Argument analysis: Justices unsure whether to resolve case about standard of review for findings of insider status

The argument yesterday morning in U.S. Bank National Association v. The Village at Lakeridge displayed a bench not at all certain the case is worth deciding. The basic problem is that the justices agreed to consider the standard of review for a judge’s determination that a particular individual is – or is not – an “insider” for purposes of a bankruptcy proceeding, but now that they’ve reviewed the briefs they’re not at all sure what the legal standard is for deciding if somebody is an insider. Because they explicitly declined to grant review as to the legal standard, they don’t have briefs on that question, so they are reluctant to resolve it. And without knowing exactly what the standard is, they find themselves unable to decide if it looks more like a factual question or a legal question.

Some background information about the Bankruptcy Code is needed to understand the quandary the justices face. The Bankruptcy Code includes a definition of “insider,” designed to identify a group that the bankruptcy court should view with suspicion; the general idea is that the insolvent bankrupt might engage in transactions that favor insiders and thus disadvantage other less-favored creditors. The statute enumerates a lengthy list of obvious insiders (partners, officers, directors, parents, spouses and the like), but all agree that the statutory definition reaches relations that do not fall within the enumerated categories if the facts of a particular case justify treating them as insiders.

This case, for example, involves a purchase of a claim against the debtor by one Robert Rabkin. At the time of the transaction, Rabkin was involved in a romantic relationship with the principal individual representative of the bankrupt, Kathleen Bartlett. Bartlett’s role with the debtor made her an enumerated insider; the bankruptcy court concluded that Rabkin’s romantic relationship with her was not enough to make him an unenumerated insider, largely because of the level of negotiating in which he engaged before making the purchase. Rabkin’s status was important because the bankruptcy court could not have confirmed the plan of reorganization that the debtor proposed if Rabkin had been an insider. The U.S. Court of Appeals for the 9th Circuit affirmed the bankruptcy court’s ruling.

The simplest way to think of the case – pressed on the justices by Daniel Geyser on behalf of the debtor, the Village at Lakeridge, and Morgan Goodspeed on behalf of the U.S. solicitor general – is that insider status depends entirely on whether the transaction proceeded at “arm’s length.” And if that is the test, then it would make sense to treat the application of that test to any particular situation as a question of fact, which appellate courts review only for clear error – in contrast to questions of law, which are generally reviewed de novo, or without deference to the lower court’s decision. Early in the argument, several of the justices seemed to see the case in just that way. Chief Justice John Roberts, for example, suggested that “arm’s length was not invented by the Court here. Arm’s length is a legal concept that goes back beyond Blackstone. It’s a familiar legal test for lawyers.” Similarly, in a colloquy with Gregory Cross (representing U.S. Bank, the creditor challenging the plan), Justice Ruth Bader Ginsburg asked if there was anything more to the standard than whether “they deal with each other as if they were strangers? Isn’t that the definition?” Jumping in to the discussion at that point, Justice Samuel Alito, noting that Ginsburg’s definition “comes right out of Black’s Law Dictionary,” seemed certain that it was a question of fact: “Isn’t that very close to a question of pure fact?”

Cross faced a tricky problem in his argument, though, because he thinks the legal standard is more complicated: In his view, the proper standard turns not only on the arms’-length features of the transaction but also on whether the “closeness” of the parties is similar to the “closeness” of enumerated insiders. So when Cross suggested that the standard was more complex than Ginsburg had described, Alito cut him off, interjecting: “I think you’re talking about two separate questions. And it’s not your fault that the two are hard to separate because we took one question and we didn’t take the other. But the issue here is what is the standard of appellate review with respect to the standard that was applied by the Ninth Circuit. I take it that is the question.”

By the time Geyser appeared, presenting argument on behalf Lakeridge, several of the justices had homed in on that problem. When Geyser tried to press the easy propriety of clear-error review for determinations of arm’s-length status, Justice Elena Kagan interrupted him to point out that “it’s not really the legal test according to the Ninth Circuit, right, because the Ninth Circuit has the arm’s-length component of its legal test, but it also has this question whether the closeness of the relationship with the debtor is comparable to that of the enumerated insider classifications in the statute. And how any particular set of facts does or does not meet that prong of the test does not seem much of a factual question.”

