Thursday, October 27, 2005

Retroactive Effect of Deprizio Amendment

Some practitioners of a certain age may have been surprised to learn that BAPCPA contains an amendment intending to fix the "Deprizio" problem - didn't they do this back in 1994? Well, a Creditors' Committee was disappointed, if not surprised, to learn that not only is there a new Deprizio amendment, but it applies even to pending cases including one that had been tried but no judgment yet entered. In re ABC-NACO, Inc., ___ B.R. ___, 2005 WL 2649305 (Bankr. N.D. Ill. 2005).

To recap, prior to 1994, lenders who had the good sense to have obtained guarantees from corporate insiders were often penalized in bankruptcy preference actions. Since 11 U.S.C. 547 and 550 permitted a trustee to avoid and recover a transfer "to or for the benefit of a creditor" made up to one year prior to bankruptcy if the creditor was an insider, courts treated payments to the lender as payments for the benefit of the insider guarantors (since they reduced the guarantors contingent liability on the guarantee), and permitted a one-year reachback, even though the lender itself was not an insider. See In re Deprizio, 874 F.2d 1186 (7th Cir. 1989). In 1994 Congress amended 11 U.S.C. 550(c) in the hope of eliminating such exposure, by providing that a transfer could not be recovered during the one-year reachback from a transferee that is not an insider.

Unfortunately (and you may be seeing a pattern here), the Congressional fix did not work perfectly. If the transfer at issue was a lien (i.e., the borrower granted additional collateral to secure the loan), a trustee could simply avoid the transfer and preserve it for the benefit of the estate, without invoking the recovery provisions of 550 (and the protection contained in it for non-insider creditors). In order to fix the hole left by the 1994 amendments, BAPCPA added a new subsection to 547 which provides that in the Deprizio scenario (i.e., a transfer made between 90 days and 1 year to a non-insider creditor, which is for the benefit of an insider creditor), the transfer shall be considered avoided "only with respect to the creditor that is an insider." Unlike most of the provisions of BAPCPA, this particular amendment is effective immediately in any case pending or commenced on or after the date of enactment of BAPCPA.

In ABC-NACO, the Creditors Committee had been given authority to pursue a preference action against a bank which had received pledges of additional collateral from the debtor within a year prior to the petition date. The preference action had already been tried, but judgment had not yet been entered, as of April 20, 2005 when BAPCPA was enacted. The defendant bank filed a post-trial motion for judgment as a matter of law relying on the BAPCPA amendment to 547. The Committee conceded that the amendment if applied would provide a defense to the claim, but contended that the retroactive application of the amendment was unconstitutional as a violation of the Takings Clause and the Due Process Clause.

Judge Wedoff rejected both arguments. As to the Takings Clause, the court found that the Committee could not have any vested property interest in the 547 cause of action until judgment is entered, relying on a "well-established principle" enunciated in McCullough v. Virginia, 172 U.S. 102 (1898) and consistently followed since then. It also found that the Committee had no vested interest in the real estate subject to the transfer, because it only could have such rights as a result of a judgment being entered on the avoidance action. It also rejected the notion that the debtor or estate had any contractual rights to have preferential transfers avoided as a result of a purported "implied provision" in the mortgage agreements incorporating the Bankruptcy Code avoidance provisions as they existed at the time the mortgages were granted.

Finally, the court rejected the Committee's complaint that retroactive application would be a denial of substantive due process, finding that the statute met the standard of being "rationally related to a legitimate legislative purpose." Although the Committee argued that Congress' goal of encouraging lending supported by insider guarantees would justify only prospective and not retroactive application (since loans already made need no encouragement), Judge Wedoff noted an additional reason for the enactment of the amendment which did justify retroactive application: that Congress never intended for there to be an extended preference period based on insider guarantees in the first place.

As a result, Judge Wedoff found no barrier to the retroactive application of the BAPCPA amendment to 547, and accordingly granted judgment in favor of the bank.

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