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Ninth Circuit Rules in Business Bankruptcy Case on Liability of Corporate Insider Who Personally Guaranteed Loan

4753524621_b49d53de46_z.jpgA corporate insider who personally guaranteed a loan, but also waived any right to indemnification by the company, was not subject to “preference liability” in the company’s Chapter 11 bankruptcy proceeding, according to the Ninth Circuit Court of Appeals. In re Adamson Apparel, Inc., No. 12-57059, slip op. (9th Cir., May 6, 2015). The Bankruptcy Code allows a bankruptcy trustee to avoid “preferences,” defined as certain types of transfers made by a debtor to a creditor before filing a bankruptcy petition. If the preference was made for the benefit of an insider, federal law states that the trustee may only recover avoided transfers from the insider in certain situations. The Ninth Circuit distinguished this case from prior decisions and ruled that the guarantor insider was not liable, finding the waiver of indemnification to be the key distinction.

The debtor, a clothing manufacturer, took out a large loan in 2002. The debtor’s president and CEO guaranteed the loan, stating that he would be personally liable for the loan if the company was unable to repay it in full. Normally, he would be entitled to indemnification, meaning the debtor would reimburse him for payments to the lender to settle the loan, but the guaranty agreements included waivers of that right.

In late 2003, the debtor received a very large order from a purchaser. It instructed the purchaser to pay the purchase price–slightly less than $5 million–directly to the lender. The guarantor paid the balance of the loan–more than $3.5 million–out of his own money in March 2004. In September 2004, nine months after directing the purchaser to make a payment on the loan, the debtor filed for Chapter 11 bankruptcy.

The Chapter 11 trustee appointed a committee to represent the unsecured creditors. 11 U.S.C. § 1102. This committee filed an adversary proceeding against the guarantor for preference liability, seeking to recover funds paid to the lender by the purchaser. The Bankruptcy Code defines a “preference” as a transfer (1) made by an insolvent debtor (2) to a creditor (or for a creditor’s benefit) (3) up to 90 days before the filing of a bankruptcy petition, or up to one year if the creditor was an insider at the time, (4) for a pre-existing debt, and (5) in a greater amount than the creditor would have been able to obtain in a Chapter 7 liquidation. 11 U.S.C. § 547(b).

A Seventh Circuit decision, In re V.N. Deprizio Construction Co., 874 F.2d 1186 (7th Cir. 1989), held that a bankruptcy trustee could avoid payments to a lender within the one-year period on a loan guaranteed by a corporate insider. Congress passed a law in response to Deprizio, stating that the trustee can only recover avoided payments from the insider guarantor, not the lender, in this situation. 11 U.S.C. § 550(c). This formed the basis of the committee’s adversary proceeding in Adamson Apparel.

After a trial, the bankruptcy court ruled that the committee had failed to establish that the guarantor was a creditor under §§ 101(10) and 547(b) of the Bankruptcy Code. The guarantor was therefore not subject to preference liability. The district court affirmed this ruling, and in a 2-1 ruling, the Ninth Circuit also affirmed.

A business that finds itself unable to pay its debts with its existing income may seek relief in bankruptcy with the help of a knowledgeable and experienced business bankruptcy attorney. James G. Schwartz has represented businesses and business owners in the Bay Area since 1976. Contact us today online or at (925) 463-1073 to schedule a free and confidential consultation.

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Court Denies Discharge in Personal Bankruptcy Case, Finding that Transfer of Cash from Bank Account to Safe Deposit Box Had Fraudulent Intent, Pleasanton Business & Commercial Law Blog, November 14, 2014

Loan Modifications and the Equal Credit Opportunity Act, Pleasanton Business & Commercial Law Blog, July 29, 2013

Photo credit: Joe Wolf [CC BY-ND 2.0], via Flickr.