Ninth Circuit Limits Insider Status to Vote on Chapter 11 Reorganization The Ninth Circuit Court of Appeals has upheld a decision by the Bankruptcy Appellate Panel (“BAP”) that the buyer of a bankruptcy claim was not an “insider” for purposes of confirming a Chapter 11 reorganization plan even though that buyer purchased the claim from an insider.

The controversial decision could open the door for debtors seeking to circumvent the Bankruptcy Code requirement that a Chapter 11 reorganization plan be accepted by at least one class of non-insider impaired claims.

In U.S. Bank N.A. v. The Village at Lakeridge (In re The Village at Lakeridge), the debtor (The Village at Lakeridge, LLC) filed bankruptcy in June 2011. The debtor had two primary creditors: U.S. Bank N.A., which held a secured claim of $10 million, and its sole equity holder, MBP Equity Partners 1, LLC., which held an unsecured claim of $2.76 million. After the debtor filed its Chapter 11 reorganization plan, MBP sold its claim for $5,000 to Dr. Robert Rabkin. Rabkin had no relationship to the debtor or MBP, but was a close personal friend and business associate of an MBP member.

U.S. Bank filed a motion to disallow Rabkin’s claim for plan voting purposes, contending that the assignment of the claim from MBP to Rabkin was made in bad faith and that Rabkin was both a statutory and non-statutory insider. The Bankruptcy Court disagreed on both counts, but found that Rabkin’s vote should be disregarded because he acquired the claim from a statutory insider.

On appeal by the debtor, the BAP agreed with the Bankruptcy Court that the assignment of Rabkin’s claim was not made in bad faith and that Rabkin was not a non-statutory insider. However, the BAP disagreed with the Bankruptcy Court’s finding that Rabkin became a statutory insider by acquiring the claim from a statutory insider. The BAP noted that “insider status cannot be assigned and must be determined for each individual ‘on a case-by-case basis, after the consideration of various factors.’”

On appeal, the Ninth Circuit upheld the BAP ruling, finding that “bankruptcy law distinguishes between the status of a claim and that of a claimant” and that insider status attaches to the claimant, not the claim.

According to the court, “if a third party could become an insider as a matter of law by acquiring a claim from an insider, bankruptcy law would contain a procedural inconsistency wherein a claim would retain its insider status when assigned from an insider to a non-insider, but would drop its non-insider status when assigned from a non-insider to an insider.”

In addition, the appeals court noted that insider status is a question of fact that must be determined following the acquisition of a claim. Rabkin was allowed to vote as a non-insider.

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