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Insider Transactions in Bankruptcy

On Behalf of | Feb 20, 2020 | Bankruptcy, Business, Firm News

When small business owners file for chapter 11 bankruptcy, seldom do they reflect on the impact of bankruptcy on affiliated entities. In bankruptcy, insider[1] transactions are subject to heightened scrutiny. It is not uncommon to have a debtor that operates a business that leases property or equipment from or to a related entity.

Filing for chapter 11 bankruptcy relief does not mean those transactions have to cease. But, the debtor should not be engaging in non-beneficial business relationships. Conducting business with a related entity should not cause the debtor monthly losses. If it only benefits the related entity, the debtor will likely be forced to cease those transactions. A business debtor is afforded a breathing spell during the chapter 11 process. However, this period is for focused restructuring. It is not an opportunity to deplete any existing cash reserves or equity in the company.

KY Chapter 11 Operating Order Guidelines

Specifically, section X of the operating order entered by the court in chapter 11 cases filed in the Eastern District of Kentucky states that: “During the pendency of the chapter 11 case, neither the Debtor in possession nor any insider shall receive any increase in compensation, whether in salary or benefits or in any other form, without prior court approval after notice and hearing. This prohibition includes transfers of property to the individual Debtor or to any insider. The Debtor in possession shall not pay the personal expenses of an insider, except for payroll tax withholding and related transmittal, without court approval. Absent court approval, the Debtor in possession shall make no payments on any debt, whether secured or unsecured, owed to an insider or to a creditor whose claim is co-signed or guaranteed by an insider.”

Disclosing Insider Transactions

When creditors, the court, or the United States Trustee Office examine insider transactions the focus is on disclosure. They also look at whether continuation of those relationships is in furtherance of the debtor’s business judgment. Failing to disclose insider transactions can lead to allegations of conflict of interest, fraud, or mismanagement. They can also create significant issues in a chapter 11 case. These issues could lead to dismissal of the case or the appointment of a chapter 11 trustee. You should fully disclose any insider transactions to your bankruptcy counsel and have those transactions as apparent as possible. Seeking relief from the court to continue those insider transactions appears to be the most prudent course of action to avoid issues in your company’s bankruptcy case.

[1] Under the Bankruptcy Code  11 U.S.C. § 101(a)(31), an “insider” is defined to include for individual debtors that are relatives, any partnership in which the debtor is a general partner, any general partner of the debtor or any corporation in which the debtor is a director, officer, or person in control.  If the debtor is a corporation, insiders include: directors, officers, persons in control, partnerships in which the debtor is a general partner, a general partner of the debtor, and the relatives of a general partner, director, officer, or person in control of the debtor.

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