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April 18, 2014

Claims Trading From The Inside Out: Ninth Circuit BAP Holds That A Non-Insider Claimant's Vote On A Plan Is Not Discounted Merely Because The Claimant Purchased Its Claim From An Insider

In an unpublished decision in In re The Village at Lakeridge, LLC, BAP Nos. NV-12-1456 and NV-12-1474 (B.A.P. 9th Cir. Apr. 5, 2013), the United States Bankruptcy Appellate Panel of the Ninth Circuit held that a vote on a plan of reorganization submitted by a non-insider claimant is not to be disregarded under Bankruptcy Code section 1129(a)(10) merely because the claimant purchased the claim from an insider. In other words, the transferee of a claim does not step into the shoes of the transferor vis à vis the transferor’s status as an insider.

Under Bankruptcy Code section 1129(a)(10), the acceptance of a proposed plan by an impaired class is determined by excluding “any acceptance of the plan by an insider.” In The Village at Lakeridge, a plan was proposed that impaired the only unsecured claim in the case – that of the debtor’s sole member. This claim was scheduled in the amount of $2,761,000. It was undisputed that the debtor’s sole member was a statutory insider under Bankruptcy Code section 101(31). After the plan was proposed, the debtor’s sole member sold the claim to a Dr. Rabkin for $5,000. Dr. Rabkin voted to accept the debtor’s proposed plan.

The secured creditor in the case filed a motion seeking to designate Rabkin’s claim under Bankruptcy Code section 1126(e) and to disallow his claim for purposes of voting on the proposed plan. The bankruptcy court granted the motion in part, holding that because the debtor’s sole member was a statutory insider, Rabkin acquired the same status when he purchased the claim. Thus, the bankruptcy court held that Rabkin’s vote on the plan could not be considered for voting purposes, leaving the debtor without the assenting class of impaired claims it needed to confirm its plan.

The Bankruptcy Appellate Panel reversed, finding that the bankruptcy court applied an erroneous legal rule. Citing to the general rule that “insider determination . . . is made on a case-by-case basis, after the consideration of various factors,” the Panel noted that it was undisputed that Rabkin was not himself a statutory insider. The Panel analyzed and distinguished the case law cited by the bankruptcy court in support of its decision, which included two cases where an insider that purchased the claim of a non-insider had its vote on a plan excluded due to the purchaser’s insider status. The Panel reasoned that if the bankruptcy court’s ruling was upheld and the vote of a non-insider like Rabkin were disregarded because the transferor was an insider in whose shoes Rabkin now stood, it would follow logically that the vote of an insider that purchased a claim would not be disregarded if the transferor were a non-insider. The Panel stated that such a result could not obtain, as “both before and after the assignment, the insider is still an insider.”

While unpublished and non-precedential, the reasoning of the Lakeridge case may be cited as persuasive in some jurisdictions depending on the local rules. With that in mind, the Panel’s decision in Lakeridgeemphasizes that plan proponents and opponents alike need to consider the status of the parties who actually held the impaired claims when the ballots were submitted, rather than the status of the parties who held such claims at the outset of the case, when determining whether a proposed plan has obtained or may obtain the votes necessary for acceptance. This consideration is especially important for a party such as a secured creditor that is considering purchasing claims in order to block or secure the vote of an impaired class. Furthermore, from the point of view of a debtor acting as a plan proponent, the Panel’s decision suggests that a debtor’s insiders may be able to manufacture a consenting impaired class by merely selling off their unsecured claims against the debtor at a discounted price to unrelated third parties who view them as an investment opportunity, which is exactly what occurred in Lakeridge.

Copyright © 2014, Sheppard Mullin Richter & Hampton LLP.

About the Author

Associate

Mr. Lauter is an associate in the Finance and Bankruptcy Practice Group in the firm's San Francisco Office.

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