Restructuring

It’s been an interesting couple of weeks for bankruptcy at the United States Supreme Court with two bankruptcy-related decisions released in back-to-back weeks. Last week, the Supreme Court issued an important decision delineating the scope of section 546(e) of the Bankruptcy Code (discussed here [1] for those who missed it). Then again, this week, on March 5, 2018, the Supreme Court issued a somewhat strange (in the authors’ view) decision involving “non-statutory insider” determinations in the Bankruptcy Code context. See U.S. Bank Nat’l Ass’n v. Village at Lakeridge, LLC, No. 15-1509, 2018 WL 1143822, at *1 (U.S. Mar. 5, 2018).[2]  The Lakeridge opinion purports to address only a narrow legal question: whether the Ninth Circuit Court of Appeals applied the proper standard of review in analyzing a bankruptcy court’s determination that a creditor was not a non-statutory insider. On that narrow question, the Court concluded that the Ninth Circuit appropriately reviewed the mixed question of law and fact on a “clearly erroneous” basis given the test articulated by the Ninth Circuit for determining non-statutory insider status.  More interestingly, as highlighted by two concurrences, Lakeridge raises further questions as to how lower courts should evaluate whether a person qualifies as a non-statutory insider under the Bankruptcy Code, an issue that could have implications in various contexts in chapter 11 cases where insider status matters. These include plan voting (at issue here), fraudulent transfer and preference analyses, severance payments, and KERPs. And from a purely entertainment perspective, the facts of the case are somewhat fun and juicy.

Insider Status
As a quick primer, section 101(31) of the Bankruptcy Code provides specific examples of who qualifies as an “insider,” including directors, officers, and controlling persons of a debtor. However, courts have long held that it is not an exhaustive list, and that other unenumerated persons can still qualify as “non-statutory insiders.” Some courts have developed different tests to determine who qualifies as a non-statutory insider, although the Supreme Court has not yet endorsed any of those tests.
Case Background
In this case, the debtor, Village at Lakeridge (the “Debtor”), had two major creditors, each separately classified under the Debtor’s chapter 11 plan:  (i) U.S. Bank – a creditor owed over $10 million, and (ii) MBP Equity Partners – the Debtor’s sole owner and thus a statutory insider, (See 11 U.S.C. § 101(31)(B)(iii)), owed $2.76 million. The Debtor sought to cram down a plan over U.S. Bank’s objection, (See 11 U.S.C. § 1129(b)), but ran into the obstacle that any such plan still required the consent of an impaired class of claims and the vote of MBP, an insider, would not suffice.  See 11 U.S.C. § 1129(a)(10).
The Debtor resolved this issue through a creative workaround. Kathleen Barlett, a member of MBP’s board and an officer of the Debtor, caused MBP to sell its claim to Robert Rabkin, Bartlett’s romantic partner, for $5,000 and Bartlett then voted the claim to accept the Debtor’s plan. Rabkin was clearly not a statutory insider, and despite an objection from U.S. Bank, the bankruptcy court concluded after an evidentiary hearing that he was not a non-statutory insider either. The bankruptcy court based its decision in part on its finding that Rabkin purchased the MBP claim as a speculative investment for which he performed adequate due diligence. The Ninth Circuit affirmed on appeal, first holding that a creditor qualifies as a non-statutory insider only if it meets two criteria: “(1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in § 101(31), and (2) the relevant transaction is negotiated at less than arm’s length.” In re Village at Lakeridge, LLC, 814 F.3d 993, 1001 (9th Cir. 2016) (citing Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1277 (10th Cir. 2008)). After finding that the bankruptcy court based its holding on the second prong of that test (i.e., that the transaction with Rabkin was at arm’s length), the Ninth Circuit affirmed the bankruptcy court’s decision under a clear error standard of review.
Supreme Court Opinion
The Supreme Court granted certiorari to answer a single, narrow issue: whether the Ninth Circuit was right to apply a clear error (rather than de novo) standard of review. In fact Justice Kagan, writing for Court, expressly acknowledged that the Court’s opinion “do[es] not address the correctness of the Ninth Circuit’s legal test; indeed we specifically rejected U.S. Bank’s request to include that question in our grant of certiorari.”  Lakeridge, 2018 WL 1143822 at *4.
The Court began by offering a general legal principal that the proper standard of review for mixed questions of law and fact depends on which court is better positioned to answer such questions.  See Lakeridge, 2018 WL 1143822 at *5 (citing Miller v. Fenton, 474 U.S. 104, 114 (1985)). Appellate courts are better suited to answering questions that may require expounding on the law, and in such instances a de novo standard of review should apply. In contrast, where mixed questions rely upon case-specific factual issues, trial court determinations deserve greater deference through a clear error standard of review. Because the bankruptcy court’s decision was based on a fact-intensive inquiry—whether Rabkin’s purchase of the MBP claim was an arm’s length transaction—the Court found that the Ninth Circuit was correct to apply a clear error standard of review.
Concurrences
The concurrences in the case (supported by four of the nine Justices) raise the question, admittedly not before the Court, of whether the Ninth Circuit’s test for non-statutory insider status is the correct approach.
Justice Kennedy wrote a brief concurrence to reiterate that the Court was not necessarily endorsing the Ninth Circuit’s test. He expressed some concern with the Ninth Circuit’s two-pronged inquiry, but suggested that Courts of Appeals should continue tinkering with different analyses to develop a better approach.
In a separate concurrence joined by Justices Kennedy, Thomas, and Gorsuch, Justice Sotomayor offered a more pointed perspective. In her concurrence, Justice Sotomayor took particular issue with the second prong of the Ninth Circuit’s test, noting that statutory insiders are unable to cleanse their votes by engaging in arm’s length transactions. Instead, she suggested that a better overall approach might be to look solely to a comparison between the characteristics of the alleged non-statutory insider and the statutory insiders to see whether they share sufficient commonalities. Alternatively, another acceptable approach might focus on a broader comparison that includes consideration of the circumstances surrounding any relevant transaction. Still, careful not to decide the appropriate test for determining whether a creditor qualifies as a non-statutory insider, Justice Sotomayor concluded by noting that a different standard of review might apply if the “correct” test was different from the one adopted by the Ninth Circuit.
Conclusion
One lesson here is that if your strategy is to sell your claim to avoid insider status, don’t sell it to someone with whom you have a romantic relationship. Not only might it defeat the goal of avoiding insider status (although in this case the parties escaped that consequence), but the details of your romantic relationship could also end up enshrined in the annals of the Supreme Court forever (a fate which the two lovebirds in this case did not escape).
On a more serious level, Lakeridge provides little binding guidance as to how lower courts should evaluate whether a creditor is a non-statutory insider under the Bankruptcy Code. Although it is clear that at least four Justices have reservations about the Ninth Circuit’s test, there is no consensus view as to a better approach, nor what standard of review would apply to such an approach.  Lakeridge’s main takeaway seems to be that Courts of Appeals will likely continue experimenting until they land on a test that the Supreme Court is ready to endorse.