U.S. Bank N.A. v. The Village at Lakeridge, LLC
U.S. Bank N.A. v. The Village at Lakeridge, LLC (In re The Village at Lakeridge, LLC), 814 F.3d 993 (9th Cir. 2016): Held that purchasing a claim from an insider of the bankruptcy debtor does NOT necessarily result in the person/entity purchasing the claim becoming an insider. United States Court of Appeals for the Ninth Circuit held that a vote on a plan of reorganization submitted by a non-insider claimant was not to be disregarded under Bankruptcy Code section 1129(a)(10) merely because the claimant purchased the claim from an insider.
FACTS: The debtor owned a commercial real estate development in Reno, Nevada. There was only one secured claim in the debtor’s case, amounting to about $10 million. There was also only one unsecured claim, listed on the debtor’s schedules at $2,761,000. The holder of the unsecured claim at the outset of the case was the debtor’s sole member, MBP Equity Partners 1, LLC (“MBP”).
The debtor filed a plan and disclosure statement that addressed the two claims in the case. Before the hearing on the adequacy of the disclosure statement, MBP sold the unsecured claim to Dr. Robert Rabkin for $5,000. After the disclosure statement was approved, Rabkin voted in favor of the debtor’s plan.
During a deposition conducted by the secured lender in connection with the plan confirmation proceedings, Rabkin testified that: (i) he had a business and a close personal relationship with Kathie Bartlett, a member of the board of MBP; (ii) he saw Bartlett regularly; (iii) he purchased the unsecured claim for $5,000 as a business investment; and (iv) other than the foregoing, he had no interest in the case or relationship to the debtor.
The secured lender then filed a motion to designate the unsecured claim purchased by Rabkin and disallow such claim for the purposes of voting on the debtor’s plan.
The bankruptcy court found that the assignment of the unsecured claim was not in bad faith, and declined to designate Rabkin’s unsecured claim on that basis. The bankruptcy court also found that Rabkin was not a non-statutory insider due to his relationship with Bartlett. However, the bankruptcy court did designate Rabkin’s claim and disallowed Rabkin’s vote on the plan because the bankruptcy court determined that Rabkin had become a statutory insider by purchasing the claim from MBP. The designation ruling prevented the debtor from obtaining an impaired consenting class of creditors as required by Section 1129(a)(10) of the Bankruptcy Code, thus blocking confirmation of the debtor’s plan.
The debtor and Rabkin appealed the bankruptcy court’s order. The secured lender cross-appealed the portions of the bankruptcy court’s order finding that Rabkin was not a non-statutory insider and finding that Rabkin’s vote should not be designated under Bankruptcy Code section 1126(e).
The Ninth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court’s ruling that Rabkin was a statutory insider merely by virtue of having purchased his claim from a statutory insider, and permitted Rabkin to vote on the plan. The secured lender appealed to the Ninth Circuit.
REASONING: This case concerns Bankruptcy Code section 1129(a)(10), which provides that if a class of claims is impaired, at least one class of impaired claims must accept the plan, “determined without including any acceptance of the plan by any insider.” The term “insider” is defined in Bankruptcy Code section 101(31), which provides a non-exclusive list of parties that are deemed insiders. Parties deemed to be insiders by virtue of being on the non-exclusive list are referred to as “statutory insiders,” and parties not on that list who nonetheless have a close enough relationship with the debtor to warrant special treatment are referred to as “non-statutory insiders.” In this case, the parties did not dispute that MBP, as the sole member of the debtor, was a statutory insider.
The Ninth Circuit reversed the bankruptcy court’s determination that Rabkin was a statutory insider such that his acceptance of the debtor’s plan should be excluded under Bankruptcy Code section 1129(a)(10). The Ninth Circuit held that the bankruptcy court applied an erroneous standard when it concluded that Rabkin became a statutory insider merely because he acquired the unsecured claim from a statutory insider.
The Ninth Circuit explained that insider status is a property of a claimant, not of the claim, and thus does not flow to the assignee as a matter of assignment law when a claim is assigned. The Ninth Circuit acknowledged that this result conflicted with a prior unpublished Ninth Circuit ruling which had held that insider status does transfer with a claim under general assignment law, In re Greer W. Inv. Ltd. P’ship, No. 94-15670, 1996 WL 134293 (9th Cir. Mar. 25, 1996), but distinguished that decision by observing that it was unpublished and not binding.
The Ninth Circuit further explained that “insider status is a question of fact that must be determined after the claim transfer occurs.” Lakeridge, 814 F.3d at 1000. This factual analysis is done on a “case-by-case basis,” after considering various factors. Id. The Ninth Circuit held that the factual inquiry could not be bypassed by a per se rule such as that created by the bankruptcy court, which would bar even a third party that acquired the claim at arm’s length from voting on a plan. The Ninth Circuit further noted that courts have held that when an insider acquires a claim from a non-insider, the claim loses its non-insider status because of the insider character of the purchaser. See In re Applegate Prop., Ltd., 133 B.R. 827 (Bankr. W.D. Tex. 1991); In re Holly Knoll P’ship, 167 B.R. 381 (Bankr. E.D. Pa. 1994). Thus, to hold that the claim keeps its insider status when transferred away from a statutory insider, but loses its non-insider status when transferred to a statutory insider, would create a procedural inconsistency in the Code.
The Ninth Circuit affirmed the finding that Rabkin was not a non-statutory insider. In doing so, the Ninth Circuit clarified the standard for becoming a non-statutory insider as a two-part, conjunctive test: “A creditor is not a non-statutory insider unless: (1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications of § 101(31), and (2) the relevant transaction is negotiated at less than arm’s length.” Lakeridge, 814 F.3d at 1001. The Ninth Circuit explained that while the secured creditor had demonstrated a close relationship between Rabkin and Bartlett, it had not shown a close relationship between Rabkin and Lakeridge, in part because Bartlett did not control either Lakeridge or its member, MBP.
COMMENT: The Lakeridge case both clarifies the law on the determination of insider status – which is relevant not just to the plan confirmation process, but also to preference actions – and also touches on the increasing area of claims trading. The ruling avoids what could have been a trap for the unwary claims trader, who, if the bankruptcy court ruling had stood, would have had to undertake due diligence as to the insider status of the assignor before purchasing a claim. Arguably, the case also gives debtors greater freedom in the plan confirmation effort by suggesting that a debtor’s insiders may increase the debtor’s chances of obtaining an impaired consenting class by transferring their claims to third parties. This prospect was raised by the secured creditor as a “slippery slope” type of argument, but the Ninth Circuit found that this effect would be mitigated by various protections in the plan confirmation process, including the requirements that the plan comply with the Bankruptcy Code, that the plan be proposed in good faith, that the plan disclose the identity of all insiders, that at least one class of impaired claims has accepted the plan, and that the plan is fair and equitable with respect to each class that did not accept it. In practice, a greater protection against that slippery slope may be the bankruptcy court’s own discretion in undertaking the insider analysis, which is highly specific to the facts of each case and, as a factual determination, may be difficult to overturn on appeal.
[This review is from California State Bar Insolvency Committee e-newsletter of 020317]