On April 5, 2013, the US Bankruptcy Appellate Panel of the Ninth Circuit (BAP) issued an unpublished and non-precedential opinion in In re The Village at Lakeridge, LLC, holding that a non-insider claimant's vote in favor of a plan of reorganization could not be disregarded as an insider's vote under section 1129(a)(10) of the Bankruptcy Code simply because the non-insider purchased the claim from an insider. On the contrary, since the purchaser was not itself an insider, its vote was required to be counted regardless of the status of the seller.

The Village at Lakeridge, LLC (Debtor) borrowed a sum of money to purchase and operate commercial real estate in Reno, Nevada in 2004. The Debtor's sole member was MBP Equity Partners 1, LLC, (MBP) of which Kathie Bartlett (Bartlett) was a director. On June 16, 2011, the Debtor filed for Chapter 11 relief. The only outstanding claims were a secured claim of about $10 million, belonging to UBS, and an unsecured claim, of about $2,761,000, belonging to MBP (MBP Claim).

On October 27, 2011, Dr. Robert Rabkin (Rabkin) purchased the MBP Claim for $5,000. During his deposition, Rabkin testified that:

UBS filed a motion to designate (or disqualify) Rabkin's vote on the plan under section 1126(e) of the Bankruptcy Code because he was a statutory insider, based on the assignment of the MBP insider claim to him, as well as a non-statutory insider, based on his relationship with Bartlett. UBS also argued that the assignment of the claim was in bad faith. Rabkin's vote was needed to confirm the plan because section 1129(a)(10) of the Bankruptcy Code requires that at least one impaired class of claims has accepted the plan, without counting the votes of insiders. In this case, Rabkin's vote was required to confirm the plan because he held the only impaired claim.

The Bankruptcy Court held that:

As a result of the designation of Rabkin's vote, the Bankruptcy Court could not confirm the plan. The Debtor and Rabkin appealed the Bankruptcy Court's designation order.

The key litigated issue is whether the insider status of an assignor passes to the assignee with the sale of a claim, causing that claim to be excluded for voting purposes under section 1129(a)(10) of the Bankruptcy Code.

The BAP acknowledged that there are two ways for a holder or purchaser of a claim to achieve insider status:

First, the BAP held that the Bankruptcy Court did not clearly err in its determination that Rabkin was not a non-statutory insider because the parties lacked the requisite degree of closeness and control required of that status.

Second, the BAP reversed the Bankruptcy Court's decision, and held that Rabkin was not a statutory insider. The BAP noted that the determination of a party's insider status is made on a case-by-case basis, but that the Bankruptcy Court appeared to determine that the assignee of an insider's claim automatically becomes a statutory insider solely by virtue of the assignment.

The BAP held that this proposition was not supported by the three cases the Bankruptcy Court cited for authority. Two of the three cases addressed an insider purchasing a claim from a non-insider. In these cases, the claims were excluded for voting purposes under section 1129(a)(10) of the Bankruptcy Code because of the status of the insider-purchaser, without regard to the status of the seller of the claims. The third case cited by the Bankruptcy Court, In re Greer West Investment Ltd. Partnership, acknowledged that the non-insider assumed the claim subject to its insider status, but went on to establish that the purchaser was an insider on an independent basis. The BAP interpreted the cited authority as requiring an independent determination of the purchaser's insider status without regard to the seller's status.

The BAP also pointed out the logical and legal inconsistency of the Bankruptcy Court's holding. If a non-insider can become an insider solely because it purchases an insider's claim, then an insider should be able to become a non-insider by purchasing a non-insider's claim. However, both before and after the assignment, the insider is still an insider. Therefore, a non-insider does not become an insider solely by purchasing an insider's claim without additional factors indicating that the non-insider is, in fact, an insider.

This case illustrates that when determining whether a proposed plan has the votes necessary to be confirmed, it is necessary to consider the status of the parties who held the impaired claims when the votes where submitted, rather than the status of the parties who held these claims at the beginning of the case. A non-insider claims purchaser does not step into the shoes of an insider claims seller to automatically assume its status as an insider without further inquiry and factual findings supporting that conclusion.

For more information on vote designation, see Practice Note, Disenfranchising Creditors: Designating Votes on Chapter 11 Plans.

For more information on confirming Chapter 11 plans, see Practice Note, Chapter 11 Plan Process: Overview.