9th Circuit Addresses Novel Bankruptcy Issue

PASADENA, Calif. (CN) - Settling an "unresolved issue" of bankruptcy law, the 9th Circuit held Wednesday that a corporate insider who personally guaranteed his corporation's loan is absolved of preference liability.

In the case at issue, Arnold Simon, the president of an apparel company, guaranteed his company's multimillion-dollar loan from CIT Group Commercial Services. Today's opinion notes that the guarantee agreements waived Simon's right to indemnification by the company in the event that the company was unable to repay the loan.

The company, Adamson Apparel, filed for Chapter 11 bankruptcy in late 2004. In March of that year, Simon paid the loan's balance - $3.5 million - from his personal funds.

A 2010 bench trial in bankruptcy court found that Simon was exempt from preference liability in the case because he was "not a creditor of Adamson."

Preference liability is "a mechanism that allows a debtor or trustee to recover from creditors who received payments in the weeks or months prior to the bankruptcy so that they can be distributed to all bankruptcy estate creditors in accordance with their priority," according to the ruling.

The 9th Circuit affirmed the lower court's decision 2-1 Wednesday, citing Simon's testimony and the fact that he never filed a proof of claim in the Adamson bankruptcy case.

Such evidence provides "more than sufficient evidence to conclude that Simon had fully waived his right of indemnification from Adamson," Judge Ronald Gilman wrote for the majority.

With no claim against Adamson, Simon cannot be considered a creditor, the court said.

Another section of the ruling delves into whether the waiver at issue could have been a sham.

"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," the 28-page opinion states. "But the mere possibility of such avoidance does not mean that it will routinely occur."

In the present case, "all evidence in the record indicates that the waiver at issue was not a sham," the court found.

"First, CIT held a lien on Adamson's inventory and accounts receivable to secure the loan," Gilman wrote. "Second, Simon never filed a proof of claim in the bankruptcy case."

Third, "Simon had no unilateral right to purchase the note from CIT if Adamson defaulted," and finally, "the trustee presented no evidence that the debt in question was the only debt that Simon guaranteed on Adamson's behalf," according to the ruling.

"The public-policy concern raised by the trustee in this case is far from frivolous, but that concern is more properly addressed to Congress, which has the ability to amend the Bankruptcy Code," Gilman said. "This court's equitable powers are limited by the text of the Code as presently worded.

"Accordingly, we hold that when an insider guarantor has a bona fide basis to waive his indemnification rights against the debtor in bankruptcy and takes no subsequent actions that would negate the economic impact of that waiver, he is absolved of any preference liability to which he might otherwise have been subjected."

Judge Susan Graber wrote in dissent that the majority got two points wrong.

"First, I would follow every bankruptcy court to have decided the issue and hold that insider-guarantors such as Simon are 'creditors,'" she said. "The majority errs by looking to extraneous facts to decide whether the waiver is valid.

"Second, even if we were to look to additional facts, the majority's analysis depends heavily on a 'fact' that the bankruptcy court expressly declined to find."

The latter point involves why Simon paid the balance of the loan at all.

"For our purposes, if the $3.5 million payment was made only to satisfy a personal debt, then that payment does not demonstrate anything with respect to whether the waiver on the Adamson-CIT loan was a 'sham,'" she said.

Graber said that she would reverse the bankruptcy court's holding that Simon was not a creditor and would remand for further proceedings.

"Not only is there no support for the majority opinion's incredibly strict application of the judicial admissions doctrine, we do ourselves and the litigants a great disservice if lawyers must be constantly wary that a mistaken guess about the content of the factual record, intended to aid the court, will be held against their clients conclusively." (Emphasis in original.)

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