Justices Tackle Designation of Bankruptcy Plan Insiders

(CN) – The Supreme Court agreed Monday to resolve a circuit split over how to determine whether a creditor involved a bankruptcy reorganization plan is an insider to the deal who shouldn’t vote on the plan.

The Village at Lakeridge LLC filed for Chapter 11 bankruptcy in 2011. At the time, two creditors held claims on its assets.

U.S. Bank held a fully secured claim worth about $10 million, while MBP Equity Partners 1 LLC held an unsecured claim worth $2.76 million. MBP is Lakeridge’s only corporate member and is managed by a five-member board, which includes Kathie Bartlett.

MBP decided to sell its unsecured claim shortly after Lakeridge filed its initial plan of reorganization. Robert Rabkin, who had a close business and personal relationship with Bartlett, bought the claim for $5,000, according to court records.

Under federal law, before it can confirm a Chapter 11 reorganization, a bankruptcy court must first determine if any people voting to accept the plan are insiders who would not vote in good faith.

U.S. Bank deposed Rabkin, who claimed he had no relationship with Lakeridge or MBP before he bought the claim. He also said he did not know how much his claim was worth or that his distribution under the proposed reorganization plan was $30,000.

The bank offered to buy his unsecured claim for $60,000, but Rabkin did not respond and the offer lapsed.

U.S. Bank later moved to disallow Rabkin’s claim for plan voting purposes, alleging he was both a statutory and non-statutory insider in the deal and that the assignment of the unsecured claim to Rabkin was made in bad faith.

The bankruptcy court ruled that Rabkin did not purchase MBP’s claim in bad faith, but nevertheless found that he became a statutory insider by buying it. “When a statutory insider sells or assigns a claim to a non-insider, the non-insider becomes a statutory insider as a matter of law,” the court ruled.

Lakeridge and Rabkin appealed the finding that he was a statutory insider for the purposes of plan voting. U.S. Bank cross-appealed the determination that Rabkin was not a non-statutory insider and had not purchased MBP’s claim in bad faith.

The Ninth Circuit’s Bankruptcy Appellate Panel ruled in Rabkin’s favor, reversing the finding that he had become a statutory insider as a matter of law by acquiring MBP’s claim and affirming the findings that he was not a non-statutory insider and that the claim assignment was not made in bad faith.

The bankruptcy panel held that insider status cannot be assigned and must be determined for each individual “on a case-by-case basis, after the consideration of various factors.” It ruled that Rabkin could vote to accept Lakeridge’s Chapter 11 plan because he was an impaired creditor who was not an insider.

Last year, a divided Ninth Circuit panel affirmed the bankruptcy appeals panel’s decision.

To be a non-statutory insider, a creditor must have a close relationship with the debtor and negotiate the relevant transaction at “less than arm’s length,” according to court records. The San Francisco-based appeals court held that Rabkin did not qualify as either a statutory or non-statutory insider.

“U.S. Bank has shown that Rabkin had a close personal and business relationship with Bartlett, and that Bartlett approached Rabkin, and only Rabkin, with an offer to sell MBP’s claim,” the ruling states. “However, Bartlett does not control MBP or Lakeridge. Rather, Bartlett was one of MBP’s five managing members, all of whom discussed potential buyers and agreed to offer the claim to Rabkin. Rabkin did not know, and had no relationship with, the remaining four managing members of MBP.”

U.S. Bank challenged the decision and filed a petition for writ of certiorari with the U.S. Supreme Court. It argued that the Ninth Circuit erroneously declined to apply the “arm’s length” test employed by other circuits, or address facts about Rabkin and Bartlett’s relationship.

On Monday, the nation’s highest court agreed to decide whether the appropriate standard of review for determining non-statutory insider status is the de novo “arm’s length” standard used by the Third, Seventh and 10th Circuits, or the Ninth Circuit’s application of only a few factors for determining non-statutory insider status.

Per its custom, the Supreme Court did not comment on its decision to answer the question.

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