High Court to Hear Bankruptcy Case on Insider Claims

Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.

By Diane Davis

The U.S. Supreme Court March 27 agreed to consider, in the context of a Chapter 11 bankruptcy reorganization, the correct standard of review for determining insider status under the Bankruptcy Code ( U.S. Bank N.A. v. The Vill. at Lakeridge LLC, U.S., No. 15-1509, review granted 3/27/17 ).

The court limited its review to only one of the three questions U.S. Bank N.A. presented to the court: whether determining statutory insider status for voting purposes is subject on appeal to review under the de novo standard applied by the Third, Seventh and Tenth Circuits, or the clearly erroneous standard of review adopted by the Ninth Circuit here.

Case of ‘Broad Relevance.’

“This will be an important procedural case,” G. Eric Brunstad, senior research scholar at the Yale Law School, New Haven, Conn., a partner at Dechert, and an adjunct professor of Law at New York University, New York, told Bloomberg BNA March 27.

“The question of the correct standard of review is one of broad relevance both within and outside the bankruptcy context,” Brunstad said.

“Standards of review are important,” Brunstad said, “because they make an appeal easier or harder, depending on the standard.”

“De novo review means that the appellate court essentially gives no deference to the determination of the trial court. Clearly erroneous review means essentially that the appellate court gives great deference to the trial court’s determination,” Brunstad said.

“The standard of review matters a great deal with appeals in bankruptcy and generally,” he said.

‘A Bit Unusual’ and ‘A Surprise.’

The acting solicitor general of the U.S., who was asked by the court to give his view of the case, opined that U.S. Bank’s petition for Supreme Court review should be denied.

The Ninth Circuit applied the correct standard of appellate review, and that aspect of the decision didn’t conflict with any decision of the Supreme Court or any other court of appeals, he said.

“It is a bit unusual, but not unprecedented, for the court to grant certiorari where the Solicitor General’s office has recommended denial,” Brunstad said.

“The issue is certainly interesting and important,” he said.

John Pottow, a professor at the University of Michigan Law School, Ann Arbor, Mich., agreed with Brunstad.

“It is a bit of a surprise, especially in light of the Solicitor General’s demurrer, but the restriction of the grant is consistent with a possible summary reversal down the road,” Pottow told Bloomberg BNA March 27.

“This might be a tempest in a teapot, but it’s always hard to read the leaves of that pot,” Pottow said. “One thing we do know: the Court is definitely avoiding the larger issue of the first question,” at least for now, he said.

The larger question presented by U.S. Bank was whether an assignee of an insider claim acquires the original claimant’s insider status so that his or her vote to confirm a cramdown plan can’t be counted.

Insider Voting

Bankruptcy courts can only confirm a debtor’s Chapter 11 reorganization plan over a secured creditor’s objection if at least one impaired class of creditors votes to accept the plan, under Bankruptcy Code Section 1129(a)(10). The process is known as a “cramdown.”

But insider votes can’t be used to cramdown a plan over the objection of a secured creditor. The Code contains a non-exhaustive list of “insiders.” Persons or entities that fall into one of those categories are referred to as “statutory insiders.”

U.S. Bank, one of two creditors of debtor The Village at Lakeridge LLC, asked the court to decide whether an insider claim can be transferred to a third party to circumvent the prohibition of insider voting.

Robert Rabkin is the other creditor. He purchased a $2.76 million insider claim from his girlfriend, a member of the debtor and its corporate designee, for $5,000.

Far-Reaching Effect?

U.S. Bank argued in its petition that the questions before the court would have a far-reaching effect on future plan confirmation fights, and in other areas of bankruptcy law that depend on a determination of insider status, including fraudulent conveyance and preferential transfer litigation.

The Ninth Circuit’s decision below creates a judicial loophole to the prohibition against insider voting, which may extend to virtually every Chapter 11 bankruptcy case, U.S. Bank said.

U.S. Bank moved to designate Rabkin’s claim as an insider claim and to disallow it for voting purposes.

The bankruptcy court granted the bank’s motion and found that Rabkin wasn’t a non-statutory insider.

The Bankruptcy Appellate Panel of the Ninth Circuit reversed, concluding that Rabkin wasn’t a statutory insider because he didn’t fall within any of the enumerated categories in the statutory definition.

The Ninth Circuit affirmed and held that a third party like Rabkin doesn’t become an insider by acquiring a claim from an insider. Rabkin wasn’t a statutory insider, and the transaction was negotiated at “arms length,” the Ninth Circuit said.

The Ninth Circuit applied a de novo review to the bankruptcy court’s definition of non-statutory insider status, which it said was a purely legal question. The court reviewed the bankruptcy court’s legal factual findings for “clear error.”

Gregory A. Cross of Venable LLP, Baltimore, Md., and Keith C. Owens and Jennifer L. Nassiri, Venable LLP, Los Angeles, represent U.S. Bank. Alan R. Smith, Law Offices of Alan R. Smith, Reno, Nev., represents The Village at Lakeridge. Noel J. Francisco, Acting Solicitor General, represents U.S. as amicus curiae.

To contact the reporter on this story: Diane Davis in Washington at DDavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

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