What is the appropriate standard of review in determining non-statutory insider status under the Bankruptcy Code?
In this case, the Supreme Court will decide whether a lower court’s determination of an individual’s non-statutory insider status during a bankruptcy proceedings should be reviewed using the de novo standard or the clearly erroneous standard. The designation of insider status matters because, under 11 U.S.C. § 1129(a)(10), an insider—both as officially defined by the statute and as defined by the more expansive case law (a non-statutory insider)— is not permitted to vote during the consideration of a debt restructuring plan, even if his debt interests are harmed by the plan. U.S. Bank National Association argues that when a party appeals its designation as a non-statutory insider, courts should apply a de novo standard of review to such analysis, because it is either a pure question of law or at least a mixed question of law and fact. In contrast, Village at Lakeridge contends that courts should apply a clear error standard to this question because it involves pure fact. U.S. Bank National Association argues that de novo review prevents forum shopping and promotes judicial uniformity. Village at Lakeridge counters that de novo review undermines judicial economy and wastes party resources.
Questions as Framed for the Court by the Parties
Whether the Ninth Circuit Court of Appeals erroneously applied a clear error standard of review for determining non-statutory insider status under the Bankruptcy Code where the material facts were undisputed, rather than a de novo standard of review applied by the majority of circuit courts that have addressed the issue.
U.S. Bank National Association (“U.S. Bank”) is a creditor of Village at Lakeridge, LLC (“Lakeridge”) for a $10 million secured claim. U.S. Bank National Association v. Village at Lakeridge, 814 F.3d 993, 996 (9th Cir. 2016). Lakeridge is controlled by MBP Equity Partners, LLC (“MBP”), which is managed by five board members and holds an unsecured claim for $2.76 million against Lakeridge. Brief for Petitioner, U.S. Bank National Association at 5. In June of 2011, Lakeridge filed for Chapter 11 bankruptcy and in September submitted a Disclosure Statement and a Plan of Reorganization. Id. Shortly thereafter, MBP sold its $2.76 million claim to Robert Alan Rabkin (“Rabkin”) for $5,000. Id. at 8. Kathleen Bartlett, a board member of MBP, has a close personal and business relationship with Rabkin. Id. at 3. U.S. Bank deposed Rabkin to inquire about the transaction and his relationship to the parties involved. Id. at 10. Rabkin stated that he had no connection to Lakeridge or MBP outside of the transaction, and that he purchased the debt as an investment. Id. Rabkin also disclosed that he had met with Lakeridge counsel before the deposition.
U.S. Bank filed a motion to designate Rabkin’s claim against Lakeridge as that of a statutory and non-statutory insider. Id. at 9. Statutory insiders, as relevant to this case, are individuals who—under Chapter 11 of the Bankruptcy Code—are relatives of the debtor or of a general partner of the debtor. 11 U.S.C. §101(31). Through case law, courts have expanded the reach of the statute to also include situations where the relationship between debtor and creditor is too close or not arising out of an arm’s length transaction, referring to them as “non-statutory insiders”. Brief for Petitioner, U.S. Bank National Association at 3–4. Either designation would cause Rabkin’s claim to lose voting rights with respect to Lakeridge’s Chapter 11 Reorganization Plan, leaving U.S. Bank as the sole voter. Id. at 8.
The bankruptcy court held that Rabkin was not a non-statutory insider because Rabkin and Bartlett do not cohabitate or purchase expensive gifts for each other, and Rabkin does not exercise control over Lakeridge. Id. at 13. The bankruptcy court also held, however, that because Rabkin had acquired the claim from MPB, a statutory insider due to its control of Lakeridge, Rabkin’s claim should be statutorily disallowed for plan voting purposes. Id. at 14. Thus, the bankruptcy court determined that, as a matter of law, when a statutory insider assigns or sells their claim to a third party, the insider status carries over. Id.
Lakeridge and Rabkin appealed the finding of insider status carry-over to the United States Bankruptcy Panel for the Ninth Circuit, and U.S. Bank cross-appealed the finding that Rabkin was not a non-statutory insider. Id. at 14–15. The Bankruptcy Panel ruled in favor of Lakeridge and Rabkin, affirming the finding that Rabkin was not a non-statutory insider and reversing the lower court’s decision that Rabkin was a statutory insider, holding that such a designation cannot be assigned and is instead determined on a case-by-case basis after considering various factors. Id.
U.S. Bank appealed to the United States Court of Appeals for the Ninth Circuit, which agreed with the holding of the Bankruptcy Panel that Rabkin was not a non-statutory insider because that designation does not attach to the claim, but pertains to the claimant only. Id. In reaching this conclusion, the Ninth Circuit determined that the issue of whether Rabkin was a non-statutory insider is a question of fact, and therefore the court applied a clear error standard of review, as opposed to the de novo standard of review that is applied when questions of law are involved. Id. at 15. U.S. Bank appealed, alleging that the Ninth Circuit applied the wrong standard of review. Id. at 16. This is the sole issue to be heard by the Supreme Court. Brief for Respondent, U.S. Bank National Association at 3.
