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.

Can an Unsecured Creditor Include
Attorney Fees, for Services Rendered
Postpetition, as Part of its Prepetition Claim?

May an unsecured or undersecured creditor include in its prepetition claim attorney fees for services performed postpetition? Most courts that have considered the question have allowed inclusion, but a significant number of courts have rejected such claims.

Rationale for Allowing Such Claims

Courts that have allowed unsecured or undersecured creditors to include postpetition attorney fees as part of their prepetition claims have held that, where the creditorís prepetition agreement with the debtor provided for payment of attorney fees, and where such an agreement is enforceable under state law, the creditor has a valid, but contingent, unliquidated or unmatured prepetition claim for attorney fees as of the petition date.

These courts have based their decisions on (i) the broad definition of “claim” contained in§101(5) of the Bankruptcy Code (“Code”) (which includes contingent, unmatured and unliquidated claims); (ii) the absence of an express prohibition against allowance of attorney fees in Code §502(b) or elsewhere in the Code; and (iii) the power to estimate contingent or unliquidated claims contained in Code §502(c). See In re Hemingway Transport, Inc., 954 F.2d 1 (1st Cir. 1992), In re Ladycliff College, 46 B.R. 141 (Bankr. S.D.N.Y. 1985), In re Byrd, 192 B.R. 917 (Bankr. E.D. Tenn. 1996). Seealso United Merchants & Mfrs., Inc. v. Equitable Life Assurance Socíy of the U.S. (In re United Merchants & Mfrs., Inc.), 674 F.2d 134 (2d Cir. 1982)(based on the Bankruptcy Act).

In In re Byrd, Chief Judge Richard S. Stair found that the undersecured creditorís claim for attorney fees could be included as part of its prepetition unsecured claim. The Judge first analyzed Code §101(5) by looking at its plain language, which defines the term “claim” as, among other things, a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.” 193 B.R. at 918. Judge Stair then analyzed Code §502(c), which provides that the amount of a contingent or unliquidated claim “shall be estimated for purpose of allowance” where “the fixing or liquidation . . . would unduly delay the administration of the case.” Id.

Based on the plain language of these Code sections, the court in Byrd found that “[a] contractual right to payment of contingent, unliquidated, postpetition attorney fees is a prepetition claim . . .î Id. at 919. The court also found significant that, while §502(b) provides “for the disallowance of claims for unmatured interest, [it] makes no mention of unsecured prepetition claims for postpetition attorney fees.” Id.

Accordingly, based upon the broad definition of “claim” contained in Code §101(5), the absence of an express prohibition against allowance of attorney fees in §502(b), or elsewhere in the Code, and the courtís power under Code §502(c) to estimate claims, the court in Byrd held that the undersecured creditor may include a claim for postpetition attorney fees in its prepetition unsecured claim. Id. Similar opinions were issued by other courts. SeeIn re Hemingway Transport, Inc., In re Ladycliff College, In re Keaton, 182 B.R. 203 (Bankr. E.D. Tenn. 1995). Seealso United Merchants & Mfrs., Inc. v. Equitable Life Assurance Socíy of the U.S. (In re United Merchants & Mfrs., Inc.).

Grounds for Disallowing Such Claims

In contrast to the courts which have allowed postpetition attorney fees by creditors with unsecured or undersecured claims, courts that have denied such claims have looked beyond Code §§101(5) and 502, and have focused on Code §506(b) (which allows an oversecured creditor to recover postpetition interest and fees). These courts reason that since Congress has stated in Code §506(b) that an oversecured creditor may recover postpetition “fees”, unsecured and undersecured creditors may not recover postpetition attorney fees. See In re Sakowitz, 110 B.R. 268 (Bankr. S.D. Tex. 1989), In re Saunders, 130 B.R. 208 (Bankr. W.D. Va. 1991), In re Woodmere Investors Limited Partnership, 178 B.R. 346 (Bankr. S.D.N.Y. 1995).

In In reSakowitz the court examined the language of Code §506(b). Relying on the maxim of statutory interpretation “that the expression of one thing is the exclusion of another,” the court said:

Congress provided for attorney fees only for the secured portion of such a claim. Congress must be presumed to have understood what it was doing. It could easily have provided for attorney fees for the unsecured portion of the claim as well as the secured portion. That it did not do so this Court feels is determinative of the issue before the Court . . .

110 B.R. at 272.

Based upon that reasoning, the court in Sakowitz found that, since Code §506(b) expressly allows oversecured creditors to recover postpetition fees, unsecured or undersecured creditors should not be permitted to recover postpetition fees. Id.

The court in Sakowitz also distinguished between prepetition and postpetition fees based upon the provisions of Code §502(b), stating:

[§502(b)] provides for the determination of a claim as of the date of the filing of the petition, it is clear that the statutory scheme provided for by the Congress in the Bankruptcy Code excludes attorney fees earned post-petition on unsecured proofs of claim or on the unsecured portion of a secured claim, notwithstanding any contractual (or statutory) provision which would allow such fees outside of bankruptcy [emphasis in original].

Id. See also In re Saunders (court agrees with reasoning of Sakowitz),
In re Woodmere Investors L.P., (finding the statutory interpretation in Sakowitz convincing).

