To cram-down a chapter 11 plan on non-accepting classes, at least one impaired class must accept the plan, not counting the votes of insiders. In what is likely to be a controversial opinion, the Ninth Circuit Court of Appeals upheld a decision by the Bankruptcy Appellate Panel that the purchaser of a bankruptcy claim was not an “insider” for plan-confirmation purposes, even though the purchaser acquired the claim from the debtor-LLC’s sole member, an insider, under questionable circumstances. In so doing, the case appears to provide a guide for insiders to “wash” their non-voting claims to obtain necessary votes by selling their claims to friendly third parties.

The debtor, a real-estate company, filed a plan of reorganization. After filing the plan, Bartlett, a representative of the debtor’s only LLC member, approached Rabkin, with whom she had a “close relationship,” and offered to sell the member’s $2.76 million claim against the debtor to Rabkin for $5,000. Rabkin later acknowledged he knew little about the debtor and did not know until long after he bought the claim that the plan proposed to make a $30,000 payment on this claim—a 600-percent profit. Bartlett testified that the seller’s board decided to sell the claim because, as an insider claim, it could not be voted in favor of the plan, and because of potential tax advantages.

The bank holding a $10 million claim secured by a mortgage on the debtor’s property challenged Rabkin’s affirmative plan vote. The Bankruptcy Court, the Bankruptcy Appellate Panel, and the Ninth Circuit each issued decisions on the bank’s challenge. The courts spent considerable energy distinguishing between “statutory” insiders and “non-statutory” insiders under 11 U.S.C. § 101(31). “Statutory” insiders are persons who are explicitly described as insiders under section 101(31). “Non-statutory” insiders are persons who are not explicitly described within the definition of “insider” under section 101(31), but who are nevertheless considered the functional equivalent of statutory insiders.

The Bankruptcy Court first held that Rabkin, the buyer, was not a non-statutory insider because his relationship with Bartlett, though acknowledged as a “close relationship,” was not comparable to the enumerated insider classifications. The court held, however, that Rabkin qualified as a statutory insider under section 101(31), as a matter of law, because he acquired the claim from a statutory insider. As a consequence, the Bankruptcy Court designated Rabkin’s claim as the claim of an insider and barred him from voting.

On appeal, the Bankruptcy Appellate Panel affirmed the non-statutory-insider determination but reversed the statutory-insider holding, thereby clearing the way for Rabkin’s affirmative plan vote to confirm the debtor’s plan over the bank’s objection.

The Ninth Circuit affirmed the Bankruptcy Appellate Panel, holding that a person does not become a statutory insider solely by acquiring a claim from a statutory insider and further holding that, despite the close business and personal relationship of insider-Bartlett and Rabkin, the evidence of their relationship was not so compelling as to justify reversing the Bankruptcy Court for clear error.

The Ninth Circuit’s decision was not unanimous. In a vigorous dissent, Judge Clifton agreed with the majority’s legal proposition that a creditor is a non-statutory insider when “(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.” Focusing on the second part of the test, however, Judge Clifton opined that the Bankruptcy Court’s decision should have been reviewed de novo for legal error, but even reviewing it under the clearly erroneous standard, “I cannot fathom how anyone could reasonably conclude that this transaction was conducted as if Rabkin and Bartlett were strangers,” noting that Bartlett did not negotiate the price or “otherwise behave in a manner that suggests he took his acquisition seriously as an economic investment.” Following a caustic analogy to the Nigerian-prince scam, the dissent concluded that, under any review standard, the transaction was not at arms-length and thus the buyer should be deemed a non-statutory insider.

As the dissent points out, this decision “has the troubling effect of creating a clear path for debtors who want to avoid the limitations the Bankruptcy Act places on reorganization plans.” The Ninth Circuit’s decision greatly increases the scope for sharp practice by insiders anxious to procure a confirmed plan of reorganization. Independent creditors will need to rely on the good judgment of the bankruptcy courts to see through such schemes. See, e.g., In re Lichtin/Wade, LLC, Case No. 12-00845-8-RDD (Bankr. E.D.N.C. Dec. 18, 2012) (designating purchaser of claim as non-statutory insider and declining to consider vote).

This case would have been decided differently if the Bankruptcy Court had been persuaded, as a matter of fact, that the purchaser of the claim ought to have been treated as a non-statutory insider. For practitioners, this case is a useful reminder of the importance of presenting a compelling case in the trial court. At least part of the Ninth Circuit’s decision was driven by the clearly erroneous standard of review applied to the Bankruptcy Court’s fact findings. The majority opinion takes the dissent to task for supporting its position on the basis of “how it would have decided this case had it been sitting as the bankruptcy court judge.”

The published decision is styled U.S. Bank N.A. v. Village at Lakeridge, LLC (In re Village at Lakeridge, LLC), Case No. 13-60038 (9th Cir. Feb. 8, 2016).