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Supreme Court: the Standard of Review for Non-Statutory Insider Status is Clear Error Under Ninth Circuit Test, But the Test May be Wrong

By Karl Johnson posted 04-23-2018 09:36 AM

  
BANKRUPTCY BULLETIN
Editors-in-Chief
Karl Johnson, Hellmuth & Johnson, PLLC
Jeffrey Klobucar, Bassford Remele, P.A.

 Contributing Editor: Karl Johnson, Hellmuth & Johnson, PLLC
Supreme_Court____U_S__Bank__N_A__v__Village_at_Lakeridge__LLC.pdf

In U.S. Bank Nat’l Assoc., Trustee, by and through CWCapital Asset Mgmt LLC v The Village at Lakeridge, LLC, ___ S.Ct. ____ (2018), the Supreme Court declared that the standard of review for a determination of non-statutory insider status under the Ninth Circuit’s “arm’s length” test is clear error. The Justices explicitly declined to endorse the Ninth Circuit's test. 

The debtor owed $10 mm to a bank and $2.76 mm to an entity that owned 100% of the debtor. In its chapter 11 plan of reorganization, the debtor placed each creditor in a separate class and proposed to impair both claims. The bank voted against the plan. The owner’s vote did not count for purposes of cramdown under § 1129(a)(10) because the owner was an insider under § 101(31)(B)(iii), which provides a non-exhaustive list of insiders.

The owner then sold its $2.76 mm claim for $5,000.00 to a man who was in a romantic relationship with an officer and director of the owner. The claim purchaser voted in favor of the plan. The bank objected that the claim purchaser was also an insider because of his romantic relationship and because the transaction was not at arm’s length. The lower courts all applied the Ninth Circuit test, under which a creditor is a non-statutory insider if two conditions are met: (1) the creditor’s relationship with the debtor is comparable to that of the insiders listed in the statute; and (2) the relevant transaction is negotiated at less than arm’s length.

The bankruptcy court held that the transaction was conducted at arm’s length based on its findings that the claim purchaser viewed the claim as a “speculative investment” and did adequate due diligence. Therefore, the bankruptcy court held that the bank failed to prove the second prong of the test. The Ninth Circuit held that whether the transaction was at arm’s length is primarily a factual question and therefore entitled to clear error review. Under this deferential standard, the Ninth Circuit affirmed.

Justice Kagan, writing for a unanimous Court, rejected the bank’s argument that application of the test used in the Ninth Circuit requires development of legal principles such that the issue should be reviewed de novo. Instead, the Court held that there is a near-universal understanding that “arm’s length” means the transaction was conducted as though the parties were strangers. Because this determination is fact intensive, the Court affirmed the use of a clear-error standard of review. The Court explicitly noted that it declined to address the question of whether the Ninth Circuit's test is correct.

Justices Kennedy and Sotomayor filed separate concurrences to clarify that the “Court’s holding should not be read as indicating that the non-statutory insider test as formulated by the [Ninth Circuit] is the proper or complete standard to use in determining insider status.” Justice Kennedy specifically asked whether the test should include an inquiry as to whether the same deal could and should have been offered to other parties who might pay a higher price.

While declining to address whether the Ninth Circuit’s test is correct, Justice Sotomayor (joined by Kennedy, Thomas, and Gorsuch, JJ) pointed out that a statutory insider is presumed to be incapable of conducting a transaction at arm’s length and cannot vote in favor of a plan under any circumstances. Consequently, applying an “arm’s length” test for non-statutory insiders results in disparate treatment of similar individuals. Significantly, Justice Sotomayor noted that the standard of review may be different with a different test.

For now, non-statutory insider status is to be reviewed for clear error if the legal test involves a determination of whether the transaction was conducted at arm’s length, but the test may be up for debate.

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