Supreme Court Holds That Bankruptcy Courts Determine Chapter 11 "Insiders"
Today, the Supreme Court held that U.S. circuit courts should defer to the bankruptcy court's factual findings about certain challenges related to a creditor’s "insider" relationship with a Chapter 11 debtor; the U.S. Bank v. Village at Lakeridge, 583 U. S. ____ (2018), decision emphasizes the bankruptcy court's autonomy and highlights the importance of lower court scrutiny, especially with regards to a Chapter 11 bankruptcy plan of reorganization.
The Village at Lakeridge ("Lakeridge") is a corporation with a single owner, MBP Equity Partners ("MBP"). Lakeridge filed for Chapter 11 bankruptcy with two substantial debts: Lakeridge owed $10M+ to U.S. Bank (the suing party in the lawsuit), and another $2.76M to its parent company MBP.
Lakeridge proposed a reorganization plan, but the plan impaired the interests of both creditors (e.g., U.S. Bank and MBP). If a reorganization plan alters the rights that the parties would otherwise have, then at least one affected party has to approve the plan. MBP accepted the plan, but U.S. Bank refused it. Lakeridge couldn't rely on MBP's acceptance alone because - as the parent company of Lakeridge - MBP was an "insider."
As the Supreme Court explains, "[C]rucially here, the consent of a creditor who is also an 'insider' of the debtor does not count for that purpose." There are also other types of insiders (besides directors, board members, corporate officers, etc.) that are called "non-statutory" insiders; these are entities who are *an arm's length* away from the debtor.
Because U.S. Bank wouldn't accept Lakeridge's plan and because MBP was an insider (and, therefore, couldn't choose to proceed with the plan), Lakeridge decided to impose a so-called "cramdown" option to get the court to approve the plan.
MBP Board Member and Lakeridge officer Kathleen Bartlett offered MBP's $2.76M claim to Robert Babkin, a retired surgeon with whom she was romantically involved, for a mere $5K. Lakeridge claimed that Babkin was a non-insider and therefore could agree to the cramdown plan. U.S. Bank DID NOT agree, citing Bartlett and Babkin's romantic relationship as proof that the transaction was not an arm's length transaction.
The Bankruptcy Court shot down U. S. Bank’s argument (e.g., Babkin qualifies as a non-statutory insider and can therefore agree to Lakeridge's reorganization plan), and the Ninth Circuit affirmed the lower court's decision.
So, if the U.S. Circuit Court upheld the lower court's decision, what is the issue here?
Basically, U.S. Bank wanted the federal court to use a different standard to review the Bankruptcy Court's determination about whether a transaction is conducted at an arm's length - i.e., is the debtor a non-statutory insider for purposes of approving Lakeridge's reorganization plan.
If you want to understand the different standards of review, you can read the Supreme Court's full opinion here. But, for our intents and purposes, all you need to know is that the Bankruptcy Court gets to make decisions about "insiders" based on the facts at bar. On appeal, the U.S. federal courts are only going to reverse decisions IF the lower court made a clear error in its findings of fact.
The Court explains that as long as "the Bankruptcy Court’s findings of fact satisfy the legal test chosen for conferring non-statutory insider status," then the appellate court should not review the basic facts of the case. The Court continues, "Here, the Bankruptcy Court confronted the question whether the basic facts it had discovered (concerning Rabkin’s relationships, motivations, etc.) were sufficient to make Rabkin a non-statutory insider."
In other words: "Given all the basic facts found, was Rabkin’s purchase of MBP’s claim conducted as if the two were strangers to each other?" The Supreme Court expounds that this inquiry belongs in the court presiding over the presentation of evidence - a.k.a. the Bankruptcy Court.
So what does this mean for your community financial institution?
If you're a creditor who needs to approve a reorganization plan, you need to understand that the Bankruptcy Court's factual determination about who qualifies as an "insider" is going to be uphold on review (UNLESS there is a clear error of fact... a very hard threshold to trigger review).
*TL;DR is an acronym that means "Too Long; Didn't Read." Send it to your S.O. next time you receive a novela via text - it'll drastically improve any situation.