Supreme Court Clarifies Standard of Appellate Review of Creditor’s Insider Status

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

Skadden, Arps, Slate, Meagher & Flom LLP

In U.S. Bank N.A. v. Village at Lakeridge, LLC, the U.S. Supreme Court issued an important decision on standards of appellate review, holding that appellate courts should review a bankruptcy court’s determination of whether a particular creditor is a “nonstatutory insider” for purposes of the Bankruptcy Code under the highly deferential “clearly erroneous” standard of review.

The holding of the unanimous Lakeridge opinion, issued on March 5, 2018, is narrow. The Court considered only the appropriate standard of appellate review and declined to review whether the substantive legal test for nonstatutory insider status that the U.S. Court of Appeals for the Ninth Circuit applied was proper. The opinion reinforces the importance and primacy of bankruptcy courts as finders of fact.

The opinion reinforces the importance and primacy of bankruptcy courts as finders of fact.

Significance of Insider Status

The issue of whether a party is an insider of a Chapter 11 debtor has numerous implications in bankruptcy cases, including whether debtor transfers to the party are subject to heightened scrutiny; whether prepetition transactions with alleged insiders are subject to longer avoidance periods; and whether the vote of an alleged insider counts as a creditor vote for purposes of determining if a creditor class has accepted a Chapter 11 plan and if that plan may be crammed down and confirmed over the rejection of another class of creditors.

The Bankruptcy Code’s statutory definition of “insider” is nonexhaustive and includes any officer, director or “person in control” of a debtor. Courts have crafted various tests to determine whether a party is a nonstatutory insider. Disputes about whether a particular party is an insider typically pose mixed questions of law and fact that require a bankruptcy court to make factual findings and then apply a judicially developed test for insider status to those findings.

Bankruptcy and Ninth Circuit Decisions

In Lakeridge, the debtor was a limited liability company with two substantial creditors: U.S. Bank and the debtor’s sole equity owner, MBP Equity Partners (MBP). The debtor owed more than $10 million to U.S. Bank and another $2.76 million to its nondebtor owner, MBP. The MBP and U.S. Bank debt claims were classified separately in two different impaired classes under the debtor’s proposed Chapter 11 plan. U.S. Bank opposed the plan and voted to reject it. MBP voted to accept it, but it was insufficient to confirm and cram down the plan on U.S. Bank because MBP, as 100 percent equity owner of the debtor, was an insider. MBP thus sold and transferred its $2.76 million claim to an alleged noninsider individual who paid $5,000 for the claim.

The sale of MBP’s claim was arranged by an MBP director who also was an officer of the debtor and who further admitted to a romantic relationship with the claim buyer. The debtor took the position that the claim buyer’s vote of acceptance of the plan should satisfy the Bankruptcy Code’s requirements for confirmation of the debtors’ cram-down plan because the claim buyer was not an insider.

U.S. Bank objected, asserting that the individual buyer of the MBP claim was a nonstatutory insider because of his ongoing romantic relationship with the debtor’s director, who had arranged the sale without offering or marketing the MBP claim to other third parties. Based on the evidence presented, the bankruptcy court determined that despite the romantic relationship, the buyer was not an insider because the evidence showed he had purchased the MBP claim at arm’s length, viewed the purchase of the claim as a speculative investment and conducted some diligence prior to the sale.

U.S. Bank appealed that determination, and the Ninth Circuit affirmed. The court applied its nonstatutory insider test: A creditor qualifies as one only if “(1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in [the Bankruptcy Code], and (2) the relevant transaction is negotiated at less than arm’s length.” The Ninth Circuit held that the bankruptcy court’s determination was entitled to deference under the “clearly erroneous” standard of appellate review because the bankruptcy court was in the best position to consider and weigh the evidence that was implicated in the mixed question of law and fact presented by the nonstatutory insider test that the appeals court had applied.

Supreme Court’s Affirmance

Writing for a unanimous Court, Justice Elena Kagan noted that insider status is relevant in a variety of circumstances under Chapter 11. Yet the Court decided only a single question: whether the Ninth Circuit was correct to review for clear error (rather than de novo) the bankruptcy court’s determination that the MBP claim buyer did not qualify as a nonstatutory insider because he purchased MBP’s claim in an arm’s-length transaction. The Court did not consider or decide whether the Ninth Circuit applied the proper nonstatutory insider test; indeed, the Court specifically rejected U.S. Bank’s request to include that question in the grant of certiorari.

The Court framed the specific issue it decided as follows: “What is the nature of the mixed question [of law and fact] here, and which kind of court (bankruptcy or appellate) is better suited to solve it?” The Court concluded that the standard of review for a mixed question of law and fact “all depends on whether answering it entails primarily legal or factual work.” The Court held that the Ninth Circuit properly applied the “clearly erroneous” standard of review because the Ninth Circuit’s nonstatutory insider test required the bankruptcy court to determine whether the facts it found showed an arm’s-length transaction between MBP and the buyer of its claim. The Court said that particular mixed question of law and fact determination “is about as factual sounding as any mixed question gets.”

Key Takeaways

The Lakeridge opinion indicates that a bankruptcy court is best positioned to decide many mixed questions of law and fact that require limited legal analysis. Parties and attorneys should therefore make strong and careful evidentiary records in bankruptcy matters, especially contested plan confirmation proceedings. Bankruptcy court decisions on mixed questions of law and fact, including questions concerning nonstatutory insider status, often are entitled to deference on appeal. Parties that must evaluate insider status in the context of a Chapter 11 case should take careful note of the Supreme Court’s guidance on nonstatutory insider status and arm’s-length transactions.

Download pdf

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.