The Supreme Court used a bankruptcy case to elucidate the standard of review when an appellate court confronts a mixed question of law and fact. According to Justice Elena Kagan, who wrote the opinion today for the unanimous Court, clear error was the proper standard of review because the arm’s-length nature of the transaction was primarily factual in nature.
In concurring opinions, four justices questioned whether the Ninth Circuit employed the proper legal test for non-statutory insider status. Implying that the dissenter in the Ninth Circuit was on the right track, they laid out a test for non-statutory insider status that would be more consonant with the statute and produce a different outcome.
At oral argument in the Supreme Court on October 31, it seemed possible that the justices might rule that review is de novo when the facts in the trial court were undisputed. However, the Court’s opinion hewed to the traditional notion that inferences taken from undisputed facts are reviewed for clear error.
The Ninth Circuit Decision
In this chapter 11 reorganization, there were only two creditors. One was a bank with a $10 million secured claim. The other was the debtor’s general partner, who had a $2.8 million unsecured claim.
The bank opposed the plan and could have defeated confirmation for lack of an accepting class, because the insider’s vote could not be counted under Section 1129(a)(10) in cramming down the plan on the bank.
To create an accepting class and open the door to confirmation via cramdown, the insider sold her claim for $5,000 to a very close friend. The plan provided a $30,000 distribution on the unsecured claim.
The bankruptcy judge ruled that the buyer automatically became an insider by purchasing the insider’s claim. The Bankruptcy Appellate Panel reversed and was upheld by the Ninth Circuit in a 2-1 opinion.
All three circuit judges agreed that the purchaser did not automatically become an insider by purchasing the insider’s claim. The majority then said that status as an insider entails a “factual inquiry that must be conducted on a case-by-case basis.” To be a non-statutory insider, the appeals court laid out a two-part test. A claim buyer “must have a close relationship with the debtor and negotiate the relevant transaction at less than arm’s length.”
The Ninth Circuit did not remand the case to the bankruptcy court because the bankruptcy judge had ruled that the buyer purchased the insider’s claim in an arm’s-length transaction. Since the purchaser bought the claim at arm’s length, the second prong of the test had not been met, leading the majority on the Ninth Circuit to rule that the purchaser was not a non-statutory insider.
The majority on the circuit court therefore 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. It was “clear” to him 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 Petition for Certiorari
The bank filed a petition for certiorari, which was granted in March 2017. The Court limited its review to the appellate standard of review. The U.S. Solicitor General, who had opposed granting certiorari, submitted a merits brief on the side of the debtor and argued that the Ninth Circuit properly applied the clear-error standard of appellate review. The Solicitor General did not take a position on whether the bankruptcy judge committed clear error.
The Unanimous Opinion
In her 11-page opinion for the unanimous court, Justice Kagan said that courts have developed standards for non-statutory insiders that “are not entirely uniform.” Many, she said, focus on whether the transaction was conducted at arm’s length.
The buyer and seller were in a romantic relationship but lived apart and kept their finances separate. Despite the close relationship, the bankruptcy judge had found that the sale of the claim was negotiated at arm’s length.
Justice Kagan said that the bankruptcy court had correctly applied the Ninth Circuit’s two-part test. The Supreme Court, however, did not include a review of the test within the grant of certiorari. Instead, the Court only agreed to review the proper appellate standard for a ruling on non-statutory insider status.
Parsing the standards of appellate review, Justice Kagan said that findings of historical fact — such as “what, when or where, how or why” — are reviewable for clear error.
On the other hand, whether historical facts satisfy the test for non-statutory insider status is a mixed question of law and fact, Justice Kagan said. She then said that mixed questions “are not all alike.”
Pinpointing the standard of review for mixed questions “all depends,” she said, on whether the work of the appellate court is “primarily legal or factual.”
Deciding whether the sale of the claim was “conducted as if the [buyer and seller] were strangers to each other” was “about as factual sounding as any mixed question gets,” Justice Kagan said. Indeed, she said, applying the Ninth Circuit’s two-part test amounts to what the Court “previously described as ‘factual inferences[ ] from undisputed facts.”
Justice Kagan said that the bankruptcy court had the “closest and the deepest understanding of the record” from hearing the witnesses and presiding over the presentation of evidence.
The appellate standard of review was therefore for clear error because the appellate court was called on to perform “[p]recious little” legal work in applying the Ninth Circuit’s two-part test.
Approaching the issue from a different direction, Justice Kagan said that even a de novo review “will not much clarify legal principles or provide guidance to other courts resolving other disputes.”
The Concurring Opinions
Justice Sonia Sotomayor wrote a seven-page concurring opinion joined by Justices Anthony M. Kennedy, Clarence Thomas, and Neil M. Gorsuch.
Justice Sotomayor said it “is not clear to me” that the two-prong test in the Ninth Circuit “is consistent with the plain meaning of the term ‘insider’ as it appears in [Section 101(31) of] the Code.”
The enumerated statutory insiders in Section 101(31) do not lose that status, Justice Sotomayor said, by negotiating at arm’s length. Therefore, she said, “it is not clear why the same should not be true of non-statutory insiders.”
Finding shortcomings in the Ninth Circuit’s test, Justice Sotomayor proceeded to offer two other tests.
First, the court could focus on “commonalities” between enumerated insiders and “characteristics of the alleged non-statutory insider.” Second, the court might consider “other aspects of the parties’ relationship” if the transaction was negotiated at arm’s length.
Had the trial court applied one of her proposed tests, Justice Sotomayor said it “is conceivable” that the standard for review might have been different.
In the penultimate paragraph of her concurrence, Justice Sotomayor said that the facts of the case as applied to one of her two alternative tests may have resulted in a finding that the purchaser was an insider, even if the clear-error test were applied.
In a signal that she and her three colleagues were dissatisfied with the Ninth Circuit’s existing test, Justice Sotomayor ended her opinion by imploring courts “to grapple with the role that an arm’s-length inquiry should play in a determination of insider status.”
Justice Kennedy wrote a separate two-page concurrence to emphasize that the Court’s opinion should not be taken as an endorsement for the Ninth Circuit’s existing two-part test. He also questioned whether the bankruptcy judge was correct in finding that the purchaser was not an insider, but said “certiorari was not granted on this question.”