Supreme Court Update: Merit Management Group v. FTI Consulting (16-784), U.S. Bank N.A. v. Village at Lakeridge (15-1509), Texas v. New Mexico (141, Orig.)

March 13, 2018 Supreme Court Update

Greetings, Court Fans!

We're back with the last of our catch-up series on the decisions announced during the Court's February sitting. Lucky for us, if you're reading this in the Northeast, it won't take much for you to suspend disbelief and imagine yourself reading our summaries of Merit Management Group v. FTI Consulting, U.S. Bank N.A. v. Village at Lakeridge, and Texas v. New Mexico back in the bleak late-winter when they were actually decided.

First up, in Merit Management Group v. FTI Consulting (No. 16-784), the Court addressed the scope of the Bankruptcy Code's "securities safe harbor," which limits the extent to which bankruptcy trustees can "avoid" (or invalidate) fraudulent transfers by a debtor, including transfers of an interest in property. The Bankruptcy Code authorizes trustees to set aside certain transfers in order to maximize the bankruptcy estate and facilitate equitable distribution of assets to creditors. But there are several limits to that power. The securities safe harbor, at issue here, provides that "the trustee may not avoid a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . or that is a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract." The question for the Court in Merit Management was whether the securities safe harbor applies any time a transfer involves a financial institution, even if the financial institution is a mere conduit between the debtor and another party. The facts of the case illustrate the issue.

Valley View Downs and Bedford Downs were two race tracks that were competing for the last harness-racing license in Pennsylvania. The license was a hot commodity, not so much because it permitted its holder to host horse races, but because licensed race tracks could also install slot machines. So enticing was the prospect of opening a "racino" that Valley View and Bedford decided to join forces. Bedford agreed to withdraw as a competitor for the license and Valley View agreed to purchase all of Bedford's stock for $55 million after it obtained the license. The plan worked. After Valley View obtained the license, it arranged for a branch of Credit Suisse (a financial institution) to finance the $55 million purchase price of all of Bedford's stock. Credit Suisse wired the money to Citizens Bank of Philadelphia (another financial institution), which agreed to serve as the third-party escrow for the transaction. The Bedford shareholders, including petitioner Merit Management Group, deposited their stock certificates into escrow with Citizens Bank and received cash disbursements totaling $55 million in return. But a harness-racing license does not a racino make. Although Valley View secured the racing license, it failed to secure a separate gaming license for the operation of slot machines. Without the steady ka-ching of the slot machines, Valley View was forced to file for Chapter 11. Respondent FTI Consulting was appointed trustee and set out to avoid the $55 million transfer, arguing that it was constructively fraudulent under the Bankruptcy code because Valley View significantly overpaid for Bedford's stock. Merit Management invoked the securities safe harbor, arguing that the transfer couldn't be avoided because it was a "settlement payment . . . made by or to (or for the benefit of) a . . . financial institution," namely Credit Suisse and Citizens Bank. The District Court sided with Merit, but the Seventh Circuit reversed, holding that the securities safe harbor does not protect transfers in which financial institutions serve as mere conduits.

The Supreme Court agreed, in a unanimous opinion authored by Justice Sotomayor. The Court took a commonsense approach to reading the safe-harbor provision. Read in context, it is clear that the focus of the securities safe harbor is on the transfer that the trustee seeks to avoid, not each component part of that overarching transfer. The language of the provision supports this contextual reading: It protects avoidance "a transfer that is" a settlement payment or a securities contract, not a transfer that involves or comprises settlement payments or securities contracts. Here, FTI identified the purchase of Bedford's stock by Valley View as the transfer that it sought to avoid. It wasn't trying to avoid the Credit Suisse to Citizens Bank or Citizens Bank to Bedford shareholders transactions, but the overarching Valley View to Bedford transaction. That transfer, even though it flowed through financial institutions, was not "by or to" a financial institution; it was a transfer by Valley View to Bedford's shareholders and therefore fell outside the securities safe harbor.

Our next case, U.S. Bank N.A. v. Village at Lakeridge (No. 15-1509), also arises in the bankruptcy context, but really concerns a broader issue of appellate procedure: the standard of review for mixed questions of law and fact. In this instance, the mixed question is whether a creditor qualifies as an "insider" of a debtor such that its consent to a so-called "cramdown" reorganization plan doesn't count. Ordinarily, a bankruptcy court can only approve a Chapter 11 reorganization plan if every affected class of creditors agrees to its terms. But in certain circumstances, the court may confirm a cramdown plan—that is, a plan that impairs the interests of a non-consenting class of creditors. One prerequisite for approval of a cramdown plan is that another impaired class of creditors has consented to it. But if the consenting creditor is also an "insider" of the debtor, it's consent to the plan doesn't count. The Bankruptcy Code enumerates certain types of "statutory insiders," but courts have also recognized numerous "non-statutory insiders." Everyone agrees that the determination whether a creditor is a non-statutory insider is a mixed question of law and fact, but there is no uniform standard for making the determination and no uniform standard of appellate review.

