Supreme Court Finds Determination of Insider Status Rests with the Bankruptcy Court and “Clear Error” is the Appropriate Standard of Review

By: Bradley P. Lehman, Esquire

McElroy Deutsch

A recent decision by the United States Supreme Court in U. S. Bank N. A., Trustee, by and through CWCapital Asset Management LLC v. Village at Lakeridge, LLC, 138 S.Ct. 960  (2018) clarified the standard of review to be applied to bankruptcy court determinations of who counts as an “insider” of the debtor under the Bankruptcy Code.

When Village at Lakeridge declared bankruptcy, it had two primary creditors: U.S. Bank and MBP Equity Partners (“MBP”). MBP also owned Village at Lakeridge. Village at Lakeridge proposed a Chapter 11 plan pursuant to which both of its creditors were in separate impaired classes. U.S. Bank would not consent to the proposed plan, and MBP’s vote could not be counted because, being the owner of the debtor, it was the classic insider. MBP devised a plan to bypass this inconvenience by selling its claim to someone else who would vote in favor of the plan. Thus, an MBP board member approached the doctor whom she was dating about buying MBP’s claim, and he agreed to purchase the $2.76 million claim for $5,000.

U.S. Bank argued that the purchaser of MBP’s claim was still an insider, albeit a non-statutory insider, and therefore could not be counted as an affirmative vote in favor of the debtor’s plan. The bankruptcy court disagreed and found that he was not an insider because he purchased the claim as a speculative investment and did so in the context of an arms-length transaction. U.S. Bank appealed, and the Ninth Circuit held that there was no clear error in the lower court’s determination that the transaction was at arm’s length. U.S. Bank appealed to the United States Supreme Court, arguing that the Ninth Circuit should have reviewed the lower court’s determination de novo.

The Supreme Court disagreed in its unanimous opinion finding that the clear error standard utilized by the Ninth Circuit was appropriate because the answer to the mixed question of law and fact involved more factual work than legal work.   Thus, deference to the bankruptcy court on the appeal through use of the clear error, rather than de novo, standard of review was appropriate.