It is not unusual for a company in need of capital (the "Debtor") to be in a friendly business relationship with a lender, supplier, vendor, investor (which could be a parent company) or strategic partner (collectively referred to herein as a "Creditor Partner"). The Creditor Partner must be careful that the relationship does not involve the Creditor Partner so closely in the Debtor’s operations that a transaction between the Creditor Partner and Debtor will not be considered arm’s length, otherwise the Creditor Partner may be considered an insider under the United States Bankruptcy Code (the "Code") if the Debtor subsequently files bankruptcy. The finding that the Creditor Partner is an insider could result in certain payments, transfers, or accomodations, even those made by the Creditor Partner to aid a financially-distressed Debtor, being avoided by the United States Bankruptcy Trustee (the "Trustee").
When a company files bankruptcy, the Trustee reviews all transactions between a debtor and its creditors during the 90 day period prior to the filing of a bankruptcy petition (the "preference period") to determine whether any of the transactions would be considered a preference under the United States Bankruptcy Code (the "Code"). In general, a Trustee may set aside a transfer as a preference if (1) the transfer was made to or for the benefit of the creditor, on account of an antecedent debt, while the debtor was insolvent, and (2) the transfer enabled the creditor to receive more than such creditor would have received in a liquidation of the debtor under Chapter 7 of the Code had the transfer not been made or transaction entered into. Thus, any payment, transaction or accommodation which improves the position of a creditor in relation to the other creditors of the debtor may be considered a preference which the Trustee can avoid.
The preference period is expanded to one year if the creditor is considered an insider under the Code. The Code defines an insider to include: (1) a director or officer of the debtor, (2) a person in control of the debtor, (3) a partnership in which the debtor is the general partner, (4) a general partner of the debtor, or (5) a relative of a general partner, director, officer or person in control of the debtor.
There is also the concept of a "nonstatutory insider" who is subject to the same one year preference period. A Creditor Partner may be considered a nonstatutory insider if the relationship between the Debtor and the Creditor Partner and other facts suggest that the transaction between them was not at arm’s length and results in an improvement of the Creditor Partner’s interest in the Debtor’s assets in a subsequent bankruptcy proceeding.
Accordingly, even a loan or credit modification transaction, intended in good faith by a Creditor Partner to aid a financially-distressed Debtor, may be avoided by a Trustee if not carefully planned and consummated. The Creditor Partner, anticipating by its action a favorable position if the Debtor were to subsequently file a bankruptcy petition, may unwittingly obtain just the opposite result.
We represent both creditors and debtors in bankruptcy proceedings. If you have a question about insider status or preferences under the Code, please telephone a member of the firm.
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