If any of this is confusing, the facts of the case simplify things a great deal. Lakeridge was attempting to reorganize under Chapter 11. It had only two creditors: U.S. Bank and MBP Equity Partners, which also happened to be Lakeridge's owner. Lakeridge's reorganization plan placed its two creditors in separate classes and proposed to impair both their interests. Because U.S. Bank refused that offer, the plan could not be fully consensual. But Lakewood also couldn't get by with a "cramdown" plan based on MBP's consent because MBP (as Lakewood's owner) was a statutory insider. Faced with potential liquidation, Lakeridge and MBP hatched a plan to transfer MBP's claim to a non-insider who would still agree to Lakeridge's reorganization plan. Kathleen Bartlett, an MBP Board member and Lakewood officer arranged to sell MBP's $2.76 million claim to Robert Rabkin, a retired surgeon, for $5,000. Rabkin—now one of Lakewood's two impaired creditors—consented to Lakeridge's proposed reorganization, but U.S. Bank cried foul. Rabkin, they pointed out, was not just any retired surgeon, but also in a "romantic relationship" with Bartlett. U.S. Bank argued that he was therefore a non-statutory insider whose consent could not set the stage for a cramdown reorganization over their its objection. The Bankruptcy Court held an evidentiary hearing at which Bartlett and Rabkin acknowledged their relationship but maintained that the transfer was the result of an arm's length negotiation. The Bankruptcy Court agreed (after all, it reasoned, these lovebirds didn't live together or share a bank account) and the Ninth Circuit affirmed. Applying its own standard for determining non-statutory insider status—which focuses on whether the relevant transaction was negotiated at arm's length—the panel majority concluded that the Bankruptcy Court's determination was entitled to clear-error review and could not be reversed under that standard of review. The dissent would have applied de novo review to the Bankruptcy Court's determination, but concluded that the determination that Rabkin was not an insider couldn't survive even clear-error review.

Without endorsing the Ninth Circuit's test for determining insider status, the Supreme Court unanimously agreed that the panel applied the proper standard of appellate review. Writing for the Court, Justice Kagan noted that everyone agreed the insider determination is a mixed question of law and fact, but pointed out that not all mixed questions are the same. The proper standard of appellate review depends largely on the substantive standard applied and whether the trial (or bankruptcy) court or an appellate court is better suited to resolve it. Here, given the Ninth Circuit's substantive standard for determining insiderhood—which boiled down to a determination of whether the suspect transaction was the result of an arm's length negotiation—the Court concluded that the issue "is about as factual sounding as any mixed question gets." Therefore, answering the extremely narrow question on which it granted cert, the Court concluded that the Ninth Circuit was correct to apply clear-error review on appeal.

Given the extremely limited breadth of the question presented, it should come as no surprise that all nine justices were able to get behind the answer. But a few weighed in separately on the seemingly more significant questions that the Court did not answer. Justice Sotomayor (joined by Kennedy, Thomas, and Gorsuch) wrote separately to point out that the Court's opinion, which "take[s] . . . as a given" the Ninth Circuit's standard, "eludes the more fundamental question whether the Ninth Circuit's underlying test is correct." Because the Court "expressly declined to grant certiorari" on the question whether the Ninth Circuit's standard is correct, Sotomayor agreed that this was not an appropriate case in which to address the proper test for determining non-statutory insider status. She nevertheless weighed in with some critiques of the Ninth Circuit standard, which should come in handy for the next West Coast petitioner seeking to disqualify an alleged insider's consent to a cramdown. (Of course, if three other Justices share these concerns, it's not entirely clear why the Court declined to grant cert on this "more fundamental question.") Kennedy also penned a solo concurrence expressing his view that the actual determination in this case (that the transfer of MBP's $2.76 million claim to the romantic partner of an MBP board member for $5,000 was an arm's length transaction) may well have been clearly erroneous.

Now then, for those of you who have made it all the way through two summaries of bankruptcy cases, this final summary is your reward. In Texas v. New Mexico (No. 141, Orig.) the Court unanimously held that the United States may intervene in an original action brought by Texas against New Mexico under the Rio Grande Compact. That's about all you need to know about this case (okay, it's more than you need to know), so we'll just leave you with the non-substantive highlight of Justice Gorsuch's opinion for the Court—his allusion to Will Rogers's quip that the Rio Grande is "the only river I ever saw that needed irrigation."

With that, Court Fans, you are up to speed. The March sitting begins on Monday the 19th and (God and Russian hackers willing) you'll be hearing from us again shortly after that, with summaries of whatever opinions The Nine have in store for us. Until then!