It is already relatively settled that an insider who has personally guaranteed the debt of his or her company may face preference exposure to the extent the guaranteed debt is paid down during the one-year preference period applicable to insiders. Without doubt, such payments directly benefit the guarantor, whose obligation to the primary creditor is reduced dollar for dollar. The guarantor is also considered to be a creditor of the debtor because of the contingent right to assert a claim against the debtor (under indemnification, reimbursement, or similar principles) for any amount the guarantor is required to pay under the guaranty. So long as the other elements of a preference action under section 547(b) of the Bankruptcy Code are present, the amount of the avoided payments can be recovered directly from the insider under section 550(c) of the Bankruptcy Code.
On May 6, 2015, the Ninth Circuit became the first circuit-level court to rule that a guarantor’s “creditor” status can be contracted away by waiving indemnification and similar rights against the debtor. Stahl v. Simon (In re Adamson Apparel, Inc.), 2015 U.S. App. LEXIS 7508 (9th Cir. 2015). Bankruptcy courts have been split on this issue, with some courts holding that such waivers should not be enforceable because they are not necessarily foolproof. Sophisticated guarantors might be able to circumvent the contractual waivers by finding a way to assert a claim through other means, such as by purchasing the debt from the creditor instead of satisfying the debt wearing its “guarantor” hat and asserting the purchased claim against the debtor wearing its “primary creditor” hat.
The Ninth Circuit acknowledges that such a scenario is possible. However, the Ninth Circuit refused to nullify all claim waivers because of a single possibility. The facts of each case need to be considered in order to determine whether the waiver was a legitimate waiver or simply a sham. In the case before the Ninth Circuit, the waiver was supported by the governing documents, testimony, and the actions of the guarantor himself who made substantial payments under the guaranty and did not file any kind of indemnification or similar claim against the debtor’s bankruptcy estate. As such, the evidence was clear that the indemnification waiver was legitimate in this case.
This case is only the first of the circuit-level case on the issue and it will be interesting to see whether other circuits follow suit. For now, the lesson for insiders with substantial guarantor liability is to carefully consider whether it is worth waiving the right to assert indemnification claims against the debtor in order to avoid preference exposure. Obviously, giving up creditor status means giving up the right to receive distributions in any future bankruptcy. On the other hand, significant preference exposure might eclipse the benefit of retaining indemnification claims. The choice of retaining or waiving claims and creditor status is not one that can be made post-facto or during the bankruptcy case itself when the risks are known. Preference analysis generally looks at the facts at the time the transfers were made. If you were a creditor at that point, then your “choice” has likely been made for you for purposes of insider preference exposure.