A bankruptcy panel for the U.S. Court of Appeals for the Ninth Circuit has held that a company, solely owned by the wife of a corporate officer of a debtor company, is not, as a matter of law, a “per se” insider under the preferential transfer rule.

The reach-back period for avoiding transfers of the debtor’s property differs depending on whether or not the transferee is an insider under section 547(b) of the Bankruptcy Code. That section specifies that per se insiders include relatives of a “general partner, director, officer or person in control of the debtor.”

A Ninth Circuit appellate panel reversed an earlier holding that because the wife of a corporate officer at a debtor company was deemed to be a per se insider, her company too should be considered a per se insider.

“We conclude that the bankruptcy court erred in expanding the statutory list of per se insiders of a corporate debtor to include corporations that are solely owned by persons who qualify as per se insiders,” the court ruled in Miller Avenue Professional and Promotional Services, Inc. v. Lois I. Brady, NC-04-1023-PMaS (Dec. 28, 2004).

The case concerned a note executed by the debtor company, payable to the defendant, Miller Avenue Professional and Promotional Services, Inc. (MAPPS), for $125,000, and secured by the debtor’s accounts receivable. MAPPS was a corporation wholly owned by Patricia Mapps, the wife of Patrick Salmon, who was an officer, director and 10 percent shareholder in the debtor company.

Shortly after the debtor failed to repay the loan on its due date, MAPPS recorded a UCC-1, perfecting its security interest. The debtor filed a chapter 7 petition 92 days after the UCC-1 was recorded. Because the UCC-1 was recorded more than 90 days but less than a year before bankruptcy, it was avoidable as a preferential transfer only if MAPPS was deemed to be an insider of the debtor.

A judge from the U.S. Bankruptcy Court for the Northern District of California concluded after a two-day trial that MAPPS could not be considered a “non-statutory” insider. But the judge held that because Patricia Mapps was the sole employee of her company, and the company existed only to shield her from liability, MAPPS should be viewed as her alter ego and as a matter of law a “per se” insider.

Not so, the appeals court ruled. Under state law, the mere finding of a unity of interest between Ms. Mapps and her company is not enough to pierce the corporate veil, the court held. A court also must find that some inequity would follow if the corporate form were recognized. A general observation that the failure to set aside the company’s claim would result in fewer assets to be distributed to other creditors was not enough to meet a finding of inequity, the Ninth Circuit stated.

The bankruptcy court did not find that Ms. Mapps formed her corporation to avoid preference liability or that she used the corporation to make the loan in order to avoid preference liability, the appeals court noted. Nor did the bankruptcy court make any other finding that it would be inequitable to other creditors to observe the corporate form in this case, the Ninth Circuit stated.

“We are not willing to say that it is inequitable as a matter of law for a corporation wholly owned by an insider to receive and retain what would be a preferential transfer within one year before bankruptcy. There must be some facts showing that, in the particular case, recognizing the corporate form would result in inequity,” the appeals court concluded.

Following this case, creditors seeking avoidance of a preferential transfer to an insider’s corporation in the Ninth Circuit will need to make a factual showing that allowing such transfer would be inequitable.