Over a cogent dissent, the Ninth Circuit approved a strategy for cramming down a plan by manufacturing an accepting creditor class eligible to vote “yes.”
The corporate debtor in this case had a problem: There were only two creditors. One was a bank with a $10 million secured claim. The other was the debtor’s general partner, which had a $2.8 million unsecured claim.
As an insider, the general partner’s vote in favor of the plan could not be counted under Section 1129(a)(10). For lack of an accepting class, the plan could not have been confirmed and crammed down, because the bank opposed the plan.
To solve the problem, the general partner sold its claim for $5,000 to a close friend of one of the owners of the general partner. The plan called for a $30,000 distribution on the unsecured claim.
The bankruptcy judge ruled that the buyer automatically became an insider upon purchasing the claim. The Bankruptcy Appellate Panel reversed and was upheld in a 2-1 opinion, with Circuit Judge N. Randy Smith writing for the majority.
The case turned on the definition of “insider” contained in Section 101(31), which names several types of people, known as statutory insiders, who are automatically insiders. By the definition’s use of the word including, Judge Smith said that others become “non-statutory insiders” if they have “a sufficiently close relationship with the debtor to fall within the definition.”
In the principal holding of the case, all three judges, including the dissenter, agreed that a “person does not become a statutory insider solely by acquiring a claim from a statutory insider.” Judge Smith said that the Code distinguishes between the status of a claim and the status of a creditor. Insider status, he said, pertains only to the claimant.
Consequently, Judge Smith said that status as an insider entails a “factual inquiry that must be conducted on a case-by-case basis.” To become an insider, a claim buyer “must have a close relationship with the debtor and negotiate the relevant transaction at less than arm’s length,” he said.
If a buyer were automatically an insider, Judge Smith said that the purchaser would be foreclosed from voting even if the transaction was negotiated at arm’s length.
The bankruptcy judge had determined that the buyer was not an insider based on his conduct and relationship with the debtor and its owners. Since the buyer as a matter of law did not become an insider by purchasing the insider’s claim, the majority on the circuit court upheld the appellate panel because the bankruptcy judge’s findings of fact on insider status were not clearly erroneous.
Circuit Judge Richard R. Clifton dissented in part. To him, it was “clear” that the buyer should have been deemed an insider. In his view of the facts, the sale was not negotiated at arm’s length.
The case had an interesting twist that is likely to arise in similar situations. During pretrial discovery, the bank offered to purchase the claim from the buyer for $50,000 and later raised the offer to $60,000. The offer was not accepted and eventually lapsed.
Neither the appellate panel nor the circuit judges bought the bank’s argument that refusing the offer showed bad faith.