B.R. 673 (Bankr. D. Conn. 1995), a case commenced before October 22, 1994, Chief Bankruptcy Judge Krechevsky applied the Deprizio Doctrine to allow recovery from a non-insider transferee during the extended preference period, stating:

I am convinced that the language of the Code provisions, in effect at the time of the transfer in this proceeding, admits no other conclusion than that reached by Deprizio and that the court of appeals of this circuit [i.e., the Second Circuit] would so hold.

Id. at 174 (footnote omitted).

In contrast, in Pereira v. Lehigh Savings Bank, SLA (In re Artha Management, Inc.), 174 B.R. 671 (Bankr. S.D.N.Y. 1994), the court refused to apply the Deprizio Doctrine to a case commenced before the effective date of the 1994 Act. The Court noted that there was no controlling Second Circuit authority, and acknowledged that the 1994 Act did not apply to the action before it. Nonetheless, the Court concluded that the 1994 Act merely clarified § 550(c), and rejected the Deprizio Doctrine:

Because I concur with the reasoning behind the clarifying amendment of section 550 I will not apply the holding of Deprizio to this case.

Id. at 677.

Similarly, two bankruptcy courts in the Fourth Circuit have reached opposite conclusions on the applicability of the Deprizio Doctrine to cases commenced before the effective date of the 1994 Act. See Hovis v. Powers Const. Co., Inc. (In re Hoffman Assoc., Inc.), 179 B.R. 797 (Bankr. D.S.C. 1995) (following Deprizio). But see Crampton v. First Union Nat’l Bank of North Carolina (In re Conner Home Sales, Corp.), 1995 Bankr. LEXIS 860 (Bankr. E.D.N.C. 1995) (rejecting Deprizio).

In contrast, recent decisionsof bankruptcy courts in the Third Circuit have followed Deprizio in cases filed before October 22, 1994. See Mazze v. Wilmington Savings Fund Soc., F.S.B. (In re Austin Truck Rental, Inc.), 177 B.R. 827 (Bankr. E.D. Pa. 1995) (absent any Third Circuit authority the Court applied the Deprizio Doctrine); Pineo v. Reeves Bank (In re Hazen & Co., Inc.), 1995 Bankr. LEXIS 967 (Bankr. W.D. Pa. 1995);

Thus, it appears that theDeprizio Doctrine endures, at least in bankruptcy cases commenced before October 22, 1994 in Circuits which have adopted the Deprizio Doctrine.

Will The Deprizio Doctrine Be Rejected Uniformly In Cases Commenced After October 22, 1994?

When Congress amended Code § 550 to overrule the Deprizio Doctrine, it did not amend Code § 547(b), which allows a trustee to avoid preferential payments. Therefore, it appears that Congress did not eliminate the Deprizio Doctrine completely, but simply prevented the trustee from seeking recovery directly from non-insiders. Thus, even in cases commenced after the effective date of the 1994 Act, a transfer made to a non-insider creditor between 90 days and one year before the filing of the petition may be avoided under § 547(b) where the transfer benefitted an insider guarantor. Under amended Code § 550, the trustee may seek to recover the avoidable transfer from the insider. The insider guarantor, in turn, could require the non-insider creditor to reduce the amount payable under the insider’s guarantee by the amount that the insider guarantor paid to the trustee.

In a footnote in O’Neil,Judge Krechevsky states: “[t]he Bankruptcy Reform Act of 1994 purports to legislatively overrule the Deprizio line of cases.” O’Neil, 182 B.R. at 174 (emphasis added). That qualifying, equivocal language shows that Judge Krechevsky is not convinced that the 1994 Act indeed completely achieved the Congressional objective of overruling the Deprizio Doctrine.

Accordingly, it seems that Courts may be receptive to arguments that the rationale of the Deprizio Doctrine applies even in cases commenced after the effective date of the 1994 Act.