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8th Circuit Case Shows That Not All Directors Are Insiders

By Myron A. Bloom

Section 101(31) of the Bankruptcy Code, the provision of the code that defines those who are "insiders" of a debtor, continues to generate litigation almost 30 years after its enactment. Last week the 8th U.S. Circuit Court of Appeals, in Rupp v. United Security Bank (In re Kunz), dealt with a matter of first impression involving Section 101(31) (A). That issue was whether a "director emeritus" is per se an insider.

The debtor, Kunz, was involved in the initial organization of United Security Bank. Kunz served as a member of United's board for many years, finally resigning in 1990. Upon resigning, he took the title of director emeritus, a title he held during the one-year period prior to his bankruptcy filing. According to the court, although a director in name, Kunz did not attend meetings of the United board; had no decision-making powers, office or staff; and was not entitled to "attend any meeting on United's business." Compensation for Kunz (and others with the same title) was set at $400 per month.

One year prior to Kunz's bankruptcy filing, he owed United in excess of $600,000, of which almost $500,000 was unsecured. In the one-year period immediately preceding the filing, he made substantial repayments to United, reducing the overall debt to about $360,000, of which only $17,000 was unsecured. Kunz then filed, and a trustee was appointed. The trustee filed an action under Section 547 of the code to recover all amounts deemed to be paid to United on account of Kunz's unsecured debt to United made within the one-year period preceding the bankruptcy filing. In so doing, the trustee claimed that United was an "insider" of Kunz because of Kunz' role as a director emeritus of United at the time of the payments.

Both United and the trustee filed motions for partial summary judgment: United argued that as a matter of law a director emeritus was not an insider; the trustee argued that as a matter of law, he or she was per se an insider. The bankruptcy court sided with the trustee, using the following reasoning: United is an insider of Kunz under the plain meaning of Section 101(31)(A) of the code, as that section includes specifically the word "director;" United held Kunz out to the public as a director; the term "emeritus" is an adjective, i.e., a word that "typically serves as a modifier of a noun" (citing Webster's New Collegiate Dictionary); the word "director" is a noun; and the word "emeritus" does nothing more than modify the noun "director," just as the word "voting" would modify the same word - it does not alter one's status as a director, merely describes the type of director one is. The result was partial summary judgment for the trustee.

The Bankruptcy Appellate Panel (BAP) granted leave to United to file an interlocutory appeal, and reversed. The BAP stated that reliance on the definition of an adjective, as the bankruptcy court had done, was misplaced, as a "former" director would, under the bankruptcy court's analysis, also be a form of director, the word "former" merely modifying the word director. Instead, the BAP (like the bankruptcy court, after heading for a dictionary) found that the concept of directorship included an element of control of a corporation, and found support for this view in the code's legislative history. Here, as a director emeritus, Kunz had no authority to control United to any extent on the facts presented. The BAP thus reversed the grant of partial summary judgment.

This time, the trustee appealed. The 8th Circuit first noted that because this case presented a matter of statutory interpretation, its standard of review was de novo, and then stated that when undertaking an examination of statutory construction, the words of a statute must be read in their context and with a view to their place in the overall statutory scheme (citing U.S. Supreme Court authority). Moreover, construction must begin, the court stated, with the assumption that the ordinary meaning of language accurately expresses legislative intent (again, citing Supreme Court authority).

It is clear, stated the court, that the word "director" when used in reference to a corporation refers to a person who is a member of a governing board and who participates in corporate governance. So how, if at all, does the label "emeritus" affect the analysis? The court resorted to (what else) a dictionary, finding that the word is defined as "holding after retirement . . . an honorary title corresponding to that held last during active service;" or "retired from an office or profession." Here, it appeared clear that United used the term emeritus consistent with common understanding. Kunz held an honorary title after retirement. He did not attend board meetings. He could not attend meetings involving United's business. He had no voting rights. He was, in reality, a retired director, something akin to an "honorary" director.

The trustee argued that the court was adding a qualification not present in the statute, and to do so actually would distort the meaning of the word "director." The court disagreed, stating that the "global" construction suggested by the trustee would "defy commonsense, frustrate legislative intent, and distort the ordinary meaning of the term." A former director, under the trustee's view, would be no different from a managing director.

Absurd results would follow. Moreover, the court's interpretation, it stated, is consistent with legislative intent. Generally, the court noted, there are two types of insiders - per se insiders, and those who have a sufficiently close relationship with the debtor that conduct is made subject to close scrutiny. The question becomes whether the relationship (between the creditor and the debtor) is close enough to gain an advantage attributable simply to affinity rather than to the course of dealings between the parties.

"We conclude that it was the legislative intent that a person with a relationship designated in the statute be treated as an insider because of the high potential for control inherent in those relationships, and that others may be found to be insiders in particular cases, based on the specific facts." Having so stated, the court held that it was more consistent with this overall understanding to hold that the "director emeritus" to not be a per se director as that term is used in the code. The court accordingly reversed and remanded.

It is important to understand what the court said and what the court did not say. It did not say that a director emeritus, or an honorary director, or similarly titled person, never can be an insider by virtue of the office. All the court did say is that such nomenclature will require a court to do more than apply a mechanistic approach, by examining the relationships involved and look for the indicia of control or influence that, after all, is what really counts in looking at the non-obvious insider relationship.

This surely makes sense. And it took only about 30 years to get there.

This article is reprinted with the permission from the June 15, 2007 issue of The Legal Intelligencer.  Copyright 2007 ALM Properties, Inc.  Further duplication without permission is prohibited.  All rights reserved.