On March 5, 2018, the Supreme Court of the United States decided U.S. Bank, N.A. v. Village at Lakeridge, LLC, No 15-1509, holding that a bankruptcy court’s determination of whether a set of facts demonstrated an arms-length transaction should be reviewed for clear error, rather than de novo.
Chapter 11 of the Bankruptcy Code allows a debtor of a company to reorganize its business under a court-approved distribution plan. Claims against the debtor are typically divided into two “classes,” and a bankruptcy court may approve such a plan only if each class of creditors agrees to its terms. But, in certain circumstances, a court may confirm what is known as a “cramdown” plan, i.e., a plan that impairs the interests of some non-consenting class. For such a “cramdown” plan to be approved, another impaired class of creditors has to consent to it. But the consent of a creditor who is an “insider” of the debtor does not count for this purpose. According to the Bankruptcy Code, an insider of a corporate debtor “includes” any officer, director or “person in control” of the entity. § § 101(31)(B(i)-(iii). Because of the word “includes,” courts have viewed the list of insider as non-exhaustive and have devised tests for identifying other, so-called “non-statutory insiders.”
This case arose in 2011 when an entity named The Village at Lakeridge, LLC, attempted to reorganize under Chapter 11. Lakeridge owed U.S. Bank over $10 million, and owed Lakeridge’s sole owner, MBP Equity Partners, another $2.76 million. The reorganization plan Lakeridge submitted to the bankruptcy court placed the two creditors in separate classes and proposed to impair both of their interests. U.S. Bank rejected the proposed plan. As Lakeridge’s sole owner, MBP qualified as a statutory insider under the Bankruptcy Code and could not provide the consent required for a cramdown. MBP, therefore, transferred its $2.76 million claim to a retired surgeon who was dating a member of MBP’s Board of Directors. The surgeon then consented to Lakeridge’s proposed reorganization.
U.S. Bank objected, and argued that the surgeon qualified as a non-statutory “insider.” The bankruptcy court did not agree. The bankruptcy court reasoned the surgeon was not an insider because the transaction between MBP and the surgeon amounted to an arms-length transaction, and noted that the surgeon purchased the MBP claim for $5,000 as a “speculative investment,” did adequate due diligence, and although he dated an MBP board member, the two lived in separate homes and managed their finances independently. The United States Court of Appeals for the Ninth Circuit affirmed, endorsing a two-part test for non-statutory insider status that asked whether the person’s relationship with the debtor was similar to those of listed insiders and whether the relevant transaction was at “less than arms-length.” The Ninth Circuit reviewed the bankruptcy court’s holding for clear error, and found none.
The Supreme Court affirmed, but expressly declined to address the correctness of the Ninth Circuit’s legal test. Instead, the Court discussed the appropriate standard of review for the mixed question of law and fact created by the Ninth Circuit’s test – de novo or clear error. The Court reasoned that the test of who qualified as a non-statutory insider involved mixed questions of law and fact, and that mixed questions are not all alike. Some require courts to expound on the law, amplifying or elaborating on a legal standard. When that is so, appellate courts should review decisions de novo. Other mixed questions immerse courts in case-specific factual issues. Those sorts of questions are “reviewable only for clear error,” in other words, with a “serious thumb on the scale for the bankruptcy court.” The Court rejected a de novo standard of review in this instance, because there was “precious little” legal, as opposed to factual, work required to determine if the arm’s-length requirement were satisfied. Instead, the “stock judicial method is merely to state the requirement of such [an arm’s length] transaction and then do the fact-intensive job of exploring whether, in a particular case, it occurred.”
Justice Kagan delivered the opinion for a unanimous court. Justice Kennedy filed a concurring opinion. Justice Sotomayor filed a concurring opinion, in which Justices Kennedy, Thomas, and Gorsuch joined.