This article is part of my bankruptcy alphabet series.  Continuing with the Letter “I” in the Alphabet Series:

You’re sitting around watching the Lakers get beat again or just enjoying a good book when the mail comes, and inside it is a lawsuit from a bankruptcy trustee of your nephew, who recently filed a bankruptcy case, seeking to recover from you the $5,000 your nephew repaid you ten months ago.   You think you’re being treated unfairly, but after you speak to a few bankruptcy attorneys, you will realize that by being a relative of the debtor who filed bankruptcy, you have a problem!

Insiders are treated differently than others in a bankruptcy context, a lesson many learn the hard way.

There are many ways in which insiders are treated differently than others in bankruptcy.   This article will not attempt to list all of them, but will focus on repayments by the debtor (preferential transfers) .

What or Who is an Insider?

Insiders are those with a close enough relationship to the debtor (person who filed the bankruptcy case) so that the laws make certain actions different with respect to these individuals or entities than with others.

Per the statutory definition set forth in 11 U.S.C. 101(31), an insider INCLUDES the following:

(A) if the debtor is an individual–

• (i) a relative¹ 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.

(B) If the debtor is a corporation, insiders include–

• (i) directors of the debtor corporation;
• (ii) officers of the debtor corporation;
• (iii) persons in control of the debtor;
• (iv) partnerships in which the debtor is a general partner;
• (v) general partners of the debtor, or;
• (vi) relatives of a general partner, director, officer, or person in control of the debtor.

(C) Partnership debtors have similar definitions for its insiders.

It is important to note that the above list is not exclusive, meaning that a court can determine others to be insiders even though they do not meet the definitions of the above listed parties.

¹ Relatives include all the way down to great grandchildren of the debtor, or cousins and others within the third degree of affinity or consanguinity, including step or adoptive relationships

The Downside to Being Inside

One of the ways insiders are treated differently is with respect to transfers made by the debtor prior to filing a bankruptcy case.   In particular, with respect to a preferential transfer (essentially repaying a debt that entitles the creditor to receive more than they otherwise would have in a Chapter 7 case), the time period for the transfer is only 90 days for most parties.  Thus, if a debtor repays an “ordinary” creditor within 90 days prior to filing a bankruptcy case and meets the other requirements for a preferential transfer, the Trustee in a Chapter 7 case can sue that creditor to recover the amount transferred.   However, for an INSIDER, the period is ONE YEAR prior to filing the bankruptcy case!

Thus, if you are an individual and repay a relative money within one year prior to filing a bankruptcy case, the relative can be sued to recover that amount.  This can be a big surprise, but one that is quite common since for some reason, many people who file bankruptcy think they are being smart by repaying their family members first before filing bankruptcy.   Unless you want to wait more than one year after repaying them, you are putting them at risk.   There are other types of transfers which can be recovered if they occur several years prior to filing a bankruptcy case.

Another Insider Example

In a Chapter 11 context, Insiders are not allowed to vote for or against the proposed repayment plan, and have other restrictions on rights that other creditors do not have.

Others Playing the Bankruptcy Alphabet Game:

1. Lincoln, Nebraska Attorney–Involuntary Bankruptcies
2. New York Bankruptcy–Jay Fleischman–I is for Income
3. Marin County attorney–I is for Income
4. Northern California attorney–I is for IRS
5. Colorado Springs Bankruptcy attorney–I is for in forma pauperis
6. Hawaii bankruptcy attorney–I is for Independent Contractor
7. Michigan Bankruptcy Attorney-I is for Income tax refunds
8. Philadelphia Bankruptcy attorney-I is for IRA
9. Northern Ohio Bankruptcy Attorney–I is for Involuntary Chapter 7

Image courtesy of RalphBijker

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One of the most common mistakes my clients make is repaying debts to friends and family before filing their bankruptcy case. In many cases this leads to extremely undesirable results.

The basic law as stated in the bankruptcy code (and in many state laws as well) is that anything repaid to a relative or other “insider” within twelve (12) months prior to filing a bankruptcy case can be recovered by the Trustee in that case.    That means that the Trustee can (and, depending on the amounts involved, will) sue that relative to recover the money or property repaid to them during that period.    This is known in legal parlance as a “preferential transfer” and the bankruptcy statute is 11 U.S.C. 547.
The law is the same with respect to any other non-relative creditor, except that for them the lookback period is only 90 days prior to filing the bankruptcy case, so it’s usually easy to wait the 90 days before filing.  But obviously much harder if a relative has been recently repaid.

There is nothing that prevents the repayment of ANY debt AFTER the bankruptcy case is completed, so if you want to repay anyone, just do it after the bankruptcy case is completed, then there’s no problems.   However, I suspect many of you will be reading this blog or obtaining your legal advice after you’ve already repaid them.

Another related issue, which will not be covered here, is simply transferring assets or money to someone prior to filing a bankruptcy case.  In California, any such transfers done without receiving equivalent value in return is considered a “fraudulent transfer” and is recoverable for up to 7 years following the transfer.

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I get asked a variation of this question at least once a week. Today’s consultation featured a mother who had quitclaimed half an interest in her home to each of her two sons about 2 years ago. She now needs to file a bankruptcy case. The sons are (rightfully) concerned. Why? Because they didn’t pay anything for the property interests they received.

In bankruptcy, this is known as a potentially “fraudulent transfer” which can be recovered by the Trustee. Of course, the Trustee must be able to specifically prove a few things in order to prevail. Among these are: 1. The transfer in question took place within 2 years prior to filing the bankruptcy case (In California, this is four years per separate California law); 2. The debtor making the transfer did not receive “reasonably equivalent value” for the transfer from the transferee AND was insolvent at the time the transfer was made, or became insolvent as a result. (insolvency is a term defined usually with reference to the Internal Revenue Code). Or if the Trustee can prove that the transfer was done with intent to hinder, delay or defraud a creditor, then that is a separate ground on which the Trustee can prevail.

There are obviously more complexities to this and you can read more about fraudulent transfers on my webpage, but this should give a warning bell to all those who are considering doing this.

Even if done innocently or involuntarily, any such transfers can be recovered–both inside and outside of bankruptcy–and the value received by the transferee (person who received the asset) can be ordered by a court to be returned.

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