Supreme Court Alert: The Court Provides Additional Guidance on the Appropriate Level of Review of Determinations of Mixed Questions of Law and Fact by the Bankruptcy Court

On March 5, 2018, the Supreme Court issued a unanimous decision in U.S. Bank National Ass’n ex rel. CWCapital Asset Management LLC v. Village at Lakeridge, LLC, holding that bankruptcy court determinations regarding whether transactions are at arms-length are predominantly factual in nature, and thus should be overturned only on the basis of clear error.[1] In the opinion, authored by Justice Kagan, the Court affirmed the Ninth Circuit’s decision to uphold, under a clear-error standard of review, the bankruptcy court’s approval of a cramdown plan.[2] That approval hinged on the bankruptcy court’s finding that a creditor, where he had been transferred his interest by an insider of the debtor with whom he had a romantic relationship and where he had paid only a fraction of the interest’s actual value, did not qualify as an insider of the debtor.[3]

At the time of the bankruptcy filing, the debtor, Lakeridge, was owned entirely by one entity, MBP Equity Partners, and had two major debts; one to U.S. Bank for more than $10 million, and one to MBP for $2.76 million.[4] Lakeridge proposed a plan that would impair both creditors.[5] U.S. Bank rejected the plan.[6] Because MBP Equity was a statutory insider, it could not overcome U.S. Bank’s objection, and it thus sought to transfer its claim against Lakeridge to an outsider.[7] A member of MBP’s board and an officer of Lakeridge, Kathleen Bartlett, made a deal with Robert Rabkin, a retired surgeon with whom she had a romantic relationship, to sell MBP’s $2.76 million claim for $5,000.[8]

Rabkin consented to the plan, and the bankruptcy court affirmed the plan.[9] U.S. Bank objected, arguing that Rabkin qualified as a non-statutory insider because he had a “romantic” relationship with Bartlett and his purchase of MBP’s loan “was not an arm’s-length transaction.”[10] At an evidentiary hearing, it was established that Rabkin and Bartlett did in fact have a romantic relationship.[11] The bankruptcy court concluded that Rabkin was not an insider despite this relationship, however, because he purchased the MBP claim as a “speculative investment” after doing adequate due diligence, and Bartlett and Rabkin lived in separate homes and managed their finances independently.[12] Indeed, the bankruptcy court determined that the transaction was made at “arms-length” and did not convey insider status.[13]

The Court of Appeals for the Ninth Circuit affirmed, holding that the bankruptcy court’s determination that the transaction “was conducted at arm’s length” “was entitled to clear-error review, and could not be reversed under that deferential standard.”[14]

The Supreme Court granted certiorari to resolve “[w]hether the Ninth Circuit was right to review for clear error (rather than de novo) the Bankruptcy Court’s determination that Rabkin does not qualify as a non-statutory insider because he purchased MBP’s claim in an arm’s-length transaction.”[15] The Court found that the question of whether the facts satisfied the legal standard applied in the Ninth Circuit was a question of mixed law and fact, but was predominately factual in nature.[16] In support, the Court explained that “[w]hat remains for a bankruptcy court, after all that, is to determine whether the historical facts found satisfy the legal test chosen for conferring non-statutory insider status. We here arrive at the so-called ‘mixed question’ of law and fact at the heart of this case.”[17]

The Supreme Court explained that this “mixed question” was actually whether, under the facts as found by the bankruptcy court, “Rabkin’s purchase of MBP’s claim [was] conducted as if the two were strangers to each other?”[18] Such a question is, the Court noted, “about as factual sounding as any mixed question gets” and “really requires what we have previously described as a ‘factual inference[] from undisputed basic facts.’”[19] Because the question was so factually driven, it belonged, the Court concluded “in the court that has presided over the presentation of evidence, that has heard all the witnesses, and that has both the closest and the deepest understanding of the record—i.e., the bankruptcy court.”[20] The Court also, as an alternative basis for its holding, noted that “precious little” legal work is involved in applying the “arm’s-length test.”[21] The Court found “no apparent need to further develop ‘norms and criteria,’ or to devise a supplemental multi-part test, in order to apply the familiar term.”[22] Thus, “appellate review of the arm’s-length issue—even if conducted de novo—will not much clarify legal principles or provide guidance to other courts resolving other disputes,” meaning “the issue is not of the kind that appellate courts should take over.”[23]

The Court held that because the bankruptcy court was in the best position to make the determination as to whether a transaction was arms-length, the bankruptcy court’s decision should be overturned only for clear error.[24]

Justice Kennedy concurred in the outcome, but wrote to make clear that the Court was not adopting the test applied by the Ninth Circuit, nor was it affirming that the standard was correctly applied.[25] He emphasized that the opinion “properly limits its decision to the question whether the Court of Appeals applied the correct standard of review, and its opinion should not be read as indicating that a transaction is arm’s length if the transaction was negotiated simply with a close friend, without broader solicitation of other possible buyers.”[26]

Justice Sotomayor issued a separate concurrence joined by Justices Kennedy, Thomas, and Gorsuch, expressing concerns regarding the test for insider status as applied by the Ninth Circuit, and doubt as to the bankruptcy court’s conclusions.[27] She noted that if the nature of the test were to change, it is possible that the applicable standard of review would also change.[28]

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This case supports the concept that bankruptcy court decisions involving mixed questions of law and fact will, if the inquiry is predominantly factual so that the court is in the best position to make those decisions, be reviewed only for “clear error.”