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Deprizio waivers in bankruptcy cases: Valid, or a sham?

May 15, 2015

The Ninth Circuit Court of Appeals in In Re Adamson Apparel, Inc. became the first appellate court to address the validity of “Deprizio waivers.” In Adamson, the court held that because the Deprizio waiver was not a “sham” provision, the insider was not a creditor of the debtor that could be subject to a preference action. The decision carved out a fact-based avenue for analysis that will likely lead to increased litigation across the country on the issue of Deprizio waivers.

Deprizio waivers arose from an opinion authored by the Seventh Circuit Court of Appeals. In Levit v. Ingersoll Rand Fin. Corp. (In re Deprizio), the court faced a fact pattern where an insider guaranteed a loan made to his corporation by the bank, and then paid the loan with the debtor’s funds within one year of a bankruptcy filing. The implication in this situation is that the insider receives a benefit by using the debtor’s funds to reduce his own liability to the bank while not being subject to the one-year preference period for insiders. The court in Deprizio had to determine whether the insider was a creditor of the debtor who could be subject to a preference action, considering all of the other elements for a preference were met. The court held that the insider was in fact a creditor because under the guaranty agreement, the insider had a contingent right of indemnification against the debtor. In response to this decision, guarantors began waiving the right of indemnification against a borrower so that the guarantor would not qualify as creditor. These waivers came to be known as Deprizio waivers.

In the wake of these Deprizio waivers, two lines of cases emerged from bankruptcy courts. One line of cases simply concluded that where a guarantor waives the right of indemnification, the guarantor cannot be a creditor and, therefore, cannot be subject to preference liability. Other cases have held that the Deprizio waivers are sham provisions that attempt to contract out a provision of the Bankruptcy Code.

Adamson produced the first appellate decisions on this issue. The Adamson court began its analysis by stating that the concern about sham waivers is a valid one. The court explained that a “savvy insider guarantor might well agree to waive his right to indemnification from the corporate debtor, but then simply purchase the debt from the lender rather than pay it off if the debtor is later unable to meet its obligations.” In such a case, the guarantor would take the lender’s position without subrogation and would have a claim against the bankruptcy estate without the burden of the one-year preference period. The opinion went on to state that although such an action is possible, it does not mean it routinely occurs. Consequently, the court concluded that the validity of a Deprizio waiver should be determined on a case-by-case basis, examining whether the facts before the court evidence sham conduct.

Turning to the facts of the case, the Adamson court held that the Deprizio waiver at issue was not a sham provision. The court focused on the fact that the debt was secured by collateral that would have partially satisfied the debt. Additionally, the guarantor never filed a proof of claim while paying off $3.5 million of the debt with his personal funds, and had no unilateral right to purchase the note from the lender if the debtor defaulted. Finally, the court found that there was no evidence presented that the debt in question was the only debt guaranteed by the insider. As a result, the court held that the Deprizio waiver was not sham and the policy concerns at issue were not implicated.

Additionally, the opinion included a vigorous dissent from Circuit Judge Graber. In the dissent, Judge Graber noted that all cases after the 1994 amendments to the Bankruptcy Code have concluded that guarantors who signed Deprizio waivers are creditors subject to preference litigation. He agreed with those courts’ reasoning that these waivers have no economic impact and should be disregarded.

The consequences of Adamson will likely spark additional litigation both within the Ninth Circuit and throughout the country. First, it will likely increase litigation within the circuit because the Adamson court stated that the validity of the Deprizio waivers is a factual determination. Thus, bankruptcy courts will have to make factual findings before making a final determination as to the validity of Deprizio waivers. Second, because there are no other appellate decisions on the issue, the Adamson court has provided three separate arguments for the rest of the country to consider: (1) that a Deprizio waiver is valid unless there are facts to support it is a sham provision; (2) that all Deprizio waivers are valid because the guarantor has waived his claim against the debtor; or (3) that all Deprizio waivers are invalid because they have no economic impact.