QUESTION OF PURE FACT?
U.S. Bank faults the Ninth Circuit majority for reviewing the bankruptcy court’s definition of “non-statutory insider” as a purely factual question and the bankruptcy court’s determination that Rabkin was a non-statutory insider as a purely factual question whereas U.S. Bank contends that insider status is a mixed question of law and fact. Brief for Petitioner at 29–31; Reply Brief of Petitioner at 23. U.S. Bank argues that this cannot be a purely factual question because the historical facts in the case are undisputed and thus the bankruptcy court had only to engage in legal analysis to apply the facts to the Ninth Circuit’s definition of non-statutory insider. Brief for Petitioner at 26. The clarifications the bankruptcy court made to the unclear legal standard, U.S. Bank continues, also involved a quintessential legal judgment in deciding what factors were relevant in determining non-statutory insider status. Id. Further, U.S. Bank contends, such relevance determinations are inherently legal and should be subjected to de novo review because they exclude a great deal of factual evidence rather than deciding what the facts were in a particular case. Brief for Petitioner at 27–29; Reply Brief for Petitioners at 7. Thus, U.S. Bank argues, the determination of non-statutory insider status is not a pure question of fact. Brief for Petitioner at 23–24.
Lakeridge counters that the question presented is a question of pure fact. Brief for Respondent, Lake Ridge at 19–20. Lakeridge contends that because courts must assess the closeness of the parties and whether transactions between the parties were conducted at arm’s length in order to determine whether a party is a non-statutory insider, the courts must engage in a highly fact-intensive inquiry. Id. at 6. Lakeridge admits that although courts may have to balance historical facts to make a determination, the determination is still based on facts rather than broad legal principles or normative judgments. Id. at 20–21. Thus, Lakeridge argues that Federal Rule of Civil Procedure 52 commands that this is a question of pure fact subject to clear error review. Brief for Respondent at 20. Further, Lakeridge asserts that the facts of motivation, intent, and the nature of the transaction in this case are in dispute. Id. at 22 n.8. Finally, Lakeridge and the U.S. Government, in support, assert that the Ninth Circuit correctly engaged in two separate reviews—the bankruptcy court’s definition of non-statutory insider status under a de novo review and a factual inquiry of whether Rabkin met the definition of non-statutory insider under a clear-review standard. Id. at 17–18.; Brief of Government at 12–13. Lakeridge argues that because application of law to fact follows a court’s factual conclusions, the Ninth Circuit correctly first concluded that the transaction occurred at arm’s length, then correctly found that Rabkin was not a non-statutory insider. Id. at 23.
QUESTION OF MIXED LAW AND FACT?
U.S. Bank argues that the determination of who is a non-statutory insider is a mixed question of law and fact. Brief for Petitioner at 29–31. This is because, U.S. Bank explains, non-statutory insider status is a catch-all category for creditors with relationships similar to those of insiders, but not actually enumerated in 11 U.S.C. §101(31). Id. at 21. Thus, determining who is a non-statutory insider, U.S. Bank maintains, requires courts to interpret the statute as applied to certain facts. Id. at 22. U.S. Bank contends that courts apply four tests to determine appropriate standards of review for mixed questions of law and fact, and under each test, the de novo standard is appropriate. Id. According to U.S. Bank, the first test—the predominance of law and fact test—says that where a question is predominantly legal, it should be reviewed de novo and where it is predominantly factual it should be reviewed according to the clear error standard. Id. at 37. Here, because the bankruptcy court engaged in normative decision-making by developing its own standards to fill the gap between a vague legal statute and undisputed historical facts, the question is a predominately legal one, and is subject to de novo review. Id. at 41. The second test—the historical practice test—also would apply de novo review because, U.S. Bank contends, there is a historical precedent of appellate courts using de novo review for determining insider status and other mixed questions of bankruptcy law and facts. Id. at 42, 44. U.S. Bank argues that under the third test—the functional analysis test—de novo review is appropriate in this case because the question of who counts as a non-statutory insider is best left to appellate courts in light of the heavy legal implications of the decision, the low concerns regarding credibility and potential factual disputes, and the need for uniform standards leading to consistent outcomes. Id. at 46–47. Finally, U.S. Bank maintains that the fourth test—the ultimate issue test—indicates that de novo review is called for because, here, the determination of insider status is dispositive of the broader question under consideration and thus clearly implicates a legal standard. Id. at 52–53.
