3rd Circ. Sheds Light On Insider Status In Bankruptcy

September 30, 2014

Insider status in U.S. bankruptcy carries with it significant burdens. Insiders face a one-year preference exposure rather than the 90-day period applicable to noninsiders, insiders are by definition disinterested persons and may not be retained to provide professional services and transactions among debtors, and insiders are subject to heightened scrutiny under the entire fairness doctrine.

From a reorganization perspective, however, the issue could impair the ability of debtors to retain critical personnel. Debtors often wish to retain certain employees whom they consider valuable to their reorganization. Section 503(c) of the Bankruptcy Code, however, prohibits, subject to certain conditions, payment of “a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business." Courts have noted that the requirements of 503(c) are almost impossible to meet. Thus, whether a debtor can make such payments to an employee will often hinge on whether the employee is considered an “insider.”

The Bankruptcy Code defines an insider of a corporation to include, among others, officers of the debtor. While some of these categories are straightforward, i.e. directors, courts have grappled with what it means to be an officer of a debtor. A recent nonbankruptcy Third Circuit decision, Aleynikov v. Goldman Sachs Group Inc., may shed light on this issue.