In In re Woodmere Investors L.P., Judge Blackshear stated that the United States Supreme Courtís decision in United Savings Assín of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365, 108 S. Ct. 626, 98 L. Ed.2d 740 (1988), provided a “more convincing reason to prohibit the recovery of post-petition attorney fees.” 178 B.R. at 356. Judge Blackshear found that the rationale in Timbers, which held that Code §506(b) permitted payment of postpetition interest only out of the “security cushion”, also was applicable to a claim for attorney fees and costs. He noted that “[s]ection 506(b) does not distinguish between interest rates and attorney fees,” and held that “[i]f no ‘security cushion’ exists to allow for post-petition interest, none exists for the allowance of attorney fees and costs.” Id.

Distinguishing between Attorney Fees and Postpetition Interest

In Byrd, supra, Chief Judge Stair distinguished the treatment of postpetition attorney fees from postpetition interest, noting that while Code §502(b) contains an express prohibition against allowing claims for postpetition interest, the Code does not contain an express prohibition against postpetition attorney fees. The court stated:

. . . § 502 . . . establishes certain conditions under which a claim shall not be allowed. These conditions include if, at the time the petition is filed, the ìclaim is for unmatured interest,î . . . [citation omitted]. Section 502 does not expressly disallow contingent, unliquidated, or unmatured claims for attorney fees. [emphasis added]

192 B.R. at 918.

Distinguishing Timbers, Chief Judge Stair stated: “[c]ontrary to the situation in Timbers [which involved Code §§361 and 506(b) relating to payment of postpetition interest], there is no general rule disallowing postpetition attorney fees set forth in §502(b).” Byrd, 192 B.R. at 919. Based upon this distinction, Chief Judge Stair rejected the decision In re Woodmere Investors Ltd. Partnership. Id.

In In re Keaton, the court criticized other courts for failing to distinguish between unmatured interest and attorney fees, stating:

Even though different rules clearly affect the allowance of unmatured interest and contingent, unliquidated attorneyís fees, some courts have converged the rules based on §506(b). . . . By isolating on §506(b), [footnote omitted] the rules on allowance of claims that apply to contingent, unliquidated attorneyís fees and to unmatured interest may appear to be singular. . . . Congress, however, chose not to exclude attorneyís fees under §502(b).

182 B.R. at 207-208.

The court then explained the special purpose for mentioning fees in §506(b), which does not apply to unsecured prepetition claims for postpetition attorney fees:

The question, then, is why §506(b) mentions fees as something that can be included in the creditorís ìallowed secured claim.î Without the clause in §506(b) concerning fees, there would be no specific rule in the bankruptcy statutes allowing the court to limit the fees to a reasonable amount. . . . Section 506(b) was intended to express limits on the extent to which the creditorís attorneyís fees will be treated as secured. It was not intended to define what fees can be included in the creditorís unsecuredclaim.

Id. at 208.

Similarly, in In the Matter of 268 Ltd., 789 F.2d 674 (9th Cir. 1986) the court stated that “Congress has chosen to treat contractual fees as part of the secured claim only to the extent they are ‘reasonable.’ ” 789 F.2d at 677. “When read in conjunction with §506(a), however, it [§506(b)] may be understood to define the portion of the fees which shall be afforded secured status.” Id. at 678. The court then held that the fees in excess of what the court deemed reasonable, could be included in an unsecured claim. The court stated: “[b]ecause §501 contemplates that undersecured creditors may pursue the unsecured portion of their claim as unsecured creditors, we find that oversecured creditors with valid contractual fee claims may do the same.”
Id.

Conclusion

Although there is a split in authority, a majority of the courts that have considered the question have not viewed Code §506(b) as a bar to a creditor including a claim for postpetition attorney fees as part of its prepetition unsecured claim.

Secured Creditors Beware: A Post-petition
Security Interest in Cash Proceeds May Be
Wiped Out by U.C.C. Article 9

Under applicable non-bankruptcy law, the commencement of insolvency proceedings may significantly limit a secured creditorís security interest in “cash proceeds” of collateral securing the indebtedness. As an example, under the provisions of the Uniform Commercial Code (“U.C.C.”), a secured creditor’s security interest in cash proceeds in a commingled bank account may be totally wiped out by the filing of a bankruptcy petition. To protect itself from the severe limitations imposed by the application of certain provisions of the U.C.C., the secured creditor should require that proceeds of its collateral be segregated and deposited into a separate account which is established for the purpose of receiving only the proceeds of its collateral.

Introduction

Bankruptcy Code §552(b) provides that perfected security interest in property of the debtor and proceeds received by the debtor before the commencement of the bankruptcy case shall extend to the proceeds of such property acquired after the commencement of the case.

However, the security interest in such after acquired property is only, “to the extent provided by such security agreement and applicable non-bankruptcy law, except to any extent that the court, after notice and hearing and based on the equities of the case, orders otherwise.” Bankruptcy Code §552(b) (emphasis added). Therefore, it is necessary to look to state law to determine the extent to which a security interest in proceeds remains enforceable after the commencement of insolvency proceedings. See Maxl Sales Co. v. Critiques, Inc., 796 F.2d 1293, 1297 (10th Cir. 1986).