Pre-bankruptcy transfers can cause a business’s reorganization to fail

Money Fence Picture

Where a business is acting as a debtor-in-possession (debtor) in a Chapter 11 bankruptcy case, to confirm a plan of reorganization, the debtor must provide a method for creditors to capture any value from the debtor’s pre-bankruptcy transfers that may be avoidable under the Bankruptcy Code.

Val-Mid Associates, LLC’s Unsuccessful Reorganization

Prior to its bankruptcy filing, Val-Mid operated two gas station/convenience stores in Arizona. On June 14, 2013, Judge Hollowell, with the United States Bankruptcy Court for the District of Arizona, denied Val-Mid’s Chapter 11 plan of reorganization and converted the case to a Chapter 7 to be liquidated.  In re Val-Mid Assocs., L.L.C., 2013 Bankr. LEXIS 2521 (Bankr. D. Ariz. June 14, 2013).

In the Val-Mid case, the Court noted that Val-Mid had made pre-bankruptcy transfers to its insiders of $98,000 and that these transfers were potentially avoidable for the benefit of creditors.  The Court reasoned that Val-Mid had “knowingly sacrific[ed] prospectively significant value” by not providing a mechanism for pursuing avoidance of the transfers in its plan of reorganization.  Thus, the Court concluded that Val-Mid’s plan lacked good faith and converted the case to a Chapter 7 proceeding.

Why it Matters

The Val-Mid case is a good reminder that a debtor must pay special attention to its pre-bankruptcy transfers to ensure that its insiders will not be subject to avoidance lawsuits during and after the debtor’s bankruptcy case.  And, to confirm a Chapter 11 plan of reorganization, a debtor must provide a method for creditors to capture value from any of the debtor’s potentially avoidable transfers.  Accordingly, it is important for businesses to consult with an attorney who can provide meaningful advice regarding pre-bankruptcy transfers and how those transfers should be analyzed and incorporated into a Chapter 11 plan of reorganization.

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