On March 5, 2018 the United State Supreme Court issued its unanimous decision in U.S. Bank NA v. The Village at Lakeridge, LLC, 583 U.S. ___ (2018), answering the narrow question of what is the proper standard of review for appellate courts in reviewing a bankruptcy court’s determination of non-statutory insider status. Although the holding in Lakeridge is narrow, the Court’s analysis—and particularly the two concurrences—offer interesting insights into the question of what parties may, and may not, constitute non-statutory “insiders” under the Bankruptcy Code moving forward.
Factual and Procedural Background
In Lakeridge, the chapter 11 debtor in possession was attempting to “cram down” confirmation of its chapter 11 plan. This strategy was troublesome, however, because there were only two impaired creditor classes: (1) U.S. Bank, the dissenting class; and (2) MBP Partners, the debtor’s sole owner. Because MBP Partners was an “insider,” under Bankruptcy Code section 101(31), its vote in favor of confirmation could not effectuate a cram down under section 1129(a)(10), which requires consent of at least one non-insider impaired class.
To obtain the necessary proper consenting, impaired class, MBP elected to sell its claim to a third-party who would vote to approve the plan. This was a sound strategy—except for one small detail: the third-party purchaser who bought MBP’s claim was dating the officer of the debtor who solicited the purchase. Based on this fact, U.S. Bank argued that the purchaser was a “non-statutory insider” under the Bankruptcy Code because of his romantic relationship with the debtor’s officer. Relying on the Ninth Circuit’s two-part test for determining whether a party is a non-statutory insider, the bankruptcy court held that the purchaser was not a non-statutory insider, and a divided Ninth Circuit affirmed on appeal.
The Majority Opinion
On certiorari, the question before the Supreme Court was merely that of the appropriate standard of review for such appeal—and not the more intriguing question of whether the purchaser constituted a non-statutory insider. And on this narrow question, the Supreme Court was unanimous in holding that with this particular mixed question of law and fact, the appropriate standard of review was “clear error.” An overview of the Ninth Circuit’s “non-statutory insider” test reveals why this determination was correct.
Under the Ninth Circuit’s test, 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 insider classifications in the Bankruptcy Code; and (2) the relevant transaction is negotiated at less than arm’s length. The Supreme Court used this test—specifically noting that it was not adopting it as the test for such determinations—as the starting point of determining which standard of review to apply.
The Court broke down how this test was to be applied, recognizing that there are three inherent determinations that must be made by the bankruptcy court. First, the bankruptcy court must make discrete findings of fact regarding the specific transaction. Second, the bankruptcy court must determine the appropriate test to be applied. And third, the bankruptcy court must apply the facts to the test to determine whether the purchaser meets the definition of a non-statutory insider under the appropriate test.
The Court noted that the first determination would be reviewed under “clear error” because it was a purely factual determination made by the court most closely familiar with the evidence. The second determination would be reviewed de novo because it is a purely legal question as to whether the correct test was applied. The final determination, the application of the facts to the test, was the “mixed question of law and facts” for which the standard of review was challenged in this case. The Court reasoned that in this case, this mixed question turns almost entirely on the factual determinations made surrounding the sale, noting that such determination was “about as factual sounding as any mixed question gets.” Accordingly, the Court determined that “clear error” was the appropriate standard.
While the ultimate opinion of the Court was narrow and not particularly earth-shattering, two concurrences were penned that add some fuel to the fire regarding what the appropriate test should be for determining who is, and is not, a non-statutory insider.
Justice Kennedy wrote a short concurrence that served two primary purposes: (1) to clarify that the Court’s decision was specifically limited to the question of the appropriate standard of review for the Ninth Circuit test; and (2) to caution lower courts against reading the Court’s opinion as an endorsement of the Ninth Circuit test. Justice Kennedy specifically warned against reading the opinion as “indicating that a transaction is arm’s length if the transaction was negotiated simply with a close friend, without broader solicitation of other possible buyers.” These warnings indicate that Justice Kennedy may not have entirely approved of the actions taken by MBC below in selling its claim solely to an insider’s romantic partner.
Justice Sotomayor wrote a second concurrence—joined by Justices Kennedy, Thomas, and Gorsuch—specifically questioning the appropriateness of the Ninth Circuit test. While the propriety of this test was not on review, Justice Sotomayor nevertheless articulated “concerns” with the Ninth Circuit test. Chief among these concerns, Justice Sotomayor noted that the conjunctive nature of the two-pronged test effectively made the test hinge on whether the transaction at issue was “arm’s length,” thereby rendering moot the determination of whether the person involved in the transaction was otherwise comparable to a statutory insider. Because the transaction could be approved even if person was comparable to an insider—like a close friend or romantic partner of an insider—the “non-statutory insider” determination under this test does not reflect the traditional rationale for excluding insider transactions. Traditional, statutory insiders, are barred from such transactions regardless of the nature of the transaction. By adding this element to defining non-statutory insiders, the test may not accurately reflect the intent of barring such transactions.
Instead, Justice Sotomayor recommended two alternatives to the Ninth Circuit test: (1) remove the “arm’s length” transaction element altogether; or (2) have the analysis of the “arm’s length” nature of the transaction be a factor in determining whether the party is an insider without making such analysis dispositive.
While the concurrences ultimately are not binding, they indicate that there is a faction of the Court that takes issue with the Ninth Circuit’s approach. If and how these concurrences are interpreted and applied by lower courts may ultimately lead to new tests regarding how a non-statutory insider is determined.