Making a Clean Break, Part I: Tenth Circuit Sheds Light on When Terminated Officer Ceases to Be Insider

A recent case out of the U.S. Court of Appeals for the Tenth Circuit provides some interesting discussion on key gating issues for fraudulent transfer analysis.  Today’s post covers one issue that is related to the statutory “lookback” period for avoidance actions against insiders.  A follow up post will discuss the court’s analysis of reasonably equivalent value. 
In Weinman v. Walker (In re Adam Aircraft Industries, Inc.), the Tenth Circuit considered whether a terminated officer continues to be an insider following termination.  The answer in that case:  no; an officer of the debtor who made a “clean break” with the company upon termination was not an insider for purposes of a fraudulent transfer action.
We discussed the Tenth Circuit Bankruptcy Appellate Panel’s review of the bankruptcy court’s decision on Walker’s (lack of) insider status in two prior posts (Ex-President Surely Feels Like a Room without a Roof: Happy Not to Be Deemed an Insider, Part I and Part II).  (So, yes, some of our faithful readers may be experiencing some post-Halloween déjà vu right now.)  Just to make sure all our readers are on the same page, a brief recap of the facts are in order.
Walker was the president and a member of the board of Adam Aircraft, a designer and manufacturer of carbon composite aircrafts.  The board of Adam Aircraft terminated Walker on the evening of February 1, 2007, but asked that Walker consider voluntarily resigning to avoid “drama” at a time when Adam Aircraft was in the final stages of obtaining debt financing from Morgan Stanley.  That evening, Walker packed up his things; after departing, he never returned to Adam Aircraft’s facilities or performed any functions as president or as a board member.
On February 2, 2007, Walker sent an email to the CEO and a board member in which he resigned as president and from the board.  He proposed certain severance terms:  (i) staying on retainer as a consultant for two years at $250,000 a year; (ii) retaining his current health benefits; (ii) obtaining the return of a $100,000 deposit on the purchase of an airplane; and (iv) obtaining a refund of $100,000 he had invested in Adam Aircraft stock.  In exchange, Walker offered (i) to be a “strong supporter” of Adam Aircraft, (ii) not to work for any competitor, and (iii) to tell all parties that he resigned for personal reasons.  Also on February 2, 2007, Walker’s replacement began his employment as president of Adam Aircraft.
At a February 5, 2007 meeting, the board accepted Walker’s resignation as president and noted that his resignation as director was effective February 2, 2007.  The board at that meeting also approved Walker’s replacements as president and to the board.  Between February 5 and February 13, 2007, the board negotiated the terms of Walker’s severance.  The board proposed 18 months of consultant work, with Walker’s pay contingent on maintaining the sales backlog of aircraft purchase orders at a certain level. Walker accepted these changes to his terms.  He executed a formal separation agreement that provided the agreed upon severance payments, but which also stated that Walker’s employment had terminated effective March 1, 2007.
Around May, 2007 Walker and Adam Aircraft executed another separation agreement substantially similar to the previous severance agreement. This agreement provided that Walker’s employment as president of Adam Aircraft terminated effective as of March 1, 2007 and that as of that date he was a “field sales liaison.” Walker, however, never performed any services as “field sales liaison,” and none of the parties intended that he do so.
Over the next year, Adam Aircraft paid Walker $250,000 in severance, $100,002 to buy back his stock, and $105,704 as a refund on his airplane deposit (with interest).
Adam Aircraft filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code on February 15, 2008.   The court-appointed trustee sought to avoid the payments made to Walker as both preferential transfers and fraudulent transfers.
The trustee prevailed in avoiding as a preferential transfer under section 547(b)(4)(A) the $62,500 that Walker had been paid within 90 days of the date that Adam Aircraft filed for bankruptcy.  However, whether the trustee could avoid the debtor’s payments to Walker more than 90 days before the petition date depended, in part, on whether Walker was an “insider” at the time the payments were made.  If Walker was an “insider,” the trustee could take advantage of sections 548(a)(1)(B)(i) and (a)(1)(B)(ii)(IV) of the Bankruptcy Code.
Insider Status
The topic of statutory and non-statutory insiders has been covered in various posts on this blog.  As a primer, the Bankruptcy Code defines an “insider” as an officer, director, or a person in control of a debtor.  These categories, the Tenth Circuit has found, are illustrative rather than exhaustive.  Someone not listed in the statute can be an insider if he or she “has a sufficiently close relationship with the debtor that . . . conduct is made subject to closer scrutiny than those dealing at arm’s length with the debtor.”
The Tenth Circuit agreed with the BAP and found there was more than sufficient evidence to support a finding that Walker made a “clean break” as an insider on February 1, 2007, and ended his status as a statutory insider, including that (i) his replacement assumed the position of president immediately on February 2, 2007; (ii) Walker never returned to the premises or performed any other duties as president after February 2, 2007; (iii) the February 5th board minutes indicated the Board accepted Walker’s resignation as president and director and noted  that Walker submitted his resignation as director, effective February 2, 2007.
Further, Walker could not qualify as a non-statutory insider.  Because he negotiated his severance package at arm’s-length soon after learning the company wanted to fire him (and after he had been stripped of his title and duties, and packed up his things), and he did not receive everything he asked for (he received a shorter period of severance payments that were tied to the sales backlog remaining at a certain level), Walker did not possess either the type of control of – or relationship to – a company necessary to make him a non-statutory insider.
The Tenth Circuit also found its ruling did not contravene the purpose of BAPCA.  Ruling for Walker would not permit insiders to “reap the benefits of their insider status and resign in exchange for future payments.”  Adam Aircraft asked Walker to resign so that their decision to terminate his employment wouldn’t imperil their critical debt financing discussions.  Walker also fulfilled the terms of his agreement because he did not look for another job in the aviation industry while he received the severance payments.
Therefore, the Tenth Circuit affirmed the BAP’s ruling for Walker on his lack of (statutory and non-statutory) insider status, and the trustee could not look to sections 548(a)(1)(B)(i) and (a)(1)(B)(ii)(IV) as a basis for avoiding payments.
Stay tuned for a follow up post that will address the trustee’s attempt to avoid the payments to Walker on the basis that they were received for less than reasonably equivalent value.
Debora Hoehne is an Associate at Weil Gotshal & Manges, LLP in New York.