In Brief: U.S. Supreme Court Adopts Deferential Standard of Review on Chapter 11 Insider Status

In Brief: U.S. Supreme Court Adopts Deferential Standard of Review on Chapter 11 Insider Status

In U.S. Capital Bank N.A. v. Village at Lakeridge, LLC, 2018 WL 1143822, No. 15-1509 (U.S. Mar. 5, 2018), the U.S. Supreme Court held that an appellate court should apply a deferential standard of review to a bankruptcy court’s decision as to whether a creditor is a "nonstatutory" insider of the debtor for the purpose of determining whether the creditor’s vote in favor of a nonconsensual chapter 11 plan can be counted. The Court, however, declined in its opinion to rule on the validity of the standard applied by the lower courts to determine nonstatutory insider status and expressly declined to consider whether a noninsider automatically inherits a statutory insider’s status when the noninsider acquires the insider’s claim.

Section 1129(a)(10) provides that, if a creditor class is impaired under a chapter 11 plan, at least one impaired class must vote in favor of the plan, "determined without including any acceptance of the plan by an insider." This provision must also be satisfied for a chapter 11 plan to be confirmed under the nonconsensual, or "cramdown," requirements set forth in section 1129(b). Thus, a cramdown chapter 11 plan cannot be confirmed in the absence of an accepting impaired class.

Section 101(31) of the Bankruptcy Code defines "insider" to include, in the case of a corporation, an officer, director, person in control, or relative of the foregoing, as well as an affiliate or managing agent. In addition, courts have recognized that other persons or entities not specifically mentioned in the provision may qualify as "non-statutory insiders." For example, the U.S. Court of Appeals for the Ninth Circuit has determined that a creditor is a nonstatutory insider if: "(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." In re Village at Lakeridge, LLC, 814 F.3d 993, 1001 (9th Cir. 2016), aff’d, No. 15-1509 (U.S. Mar. 5, 2018).

Single-asset real-estate debtor Lakeridge, LLC ("Lakeridge") was unable to obtain confirmation of its chapter 11 plan because the only impaired secured creditor that supported the plan—sole shareholder and secured creditor MBP Equity Partners ("MBP")—was disqualified from voting to accept it as an insider. MBP therefore sold its $2.8 million secured claim for $5,000 to an individual who then voted for the plan. On the basis that the buyer was romantically attached to an MBP board member and Lakeridge officer, Lakeridge’s secured bank lender objected to confirmation. It argued that the buyer of the claim was also disqualified from voting on the plan as a nonstatutory insider.

The bankruptcy court confirmed the chapter 11 plan, finding that the claim transfer was conducted at arm’s length and that the buyer was therefore not a nonstatutory insider. A divided U.S. Court of Appeals for the Ninth Circuit affirmed, ruling that the bankruptcy court’s finding was entitled to deference as not being "clearly erroneous," rather than being subject to "de novo" review.

Writing for the unanimous court, Justice Kagan affirmed the approach of the Ninth Circuit. She explained that the bankruptcy court is better situated to determine the "mixed question" of law and fact of whether a creditor is a nonstatutory insider, at least when the question is the fundamentally factual one of whether a transaction was conducted at arm’s length. In such a case, the deferential standard of appellate review for questions of fact should apply. The Court, however, both assumed the correctness of the Ninth Circuit’s standard for identifying a nonstatutory insider (which four justices, in a concurring opinion, called into question) and recognized that in a different circumstance (involving the second prong of the standard, which was not an issue before the Court), even that standard might call for a different standard of review. Thus, the Court’s decision, while somewhat clarifying, may spawn further uncertainty.

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