Bankruptcy Insider for Preferences: Key Things to Know

What is an insider in bankruptcy, and why should I care? What is a statutory insider, and is there such a thing as a non-statutory insider? The issue with insiders is fraudulent transfers, which would give a Chapter 7 trustee the right to go claw back money used to repay the debt of an insider just prior to filing.

What is a fraudulent transfer, and why should I care?

In bankruptcy, a fraudulent transfer typically occurs where the debtor disposes of property by giving it to someone in the time prior to filing bankruptcy for less than value. And here’s the kicker: a fraudulent transfer doesn’t require fraud or actual intent to defraud.

The trustee can then clawback the thing that was transferred, and then sell the item (or distribute the cash) for the benefit of the giver’s debts and creditors. This can be done by the trustee filing a lawsuit for a cause of action under Section 547, Section 548, or other provision of the Bankruptcy Code, or a state voidable transfer law.

So this is why it’s extremely important to understand whether someone filing bankruptcy sold, transferred, or gave away anything valued at more than $2000 in the X years before they filed bankruptcy (the time varies based upon the jurisdiction and state’s uniform voidable transfer act).

Often, the lookback period for preferences  is 90 days.  If the person who received the money or thing transferred is an insider, the time can become even longer than 90 days. So it’s important to know if the recipient was an insider or not.

What is a statutory insider in bankruptcy?

Section 101(31) defines “insider” (31) The term “insider” for an individual debtor as: (i) relative of the debtor or of a general partner of the debtor; (ii) partnership in which the debtor is a general partner;
(iii) general partner of the debtor; or (iv) corporation of which the debtor is a director, officer, or person in control;

Section 101(45) defines “relative” for a statutory insider: individual related by affinity or consanguinity within the third degree as determined by the common law, or individual in a step or adoptive relationship within such third degree.

The Ninth Circuit BAP had this issue where someone was trying to avoid a preferential transfer which happened before a bankruptcy was filed. However, it occurred more than 90 days before filing. “Here it is undisputed that the transfer complained of occurred when appellees recorded their lien on August 5, 1986, or greater than 90 days prepetition. Friedman can thus only avoid the transfer as a preference if appellees were insiders.” In re Friedman, 126 BR 63, 69 (BAP 9th Circuit 1991).

“As a matter of law, a statutory insider has a sufficiently close relationship with a debtor to warrant special treatment.” In re The Village at Lakeridge, 814 F. 3d 993, 999 (9th Circuit 2016), affirmed by SCOTUS,138 S. Ct. 960 (2018).

So it seems simple. Just follow the bankruptcy code, which defines “insider” and “relative.”

But wait there’s more: the bankruptcy nonstatutory insider

Note there’s a concept of nonstatutory insider:

“A creditor is not a non-statutory insider unless: (1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in § 101(31), and (2) the relevant transaction is negotiated at less than arm’s length.” Id. at 1001.

Taking it out of legalese, if the relationship is close enough to resemble that of a statutory insider, and the transaction looks a little more cozy than two strangers, that can be enough to make it a nonstatutory insider and extend the lookback period to a year.

“A court must conduct a fact-intensive analysis to determine if a creditor and debtor shared a close relationship and negotiated at less than arm’s length.” Id.

Therefore, the focus now shifts from one of control.  To extend the difference between the transfer and the bankruptcy petition filing from 90 days a year, there can be merely a very close relationship, in conjunction with conduct and behavior of the transaction in question that is not like that involving a stranger.

Examples of nonstatutory bankruptcy insiders following Lakeridge

As you can see, this start becoming a very fact-specific analysis that reviews the relationship between the two parties involved.

In 2017, a bankruptcy court found that the boards of both parties shared ownership and officers to satisfy the first prong, and that the transaction was not conducted as if the parties were strangers, so therefore it involved non-statutory insiders. In re Palmdale Hills Property LLC, (Bankr Ct, CDCA AP 1:16-ap-01120-GM. 2017).

Also in the San Fernando Valley bankruptcy court, the judge found that the relationship between a trust and the debtor was sufficiently close (even though there was no control). The court also found that the transactions involved were not negotiated at arm’s length. As such, a non-statutory insider relationship was determined. In re Rexford Properties, LLC, 557 BR 788 (Bankr Ct, CDCA 2016)

Summing up

Facts matter, and each case is different. Determination of non-statutory insider status is made on a case-by-case basis, from the totality of the circumstances. Id. at 797. But the bottom line is, in the Ninth Circuit, and possibly beyond as The Vill. at Lakeridge was affirmed by the Supreme Court, the definition of “insider” in bankruptcy is broader than the statute says.