Bankruptcy Court Provides Clarity on Unwritten Elements of Avoidance Actions under the Bankruptcy Code

The Bankruptcy Code confers upon debtors or trustees, as the case may be, the power to avoid certain preferential or fraudulent transfers made to creditors within prescribed guidelines and limitations. The U.S. Bankruptcy Court for the District of New Mexico recently addressed the contours of these powers through a recent decision in U.S. Glove v. Jacobs, Adv. No. 21-1009, (Bankr. D.N.M. June 11, 2021), holding that any attempt to avoid such transfers must be supported by evidence that the avoidance will benefit the debtor's estate and the debtor's creditors — not just the debtor itself. Debtors, the court reasoned, should not be permitted to manipulate the Bankruptcy Code's avoidance powers merely to create a windfall for themselves.

Factual Background

U.S. Glove, Inc. is a New Mexico corporation specializing in the manufacture of gymnastic wrist supports and grips. Before October 2018, Michael Jacobs owned 100% of U.S. Glove's outstanding capital stock. On Oct. 18, 2018, Jacobs redeemed 57% of the outstanding stock he held in exchange for $3,390,000. To fund the redemption, U.S. Glove issued two separate promissory notes in favor of Jacobs: one in the amount of $2,140,000 secured by a security interest in U.S. Glove's accounts, inventory, equipment and other tangible and intangible property; and the other in the amount of $1,250,000, which was unsecured. Jacobs, for unknown reasons, did not perfect his security interest related to the $2,140,000 note until June 1, 2020.