In its second Bankruptcy law decision in a week, the United States Supreme Court has limited the role of appellate courts in reviewing Bankruptcy Court determinations of insider status under section 101(39) of the Bankruptcy Code. The case, U.S. Bank N.A., Trustee, by and through CWCapital Asset Management LLC v. Village at Lakeridge, LLC, was a unanimous decision but was accompanied by two concurrences, one of which was joined by four Justices. It highlights the importance of factual determinations at the trial court level while casting doubt on existing legal definitions of what constitutes an “insider” under the Bankruptcy Code.
The defined term “insider” is instrumental in many different parts of the Bankruptcy Code. For example, the preference period for an insider is one year, as compared to the 90 day preference period for non-insiders. Transactions between the debtor and insiders are subject to stricter scrutiny for purposes of equitable subordination and substantive consolidation. And in contested confirmation proceedings, for certain purposes the votes of insiders are ignored.
The last of these was at issue in Lakeridge. The debtor was attempting to confirm a plan of reorganization under the “cramdown” provisions of section 1129, which require, among other things, that the plan be accepted by an impaired class (where “acceptance” is determined solely by the votes of non-insiders). The only accepting impaired class consisted of a $2.76 million loan that had been made by MBP, the debtor’s parent company, and had been sold by MBP for $5000 to Rabkin, a retired surgeon. The sale had been arranged by a member of the debtor’s board of directors who was involved in a romantic relationship with Rabkin. Thus, whether the plan could be confirmed hinged upon whether Rabkin, as the holder of the secured debt, was an insider.
Under section 101(31) of the Bankruptcy Code, insider includes any officer, director or person in control of a corporate debtor, but is not limited to those. The courts have developed standards to determine those who are neither an officer, director nor person in control of a corporate debtor (so-called “non-statutory insiders”) may yet be determined to be an insider. In the Ninth Circuit, a creditor qualifies as a non-statutory insider if two conditions are met: (1) the closeness of its relationship with the debtor is comparable to that of the enumerated “statutory” insider classifications, and (2) the relevant transaction is negotiated at less than arm’s length.”
The bankruptcy court held that Rabkin was not an insider, notwithstanding the romantic relationship, because his purchase of the loan was found to be arm’s length. The Ninth Circuit Court of Appeals affirmed, holding that it could overturn the bankruptcy court determination only if it was “clearly erroneous”.
The Lakeridge Decision
The Supreme Court affirmed the ruling of the Ninth Circuit. It reasoned that the determination of Rabkin’s status was a “mixed question” of law and fact, and that the appropriate appellate standard for a mixed question depends upon which predominates: case-specific factual questions or more general pure legal questions. It found that the particular question in Lakeridge – whether Rabkin’s purchase of the loan had been negotiated at less than arm’s length – was “about as factual sounding as any mixed question gets.” It concluded that for relatively factual mixed questions the more deferential “clearly erroneous” standard is appropriate.
There were two concurring opinions. One, by Justice Kennedy, stated that there was “room for doubt” whether the Bankruptcy Judge was correct in finding that Rabkin was not an insider, but noted that this question was outside of the scope of the limited grant of certiorari. The other, by Justice Sotomayor, and joined by three other justices, questioned the correctness of the Ninth Circuit’s standard, and suggested that other formulations might be appropriate. The concurrence further stated that for such other formulations a less deferential standard of review might be appropriate, and that had such standards been applicable the finding that Rabkin was not an insider might have been overturned.
An interesting question that the Court did not decide was whether Grabkin automatically inherited MBP’s insider status when he purchased its loan. The bankruptcy court decided that insider status traveled with the claim, and the bankruptcy appellate panel reversed on that point. The Ninth Circuit affirmed the appellate panel, ruling that insider status does not travel with a claim and instead must be determined based on the holder of the claim. The Court’s grant of certiorari did not include this question.
Potential Lessons from the Lakeridge Decision
One lesson of Lakeridge is that insider determinations of a bankruptcy court may be difficult to overturn on appeal. Many of the appellate judges who reviewed the case, including one of the circuit judges and four justices, were plainly skeptical of the finding. Nevertheless, they applied a deferential standard of review and sustained the result.
Justice Sotomayor’s concurrence also suggests that the standard for determining a non-statutory insider as formulated by the Ninth Circuit may be susceptible to challenge.
Like the recent Merit Management decision (discussed in our recent alert), this decision was both unanimous and narrow. The narrowness of Lakeridge is emphasized by way that the decision and concurrences carefully delineate several issues that were not decided. This suggests that the Court is being cautious about making significant changes to the Bankruptcy law.
 As the Lakeridge case was filed in the Ninth Circuit, that was the relevant standard. Justice Sotomayor’s concurrence states that the standard in most other circuits is analogous.
 The analogous but distinct question of whether taint travels in the context of avoidance actions was discussed in a prior alert.