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Who is a “Non-Statutory Insider” for Purposes of Determining Whether a Payment Was Preferential in Bankruptcy?

Man at DeskOne of the objectives of the Bankruptcy Code is to ensure that each class of creditors is treated equally. And one of the ways that is accomplished is to allow the debtor’s estate to claw back certain pre-petition payments made to creditors. Accordingly, creditors of a debtor who files for bankruptcy are often unpleasantly surprised to learn that they may be forced to relinquish “preferential” payments they received before the bankruptcy filing.

In a recent case in the U.S. Bankruptcy Court for the Eastern District of Michigan (the “Bankruptcy Court”), the Bankruptcy Court considered whether payments made to the debtor’s boyfriend were preferential, and thus recoverable by the bankruptcy estate.

Bankruptcy Code Section 547(b)(4)(A) provides that payments made to any creditor within 90 days before a debtor files for bankruptcy can be avoided and recovered for the estate as preferences. In this case, the payments at issue were made outside of the 90-day window. However, with respect to payments made to an “insider” of the debtor, Bankruptcy Code Section 547(b)(4)(B) provides that the time period for recovering preferential payments enlarges to one year before the bankruptcy filing.

The debtor in this case made payments to her boyfriend, a 72-year-old Vietnam War veteran, outside of 90 days but within one year before her bankruptcy filing. The payments were made to repay funds loaned to the debtor by her boyfriend which she used to reinstate her mortgage. After filing for bankruptcy, the Chapter 7 trustee in the case initiated an adversary proceeding against the boyfriend in an attempt to recover the funds as a preferential transfer.

The Bankruptcy Court ruled in favor of the boyfriend, holding that he did not qualify as an “insider,” and the trustee appealed the decision to the U.S. District Court for the Eastern District of Michigan (the “District Court”). The District Court reversed the decision and remanded the case to the Bankruptcy Court for further proceedings[i].

The Bankruptcy Court’s Analysis

Upon remand of the case, the Bankruptcy Court undertook an analysis of who constitutes an “insider” for purposes of the preferential transfer provisions of the Bankruptcy Code[ii]. The Bankruptcy Code defines “insider” to include a “relative of the debtor or a general partner of the debtor.” However, as the District Court pointed out, “courts have recognized that the statutory list of presumptive insiders is not exhaustive,” and “creditors whose relationships with the debtor are analogous or equivalent to a statutory category have been found to be ‘non-statutory insiders.’”

In reversing the Bankruptcy Court, the District Court found fault with the test the Bankruptcy Court used to determine that the debtor’s boyfriend was not a non-statutory insider, resulting in a “truncated” analysis which led to error. In its initial decision, based on its reading of the U.S. Supreme Court Village at Lakeridge case, the Bankruptcy Court declined to find that the boyfriend was a non-statutory insider because his relationship with the debtor was not comparable with a marriage. On remand, the District Court directed the Bankruptcy Court to also consider: “(1) the existence of other comparable familial relationship (i.e., brother-sister (‘sibship’); and (2) whether the loan was an arms-length transaction.”

Regarding the first issue, the Bankruptcy Court reiterated findings from its first ruling that the debtor and her boyfriend were not acting as if they were, nor holding themselves out to be, a married couple. They did not cohabitate, intermingle their finances, or otherwise exhibit behaviors of a husband and wife.

The Bankruptcy Court also found that their relationship was not comparable to a “sibship” or other familial relationship. In short, the Bankruptcy Court explained that the debtor and her boyfriend “never held themselves out as family,” and thus the boyfriend should not be considered a non-statutory insider.

The Bankruptcy Court then turned to the issue of whether the loan was an arms-length transaction. Despite the fact that the loan was neither in writing nor called for interest, the Bankruptcy Court found that the loan was made at arm's length. According to the Bankruptcy Court, the fact that there was an expressed expectation of repayment, a promise to repay, all amounts borrowed were documented, and the boyfriend had no ability to compel payment, all supported its findings. In addition, the fact that both the debtor and her boyfriend served in the military, which ingrained in both of them a sense of duty and responsibility, weighed in favor of finding an arms-length transaction despite there being no loan documentation.

As this case demonstrates, cases involving disputes over allegedly preferential transfers require a careful fact-based analysis. If you have any questions about this case, preferential transfers, or bankruptcy issues, in general, please contact Patricia Scott at (517) 371-8132 or at pscott@fosterswift.com.

[i] Miller v. Sandell, Case No. 19-13577 (E.D. Mich., Decided April 30, 2020).

[ii] Miller v. Sandell, Adv. Case No. 18-94577 (E.D. Bankr. Mich., Decided May 11, 2020).

Categories: Chapter 7, Eastern District of Michigan

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