Lakeridge disagrees and argues that even if this is a mixed question, the Court’s usual framework dictates that clear error review applies. Brief for Respondent at 26, n.10. Lakeridge argues that the framework, rather than being four separate tests, looks first at the statutory standard, then to historical tradition, and lastly to functional considerations. Id. Lakeridge maintains that there is no applicable statutory directive, outside of Rule 52, that favors the clear error standard. Id. at 18. Rather, Lakeridge argues that the issue here involves non-statutory insiders, a category not explicitly found in the statute, but implied from the open-ended definition in 11 U.S.C. 101(31). Id. at 27. In opposition to U.S. Bank, Lakeridge also argues that there is no historical directive because courts are divided 4–3 on the appropriate standard of review. Id. at 18. Lakeridge further contends that functional analysis suggests a clear error standard for four reasons. Id. at 4. First, Lakeridge posits that appellate judges would be at a disadvantage using a cold record to make fact-intensive inquiries and case-by-case determinations based on the totality of the circumstances. Id. at 30. Next, Lakeridge indicates that judicial and party resources would be wasted with de novo review because such review requires multi-judge panels to revisit an entire evidentiary record. Id. Third, Lakeridge argues that bankruptcy cases, by their nature, involve limited funds, and such funds should be used to pay back legitimate creditors or increase the odds of successful reorganizations rather than being wasted on expensive litigation. Id. at 31. Finally, Lakeridge contends that clear error review would allow bankruptcy trial court judges with comparative experience and expertise to try cases. Id. at 32. Lakeridge concludes by arguing that whether or not fact-finding resolves the ultimate issue in this case is irrelevant because even if fact finding dictates the end result, “ultimate” facts are still facts. Id. at 22.
IMPLICATIONS FOR BANKRUPTCY LAW
U.S. Bank argues that the Ninth Circuit’s clear error standard of review differs from the Third, Seventh and Tenth Circuits’ approaches, and thus resolution of this case will prevent forum shopping. Petition for a Writ of Certiorari at 23-24. Additionally, resolving the question of the appropriate standard of review for determining non-statutory insider designation, U.S. Bank contends, will implicate many areas of bankruptcy law beyond Chapter 11 reorganizations. Id. U.S. Bank notes that insider designation is used in fraudulent conveyance and preferential transfer litigation under Sections 547, 548 and 550(c) of the Bankruptcy Code. Id. Additionally, Section 727(a)(7) of the Code, which permits denial of discharge of debt in bankruptcy if certain enumerated acts occurred and the creditor is an insider, will be affected, according to U.S. Bank. Id. Further, U.S. Bank points out, insider designation is an important component of the application of the Uniform Fraudulent Transfer Act and the Uniform Voidable Transaction Act, state-adopted statutes which grant creditors remedies against debtors who transfer property in anticipation of litigation. Id.
The United States (“the Government”), in support of Lakeridge, counters that the standard of review question need not be resolved by the Court because the standard applied by the Ninth Circuit is not contrary to that of any other Circuit. Brief of Amicus Curiae United States (“the Government”), in Support of Respondent at 12. The Government contends that the proper interpretation of other Circuits’ decisions is that insider designation is a mixed question of law and fact, thus de novo review is applied to the legal interpretation of lower courts and clear error review is applied to their factual findings. Id. at 13. The Government further argues that the Ninth Circuit took this approach, and therefore the courts are not split. Id. at 14. Moreover, the Government. argues that the heart of the dispute at issue is a factual contention, for which the Supreme Court traditionally does not grant petition for writ of certiorari, and therefore overturning the lower courts’ finding is unwarranted. Id. at 16.
JUDICIAL UNIFORMITY VERSUS JUDICIAL ECONOMY
U.S. Bank argues that, due to its complexity, bankruptcy law does not allow a neat application of law to facts, therefore the Court should apply de novo review so as to provide meaningful appellate proceedings for all litigants. Brief for Petitioner at 35. U.S. Bank also asserts that if the clearly erroneous standard of review is applied, litigants in bankruptcy proceedings will be harmed by possible misapplication of statutory objectives and policies that can only be properly considered in the context of the whole case. Id. Further, U.S. Bank contends that the clearly erroneous standard of review would lead to disparate results in different Circuits, damaging judicial uniformity. Id. at 34-35.
Lakeridge contends that de novo review is time-consuming and damages judicial economy. Brief for Respondent at 19. Lakeridge argues that it is well-settled that factual determinations are best left to the trial level, whereas appellate courts should focus on questions of law that Chapter 11 reorganizations do not raise. Id. Further, Lakeridge argues that the U.S. Bank’s approach may waste resources. Id. at 30. For example, Lakeridge notes that in the present case two separate levels of three-judge panel de novo review would be required. Id. Additionally, Lakeridge contends that the clearly erroneous standard allows the parties to preserve resources which are necessarily scarce in bankruptcy litigation and can be used to repay legitimate creditors or increase the probability of a successful reorganization. Id. at 31. Further, Lakeridge argues that applying de novo review at the appellate stage is contrary to a Congressional policy favoring swift resolution of bankruptcy claims. Id. at 4.
Diane Davis, Creditor Not An ‘Insider’; Can Vote on Chapter 11 Plan, Bloomberg BNA (Feb. 16, 2016).
Amy Howe, Today’s orders – Two grants, one CVSG, still no Masterpiece Cakeshop, SCOTUSBlog (Mar. 27, 2017).
Amy Howe, Justices issue additional orders from September 26 conference (Update), SCOTUSBlog (Oct. 3, 2017).