Supreme Court Struggles With Who’s an ‘Insider’ in Bankruptcy

By Diane Davis

The U.S. Supreme Court Oct. 31 struggled with central elements of a closely watched bankruptcy case that seeks to more clearly define what types of creditors may hold sway over a company or other debtor in Chapter 11 and prevent it from reorganizing.

The court took a hard look during oral argument at the standard of appellate review for determining a creditor’s insider status. Standard of review weighs the importance of bankruptcy court decisions on appeal, and determines the amount of deference an appellate court will give ( U.S. Bank N.A. v. The Village at Lakeridge, LLC, U.S., No. 15-1509, oral arg. 10/31/17 ).

Questions of law are always reviewed de novo—the appellate court gives no deference to what the bankruptcy judge has done—but questions of fact are usually reviewed under a clearly erroneous standard, which is highly deferential and hard to overturn on appeal.

The U.S. Court of Appeals for the Ninth Circuit, in a split decision below, held that non-statutory insider status is a pure question of fact that should be reviewed for clear error.

The justices clearly struggled with determining whether the insider status question was a mixed question of law and fact as U.S. Bank argued, or a mere question of fact as debtor The Village at Lakeridge contended in the case before the high court.

Surprisingly, the court seemed to suggest that it also might need to rule on a question in the appeal that it decided not to take up: What is the proper legal standard for determining whether a creditor is a statutory or non-statutory insider?

Insider Status Matters

The case revolves around determining whether creditor, Robert Rabkin, was an insider and, therefore, couldn’t vote in favor of The Village at Lakeridge’s Chapter 11 plan to get it approved by the bankruptcy court.

Before a bankruptcy court approves a Chapter 11 reorganization plan, it must determine if anyone voting to accept it are insiders.

Bankruptcy Code Section 101(31) contains a non-exhaustive list of persons and entities considered insiders. Those on the list are considered “statutory insiders;" those who have a close relationship with the debtor and negotiate transactions at less than arm’s-length but aren’t on the list are “non-statutory insiders.”

U.S. Bank objected to The Village at Lakeridge’s plan and wanted the bankruptcy court to designate Rabkin as an insider and disallow his vote in favor of the plan.

Rabkin purchased the $2.76 million claim for $5,000 from Kathleen Bartlett, a member of MBP Equity Partners 1, LLC’s board of managers and a corporate designee. Bartlett and Rabkin had a romantic relationship.

Clarity and Uniformity

This case is a “paradigm” example of a mixed question of law and fact, argued Gregory A. Cross, Venable LLP, Baltimore, who represented U.S. Bank. “The historical facts aren’t in dispute and the legal measure is settled,” he said.

The question before the court, he said, is “what standard of review should govern the application of the legal standard to the undisputed facts.”

Cross explained that the legal standard, which should be reviewed de novo, as articulated by the Ninth Circuit, is a two prong test: whether the relationship of the parties was sufficiently close and was transacted at arm’s length.

He urged the court to give greater “clarity” to insider status under the Bankruptcy Code in response to a question from Justice Ruth Bader Ginsburg about what he would want added to the standard in the Code. It is too important an issue to leave up to rulings by 352 different bankruptcy judges in this country, he said.

There is a “great need for uniformity,” Cross said. It can’t be left up to ad hoc bankruptcy judge determinations, he said.

The “beauty of this case” is that it is “somewhat ambiguous,” Justice Stephen G. Breyer said, when he was discussing the problem with “labels.”

Justice Sonia Sotomayor told Cross that he had a lot of strong arguments on the facts, but indicated that she was still struggling with why this isn’t a finding of fact as opposed to a conclusion of law.

The justices particularly struggled with defining the terms “closeness” and “arm’s length.”

Cross repeatedly emphasized that “we are solving for insider status” here, and “arm’s length status” is just a measure of it.

Arm’s length is a familiar test that lawyers are familiar with, Chief Justice John G. Roberts, Jr. observed.

Cost of Appellate Review

The Village at Lakeridge, represented by Daniel L. Geyser, Stris & Maher LLP, Dallas, argued that the Ninth Circuit applied the correct standard of review because the question of whether a person is an insider is a question of fact.

Geyser emphasized the cost to the parties if there are multiple rounds of appellate review by appellate judges to create an entire evidentiary record and to redo a trial judge’s fact-intensive work.

Justice Neil M. Gorsuch asked Geyser whether it was possible to decide what the standard of review is without defining what is the right legal test. Otherwise, the court would send the wrong signal to lower courts that they were endorsing the Ninth Circuit’s formulation of what the test is, he said.

According to Gorsuch, there is a “high degree” of difficulty separating these two issues.

Geyser agreed, but said every court of appeals has focused on adopting the arm’s length test.

After Gorsuch suggested that maybe the court should wait until the courts of appeal sort out the issue on closeness and arm’s length, Geyser quipped, "[i]f the court would like to dismiss the case as improvidently grantable, we’ll take a win any way we can get it.”

Justice Samuel A. Alito, Jr. wanted to know why it is preferable that bankruptcy judges as opposed to a court of appeals panel decide whether these facts make the person in question comparable to a statutory insider.

According to Geyser, even if the facts are established, trial courts must still reweigh and balance those facts, and they do that much better than appellate courts.

Having de novo review encourages additional appeals, which means it will hold up the administration of the estate and prevent creditors from getting paid, he said. It also prevents a debtor’s reorganization, and Congress is concerned with efficiency and finality, Geyser said.

‘Motive for Fight’

The Justice Department agreed with The Village at Lakeridge and filed a “friend of the court” brief in support of their argument. Morgan Goodspeed, assistant to the solicitor general, said that because this is the type of test that is well established and familiar, it is a pure factual inference and should be reviewed for clear error.

What matters for purposes of insider status is the claimant rather than the claim, Goodspeed said. But we “aren’t arguing that the bankruptcy court gets to define the legal rules for defining when something is at arm’s length,” she said.

This was a fight about Rabkin’s motives and that fight is a “factual inference,” Goodspeed said.

Gorsuch said he agreed with the Justice Department’s brief that determining the standard of review requires precise identification of the particular questions raised on appeal.

The court can still decide that question if it “wishes to,” Goodspeed said, which leaves it unclear whether the court will limit its decision to the standard of review question it took up, or broaden its ruling to the legal standard for determining insider status.

Gregory A. Cross, Venable LLP, Baltimore, represented U.S. Bank; Daniel L. Geyser, Stris & Maher LLP, Dallas, represented The Village at Lakeridge; Morgan Goodspeed, Assistant to the Solicitor General, Justice Department, filed an amicus brief supporting The Village at Lakeridge.

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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