We recently discussed the elements a trustee must prove to avoid (that is, invalidate) a preferential payment to a creditor made before a New York bankruptcy filing (called a “preference”). One requirement is that the payment occur within 90 days of the petition or between 90 days and one year of the petition if the creditor is an “insider.” But who exactly are insiders? Section 101(31)(A) of the Bankruptcy Code gives five answers when the debtor is an individual, i.e. not a corporation or municipality:
- The debtor’s relatives
- Relatives of general partners of the debtor
- Partnerships in which the debtor is a general partner
- General partners of the debtor
- Corporations of which the debtor is a director, officer, or person in control
(It should be noted that “general partnerships” are businesses that are operated without a formal agreement of incorporation.)
“Relatives” in the Bankruptcy Code are defined in §101(45) as any “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.” Third-degree relatives go as far out as great-grandparents, uncles and aunts, nephews and nieces, and great-grandchildren, so payments to first cousins won’t be considered preferences. Relatives by affinity are by marriage.
The definition of “insider” also includes an important subcategory of entities called “affiliates,” who only appear in business bankruptcies. These are people or corporations that control, directly or indirectly, 20 percent of the voting power in the corporate debtor in bankruptcy. Affiliates can also be corporations 20 percent of whose shares are controlled by the debtor. Insiders of affiliates are also insiders for the purposes of preference actions. Problems with preferences to or from affiliates occur in business bankruptcies when the business is closely held (i.e. not a publicly traded entity) and the business owner tries to transfer assets to himself of herself, relatives, or other insiders.
Although a lot of people can be insiders, that doesn’t mean debtors should worry that debt payments to them will always result in a successful preference action. The trustee must prove all the other points, and in many cases debtors can easily prove that they weren’t insolvent when the payment was made. Still, it might be a good idea to wait out the one-year insider preference period. Payments to insiders can be thorny situations that make hiring an experienced New York bankruptcy lawyer a sensible choice.
For answers to more questions about preferences, insiders, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced business bankruptcy lawyer Bruce Weiner for a free initial consultation.