Supreme Court Clarifies Appellate Role in Bankruptcy Cases

(CN) - A unanimous Supreme Court ruled Monday that the Ninth Circuit correctly reviewed a bankruptcy court’s ruling for clear legal error rather than employing the de novo “arm’s length” standard used in three other circuits.

The opinion written by Justice Elena Kagan resolves 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.

Previously the Third, Seventh and 10^th Circuits all embraced a de novo review of such matters.

Justice Anthony Kennedy wrote a concurring opinion, as did Justice Sonya Sotomayor. Justices Kennedy, Clarence Thomas and Neil Gorsuch also joined Sotomayor's opinion.

The case stemmed from a 2011 Chapter 11 filing by the Village at Lakeridge LLC. 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 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.

Upon review, the justices concluded that appellate review of an arm's-length issues as presented in this case -- even if conducted de novo -- would do little to clarify legal principles or provide guidance to other courts resolving similar issues.

"And that means the issue is not of the kind that appellate courts should take over," Kagan wrote.

"The Court of Appeals therefore applied the appropriate standard in reviewing the bankruptcy Court's determination that Rabkin did not qualify as an insider because his transaction with MBP was conducted at arm's length," she continued. "A conclusion of that kind primarily rests with a bankruptcy  court, subject only to review for clear error."

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