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Supreme Court Upholds Clear Error Review for Bankruptcy Court Determination of Insider Status

In U.S. Bank Nat'l Ass'n v. Village at Lakeridge, LLC the Supreme Court considered whether the Ninth Circuit's application of clear error review to a bankruptcy court's determination under its non-statutory insider test was erroneous. In the Ninth Circuit, an individual or entity is a non-statutory insider whose dealings with a bankruptcy debtor are subject to more scrutiny where (1) the closeness of its relationship with the debtor is comparable to 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 (2016). Certiorari was granted only on the issue of whether the bankruptcy court's determination that a transaction was or was not at arm's length is a mixed question of law and fact for which de novo or clear error review was required.

As background, Village at Lakeridge filed for Chapter 11 relief, owing money to two creditors: U.S. Bank with a claim of at least $10 million and MBP, its owner, with a claim of $2.76 million. Lakeridge proposed a plan to impair both claims of U.S. Bank and MBP, but U.S. Bank refused to consent to the plan, leaving Lakeridge either to seek confirmation of a cramdown plan pursuant to § 1129(b) or be liquidated. In order to confirm a cramdown plan, Lakeridge needed the consent of at least one impaired class of creditor, but MBP could not consent for cramdown voting purposes because it is an insider pursuant to §§ 1129(a)(10), 101(31). Instead, an MBP board member Bartlett brokered an assignment of MBP's $2.76 million claim to her romantic partner Rabkin, who paid $5,000 for the claim as a speculative investment. Rabkin voted for the cramdown plan, but U.S. Bank objected and sought that Rabkin's claim be deemed an insider claim and that Rabkin be deemed ineligible to vote on the plan. In addition to finding that Bartlett and Rabkin were romantic partners, the bankruptcy court found that they did not cohabitate, they maintained their finances independently, and that the due diligence Rabkin did in connection with the claim purchase was "adequate." Based on these facts, the bankruptcy court found that the transaction was conducted at arm's length, that Rabkin was therefore not a non-statutory insider, and that Rabkin was qualified to vote on the cramdown plan. The Ninth Circuit affirmed, finding no clear error.

U.S. Bank's disagreement on appeal was over whether the bankruptcy court's determination of what an arm's length transaction should be reviewed de novo as a legal conclusion or for clear error as a finding of fact. The Supreme Court conceded that the determination of whether a creditor is a non-statutory insider is a mixed question, but noted that the work done under the Ninth Circuit's test is primarily factual, not legal, work. The Court held that if a mixed question primarily compels courts to marshal and weigh evidence, make credibility judgments, and otherwise address "multifarious, fleeting, special, narrow facts that utterly resist generalization," Pierce v. Underwood, 487 U.S. 552, 561-62 (1988), then the determination is essentially factual and calls for deferential clear error review on appeal. After defining the "widely understood" legal phrase "arm's length," the Court held that determining whether a transaction is done at arm's length is essentially a factual inference from undisputed basic facts. Consequently, and without passing the correctness of the Ninth Circuit's test for determining whether an entity is a non-statutory insider, the unanimous Court held that the bankruptcy court's determination under the Ninth Circuit's test is entitled to clear error review.

In concurrences written by Justices Kennedy and Sotomayor, at least four members of the Court have criticized the overall outcome of this decision and questioned whether it was appropriate that Rabkin not be determined a non-statutory insider under the current Ninth Circuit test. Thus, while the non-statutory insider test may currently lend itself creative vote-getting strategies under § 1129(b), that victory may be short-lived.

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