One basic tenet of bankruptcy law is that each creditor be treated the same as others in its class (secured, unsecured, priority). If you pay one and then seek to wipe out the others, this is seen as a "preference" and trustees have the right to demand a return of the money.
Thus the courts and trustees scrutinize payments to creditors for certain "look-back periods" depending on the relationship between creditor and debtor. If it is an "arm's length" transaction between the parties, then the look-back is 90 days. If the creditor is an "insider" (one familiar with the financial status of the debtor and often enjoying a special relationship, such as family), then it is one year.
But what if you are a part owner of a small business, and that business files bankruptcy after paying you money? Are you an insider? According to a 7th Circuit Court of Appeals decision in In re Longview Aluminum, you can be! In that case, a minority member of an LLC (he held a 12% ownership interest) was paid $200,000 by the LLC four months prior to that LLC filing bankruptcy.
The member, one Dominic Forte, argued that because he had no management or decision-making responsibilities in the company, and bankruptcy law has not established a clear definition of LLC members in the event of insolvency, he should be classified as a non-insider. This would have prevented a finding of a preference because the money was paid more than 90 days prior to the bankruptcy being filed. The court did not agree.
This could have a serious impact on bankruptcies filed by small businesses if the 3rd Circuit (where we are here in New Jersey) follows this ruling. Many LLCs have one owner or, if there are two, it is a husband and wife situation. However, where there are multiple members (or shareholders of a subchapter S corporation) the transactions between the business and these owners for one full year would have to be scrutinized before the filing. It will be interesting to see what happens here, but at the very least, New Jersey businesses looking to file bankruptcy should proceed with caution.