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In “Non-Statutory Insider” Case, Supreme Court Clarifies the Standard of Review for Mixed Questions of Law and Fact

In U.S. Bank Nat'l Ass'n v. Village at Lakeridge, LLC, No. 15-1509, 2018 U.S. LEXIS 1520 (Mar. 5, 2018), the Supreme Court analyzed the appropriate standard of review for appellate courts reviewing a bankruptcy court’s determination of a “mixed question” of law and fact.  But the Court did not address whether the lower courts’ various “non-statutory insider” tests should be refined—although the concurrences strongly suggest that issue may be ripe for increased scrutiny.

The debtor in this case, Village at Lakeridge, LLC (“Lakeridge”), was a Reno, Nevada company wholly owned by MBP Equity Partners (“MBP”).  Lakeridge had two main creditors:  MBP and U.S. Bank (which Lakeridge owed $10 million on a loan).  Both creditors were impaired under Lakeridge’s proposed plan.  After failing to achieve consensual confirmation, Lakeridge looked to the Bankruptcy Code’s cramdown provision, 11 U.S.C. § 1129(b).  To confirm a cramdown plan, Lakeridge needed consent from one class of impaired creditors that was not an insider.  See 11 U.S.C. § 1129(a)(10).  That posed a problem:  U.S. Bank refused to consent and MBP—as Lakeridge’s parent company—was an insider and thus could not provide the necessary consent.

As a workaround, Lakeridge arranged to transfer MBP’s claim to another party.  Kathleen Bartlett (who both served on MBP’s board and was an officer of Lakeridge) arranged for her boyfriend, Robert Rabkin (“Rabkin”), to purchase MBP’s multimillion dollar claim for $5,000.  Rabkin then consented to Lakeridge’s cramdown plan. 

U.S. Bank objected that Rabkin should be regarded as an insider for plan confirmation purposes.  U.S. Bank argued that, even though Rabkin was not formally affiliated with MBP or Lakeview, his relationship with Bartlett meant that he should be regarded as a “non-statutory insider” who could not consent to a cramdown plan. 

At an evidentiary hearing, both Rabkin and Bartlett conceded that they were involved in a romantic relationship.  Yet the bankruptcy court held Rabkin was not a non-statutory insider because, it concluded, Rabkin did not co-habit or mingle finances with Bartlett and had purchased the MBP claim as a speculative investment.  Under the applicable Ninth Circuit test, a creditor cannot be a non-statutory insider if the relevant transaction was negotiated at arm’s length.  The bankruptcy court held that the claim purchase was an arms’ length transaction, and thus Rabkin was not an insider.

The subsequent appeals focused on how the appellate courts should review the bankruptcy court’s determination on that point.  The Ninth Circuit affirmed the bankruptcy court, applying clear-error review and finding the bankruptcy court’s conclusions could not be invalidated under that deferential standard.

The Supreme Court granted certiorari solely on the issue of the standard of review.   In a unanimous decision by Justice Kagan, the Court held that the standard of review for a bankruptcy court’s determination whether a creditor is a non-statutory insider must proceed in three separate steps:

  1. First, the bankruptcy court must decide which legal test to apply.  (As the Court recognized, various circuits have developed tests for identifying non-statutory insiders; those tests are similar, but not identical.  See 2018 U.S. LEXIS 1520, at *6-7.)  The bankruptcy court’s selection of the appropriate test is a “purely legal” question that is subject to de novo review. 
  1. Second, the bankruptcy court must make findings of “historical facts” to evaluate the creditor’s insider status.  These factual findings are reviewed for clear error.
  1. Finally, the bankruptcy court must determine whether the historical facts satisfy the chosen legal test.  This determination is a “mixed question” of law and fact.  In Lakeridge, the parties disagreed about the proper standard of review for this step, and thus the thrust of the Court’s decision focuses on this point.   The Court held that, because “[m]ixed questions are not all alike,” the standard of review depends upon the nature of the mixed question the bankruptcy court is answering.  If the bankruptcy court is “developing auxiliary legal principles of use in other cases,” then the determination should be reviewed de novo.  On the other hand, if the bankruptcy court is examining “case-specific factual issues,” then review should be for clear error.  Id. at *15.

“In short,” Lakeridge holds, “the standard of review for a mixed question all depends—on whether answering it entails primarily legal or factual work.”  Id.  In this instance, the bankruptcy court considered whether the facts about Rabkin’s relationship and subjective intent in purchasing the MBP claim showed that the transaction at issue was conducted at arms’ length.  That determination, the Supreme Court concluded, was “about as factual sounding as any mixed question gets”—and, accordingly, the Ninth Circuit was correct to apply clear-error review to it.

This short and crisp decision will provide a helpful analytical pathway for lower courts wrestling with the standard of review in bankruptcy appeals.  But Lakeridge is also noteworthy for what it did not decide.  As the decision repeatedly explained, the Court did not opine on whether the Ninth Circuit’s test for assessing non-statutory insiders was correct.  See 2018 U.S. LEXIS 1520, at *10; see also id. at *8 n.1.  Yet both concurrences, by Justices Sotomayor and Kennedy, suggest that it is far from clear that the Ninth Circuit’s test is right.  See 2018 U.S. LEXIS 1520, at *22 (Sotomayor, J., concurring) (expressing “concerns with the Ninth Circuit’s test” and inviting the lower courts to engage in “additional consideration” of the correct standard for evaluating non-statutory insiders); id. at *18 (Kennedy, J., concurring) (encouraging courts of appeals to “elaborate in more detail” the legal test for assessing non-statutory insiders). 

As Justice Sotomayor stressed, the Ninth Circuit’s test defeats a finding of non-statutory insider status if the bankruptcy court concludes the transaction was conducted at arms’ length, regardless of whether or not the creditor is closely connected with the debtor.  That formulation, she argued, is problematic, since the plain meaning of the term “insider” in the Bankruptcy Code “generally rests on the presumption that a person or entity alleged to be an insider is so connected with the debtor that any business conducted between them necessarily cannot be conducted at arm’s length.”  Id. at *23.

Lakeridge provides a straightforward answer on the standard-of-review issue, but generates other questions on the appropriate test for identifying non-statutory insiders.  The latter is sure to spark discussion among the lower courts in future cases.