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Seventh Circuit Affirms Ruling that Member of a Limited Liability Company Was an ''Insider'' for Purposes of Preference Recovery Under 11 U.S.C. Sec. 547(b)

Monday, September 19, 2011
In re Longview Aluminum, LLC, No. 10-2780, 2011 BL 227017 (7th Cir. Sept. 2, 2011) The United States Court of Appeals for the Seventh Circuit affirmed a bankruptcy court’s ruling avoiding certain transfers to a member of a limited liability company as a preferential transfer under 11 U.S.C. § 547(b)(4)(B). Rejecting the member’s assertion that he did not qualify as an "insider" under 11 U.S.C. § 101(31)(B), thereby enabling the trustee to recover transfers made by the debtor to the member within one year of bankruptcy, the Seventh Circuit concluded that a member of a limited liability company may qualify as a statutory insider and that, in the present case, the member had sufficient rights and powers as a member of the debtor’s board of managers to deem him an insider under the statute. As a consequence of the decision, the member was required to return over $200,000 in payments made to him during the one year preceding the debtor’s bankruptcy filing.

Debtor’s Settlement Payments to Forte within One Year of its Bankruptcy Filing

Longview Aluminum LLC ("Longview" or "Debtor"), had a board of managers comprised of five members ("Board"), including Dominic Forte ("Forte"). From June 2001 until June 2002, Forte asked Longview to provide him with its business records. After Forte's requests were repeatedly denied, he sued another board member, Michael Lynch, who held a 50% interest in Longview, alleging that he had used his controlling interest to prohibit Forte from reviewing Longview’s business records and excluded Forte from participating in management decisions. In response, the members of the Board, other than Forte, executed a consent dated August 20, 2002, formally suspending Forte’s right to access Debtor’s business records until the conclusion of (1) Longview’s investigation into the purpose of Forte’s requests; (2) an audit of Longview’s account; and (3) the discovery in an unrelated lawsuit involving Longview. Several months later, on November 7, 2002, Forte and Longview entered into a settlement agreement under which Longview was to pay $400,000, plus attorney’s fees and costs, to Forte in exchange for his agreement to leave the Board. Later that day, Longview gave Forte $200,000, as an initial payment, and, on January 16, 2003, Longview gave Forte an additional $15,000, representing attorney’s fees and costs. However, prior to payment of the remaining funds, on March 4, 2003, Longview filed a petition for chapter 11 bankruptcy protection.

Bankruptcy Court Avoids Payments Made to Forte as Preferences to an Insider

Following Debtor’s bankruptcy filing, the appointed trustee ("Trustee") filed an adversary proceeding against Forte, seeking to recover the settlement payments as preferential transfers made to an insider within one year of Debtor’s bankruptcy petition under § 547(b)(4)(B). While Forte admitted that the $15,000 payment was a preferential transfer made within 90 days of Debtor’s bankruptcy filing, he denied that the $200,000 payment constituted a preferential transfer on the grounds that he was not an "insider" within the meaning of § 101(31)(B). Ultimately, the bankruptcy court disagreed, however, and ruled in favor of the Trustee. Following a subsequent appeal to the district court, which affirmed the bankruptcy court’s decision, Forte appealed the lower courts’ rulings to the Seventh Circuit.

Overview of "Insider" Status under § 547(b)(4)(B)

Rendering its decision on appeal, the Seventh Circuit began with an analysis of "insider" status for purposes of preference recovery under § 547(b)(4)(B) and observed that an insider of a corporation is defined non-exclusively under § 101(31)(B) to include a: (1) director of the debtor; (2) officer of the debtor; (3) person in control of the debtor; (4) partnership in which the debtor is a general partner; (5) general partner of the debtor; or (6) relative of a general partner, director, officer, or person in control of the debtor. In applying this definition, the Seventh Circuit found that certain courts have focused on the similarity of the alleged insider’s position to the statutory categories, while other courts have focused on the alleged insider’s control of the debtor. See, e.g., In re Krehl, 86 F.3d 737, 741 (7th Cir. 1996). Under this second approach, the Seventh Circuit noted that the term "insider" can encompass anyone with a "sufficiently close relationship with the debtor that his conduct is made subject to closer scrutiny than those dealing at arm’s length with the debtor." Id.

Seventh Circuit Rules that a Member of an LLC can be an Insider under § 101(31)(B)

Applying the first approach to the present case, the Seventh Circuit rejected Forte’s assertion that the district court erred when it used the similarity approach to compare a director of a corporation to a member of an LLC and expanded the term "director" to include members and managers of an LLC. In this regard, the Seventh Circuit was guided by the fact that the enumerated list is not exhaustive and the definition of an "insider" has been expanded by bankruptcy courts to include positions comparable to those enumerated, including in the LLC context. See, e.g., In re Krehl, 86 F.3d at 741. Further, the Seventh Circuit noted that under Delaware law, the management of an LLC is vested in its members, just as a corporation must be managed by a board of directors. See 6 Del. C. § 18-402, 8 Del.C. § 141(a). While Forte further argued that an LLC manager’s authority can vary significantly from that of a director of a corporation because his powers are set forth in an LLC agreement, the Seventh Circuit found instead that, under Delaware law, authority is vested by default in the members of the LLC and that, in the instant case, Debtor’s LLC agreement provided its members with authority similar to that of a director of a corporation. As such, the Seventh Circuit affirmed the district court’s ruling that a member of an LLC can be a statutory insider under § 101(31)(B).

Forte’s Relationship to Debtor

Additionally considering Forte’s relationship to Debtor under the second approach, the Seventh Circuit agreed with the district court’s finding that the effect of the written consent which prohibited Forte from reviewing Debtor’s books and records, was not sufficient to remove Forte’s status as an insider. On this issue, the Seventh Circuit was guided by the fact that there was never a formal vote or document executed that removed Forte’s member status and that Forte’s surviving member status allowed him to maintain significant rights, including voting rights and a seat on the Board. Furthermore, the Seventh Circuit distinguished the cases relied upon by Forte, where an individual in a position similar to a director was found not to have insider status because he did not actively participate in corporate management, see, e.g., Butler v. Shaw, 72 F.3d 437 (4th Cir. 1996), on the grounds that while the individuals in those cases were not "in control of" the company before their formal resignation or departure, Forte still had rights and control over Debtor as a member on the board during the one-year preference period. Finally, the Seventh Circuit rejected Forte’s argument that because members and managers are not set forth in the statute's definition, they could only be deemed insiders if they fell within the non-statutory criteria and there was no close relationship in the present case or less than arm’s-length transaction. While acknowledging that courts consider those factors and frequently use the control approach, the Seventh Circuit resolved that the similarity approach produces a better interpretation of the statue where, as in the present case, the issue was whether a member or manager of an LLC was a statutory insider. Accordingly, the Seventh Circuit concluded that Forte’s relationship to Debtor showed that he was an insider under § 101(31)(B).

Seventh Circuit Affirms Bankruptcy Court’s Ruling

Ultimately, the Seventh Circuit affirmed the lower courts’ rulings and held that Forte was an insider for purposes of a preference under § 547(b)(4)(B). The decision illustrates that the definition of an insider under §101(31)(B) is non-exhaustive and includes an analysis of the similarity of the recipient to the statutory categories of insiders, as well as of the recipient’s relationship to the debtor. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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