Elaborating on that point, Kagan seemed convinced that under the two-part standard (closeness plus arm’s-length) clear-error review made little sense: “One way of thinking of this is that once you have the facts and the facts are uncontested and you’re trying to figure out whether those facts satisfy a given legal standard, here whether they’re comparably close to the statutory insiders, … what the Court is then doing is trying to figure out how important each fact is, given the legal test. And that sounds like a legal inquiry to me.”

Faced with colleagues on one side suggesting that arm’s-length status is a “quintessential” fact question and Kagan on the other side suggesting that the actual 9th Circuit standard can’t be treated as a fact question, Justice Neil Gorsuch pressed the view that the court simply can’t decide the standard of review without first deciding what the legal rule is: “[H]ere we’re being asked to decide what the right standard of review is. Can we do that with any degree of assurance when we don’t know what the right legal test is? And don’t we run the risk, perhaps, of sending the wrong signal to lower courts that we’re … endorsing the Ninth Circuit’s formulation of what the test is?” Closing with a quip, he suggested the problem posed “a high degree of difficulty, … like one of those high dives, you know it’s a 10 out of 10 difficulty.”

Geyser’s response was to stand by his view that the legal test is the single question of whether a transaction is conducted at arm’s length, but Gorsuch would not accept that position, reporting that he “had a law clerk survey that for me and I’ve looked at it and I’m not sure I entirely agree.”  Joined by Justice Sonia Sotomayor, Gorsuch pressed Geyser hard to admit that the lower-court cases consider both “closeness” and “arm’s length.” Ultimately, though, Gorsuch returned to the idea that perhaps “we [should] wait to see what the courts of appeals sort out on all this before we decide what the standard of review is?” I should point out that it is easy for Gorsuch to complain that the justices decided to review the wrong question – the court granted review in this case a week before he was confirmed.

Aside from the serious questions about whether the justices have a case in front of them apt for resolution, the most interesting strain of the argument was the protracted debate about whether the issues in the case are better suited for resolution at the bankruptcy-court level or the appellate level.

Recognizing the strong element of finance, several of the justices seemed to find the whole area one best committed to the bankruptcy courts. Sotomayor, for example commented that “I think it’s better left in the hands of the bankruptcy judge who deals with financial transactions all the time.” In the same vein, Alito asked pointedly, “Which entity is better positioned based on role and experience to determine whether a particular transaction is the kind of transaction in which strangers would engage, the bankruptcy judge or a panel of the court of appeals[?]” Continuing in that vein, Roberts commented:

I think it’s pertinent whether they’re more difficult for the district judge or more difficult for the court of appeals. And it seems to me that a lot of the issues we’re talking about here are the sort of things that district court judges, bankruptcy court judges, look at all the time. But to get the intense factual record on a subsidiary issue and ask the court of appeals to look at it after the district court has already done it … I’m not quite sure that’s desirable.

Justice Stephen Breyer piled on, preoccupied with the importance of oral testimony to the bankruptcy court’s deliberations (“He heard them. He saw them.”) and the relative incapacity of an appellate court left only with “a cold record.”

Taking the opposite tack, Justice Anthony Kennedy seemed to wax poetic over the important role that appellate courts can play in developing law over the long run. Responding to Geyser’s suggestion that it is wasteful for multiple levels of appellate panels to review bankruptcy-court factual findings, Justice Kennedy retorted:

[Y]ou’re assuming that it’s not cost-effective for courts over a period of time to elaborate certain standards for the guidance of district courts … That’s not the way the system works. … [A]n appellate opinion after it makes a resolution explains neutral standards that are principles that are applicable to other cases. That’s the whole function of the judicial process. …. You say “Oh, that’s inefficient.” We might as well just let everybody do everything they want every time.

Trying to make sense of the argument as a whole, it is hard to see an obvious path to a decision. It seems quite likely that most of the justices would find treatment as a factual question appropriate if the legal standard were the unitary arm’s-length test pressed by the debtor and the solicitor general. It is almost as likely that most of the justices would find the closeness-to-an-enumerated-category test a legal question. If those alignments hold, though, the dispute turns on the correct definition of the legal standard. Nothing in the argument suggested any appetite for reaching out to articulate the legal standard directly. Of course, the justices could ask for briefs on that question and perhaps set the case for reargument, but presumably the eight of them who were on the bench in March already have decided that the question is not ripe or suitable for plenary consideration. The justices might be reluctant to drop another case from a calendar already truncated by the departure of the Trump travel- ban cases and the dismissal of the PEM matter in August. But in truth this case seems a likely candidate for dismissal.