Creditor Strategies to Combat Insider Transactions – Part 2 of 2
In the first part of this article series, we reviewed the insider transactions that were challenged by the Unsecured Creditors Trustee in the Senior Care Centers bankruptcy case. The Trustee’s Complaint alleged that the Senior Care Debtors, who were among the largest providers of skilled nursing services in the country, funneled millions of dollars to related companies prior to their bankruptcy filing.
The Trustee contended that the funds were drained through a series of improper, self-dealing transactions among commonly owned companies. The owners of those companies established a network of landlord entities to lease property to the operating facilities at above market rates. The Trustee alleged further that significant funds were also channeled to the landlords through lease buy downs that offered negligible value to the facilities. The objective of those transactions was to transfer funds to ownership free and clear of the claims of “legitimate, arm’s length creditors.”
While Part 1 discussed several discovery tools and litigation strategies for creditors facing challenges similar to those at issue in Senior Care, this follow-up piece addresses the involuntary bankruptcy option and potential causes of action that may be pursued in the bankruptcy proceeding as a vehicle to avoid and recover inter-company transfers.
Involuntary Bankruptcy Filing
The United States Bankruptcy Code authorizes creditors to force an insolvent company into bankruptcy if certain conditions are satisfied. Involuntary petitions are often viewed as a last resort because the potential penalties for improper filings are significant.
Despite these risks, involuntary bankruptcy filings offer creditors numerous benefits. First, the bankruptcy process is predicated on transparency and full disclosure. A debtor is required to open its books and records and may be subject to extensive discovery. Access to financial information and transaction history is particularly important where the debtor is a private, closely held entity. Information on such entities is not readily available to creditors outside of bankruptcy and often serves as the critical foundation to unwind insider transactions.
Second, an involuntary bankruptcy filing enables creditors to monitor a debtor’s ongoing operations. The close monitoring of the case by creditors and the Office of the United States Trustee limits the likelihood of ongoing fraud.
Lastly, the Bankruptcy Code includes several provisions providing for the avoidance and recovery of improper transfers made prior to the bankruptcy. In short, an involuntary bankruptcy can be a useful tool to level the playing field and ensure fair treatment among all creditors.
It would be unwieldy to delineate a complete analysis of involuntary petitions, though understanding key elements to its strategy offers creditors additional avenues of action. Before pursuing an involuntary bankruptcy, creditors must conduct a comprehensive analysis of the costs and benefits of this option. A full investigation of the requirements for involuntary bankruptcy filings must be conducted prior to the filing and all petitioning creditors should be cognizant of the process of filing and litigating an involuntary petition as well as the penalties that may be assessed if the petition is dismissed as improper.
Fraudulent Transfer Action
If an order for relief is entered, and the company remains in bankruptcy, several causes of action may be pursued to attack insider transactions. First, a pre‑bankruptcy transfer made by a debtor may be avoided and recovered as a fraudulent transfer. Importantly, the fraudulent transfer provisions empower the trustee or creditor representative to trace the funds to the ultimate recipient. The resulting effect of avoidance is that the transfer recipient is compelled to return the funds to the bankruptcy estate.
There are two types of fraudulent transfers. The first, which requires a showing of actual fraud, arises where the debtor knowingly and intentionally transferred assets to hinder, delay or defraud its creditor. The second does not require any proof of intent but rather only requires proof that the transferor received less than reasonably equivalent value and was either insolvent at the time of the transfer or rendered insolvent as a result of such transfer. Above market lease payments made by a debtor while insolvent, as alleged in the Senior Care bankruptcy litigation, is an example of a transaction that may be avoidable as constructively fraudulent.
A second powerful weapon to recover funds from a debtor’s related entities is the preference action. Subject to certain defenses, including for transfers made in the ordinary course of business, transfers made within ninety days of the bankruptcy filing (or longer if the recipient is an “insider” of the debtor) may be avoided and recovered if certain requirements are met. Among other things, the Bankruptcy Court will examine whether the: (i) debtor was insolvent at the time of the transfer; and (ii) transfer effectively provided the recipient an advantage over other creditors. Like fraudulent transfer actions, the proceeds of preference claims will be distributed first to the administrative costs of the bankruptcy, next to priority claims and then equitably among unsecured creditors.
For more information, please contact John C. Kilgannon, Esquire at email@example.com or the Stevens & Lee attorney with whom you regularly work.
John C. Kilgannon
This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.
 United States Bankruptcy Court for the Northern District of Texas (Dallas Division), Case No. 18‑33967.
 Litigation against debtors and/or their related entities is not limited to fraudulent transfer and preference actions; however, these two causes of action tend to be the most prominent.
 11 U.S.C. §548.
 It should be noted that fraudulent transfer actions may also be pursued outside of bankruptcy by individual creditors as most states have adopted fraudulent transfer statutes similar to those provisions in the Bankruptcy Code.
 11 U.S.C. §547.
 An “insider” for purposes of the one year lookback may include “directors, officers and persons in control” of the SNF. This definition has been expanded to include “non‑statutory insiders” which may include entities that engaged in transactions with the SNF that were not at “arm’s length.”