Two recent developments at the Supreme Court — both featuring the incomparable Justice Elena Kagan — merit particular attention in this forum. Early on in the month of March, the Supreme Court decided a bankruptcy case involving a large national bank — U.S. Bank, N.A. v. The Village at Lakeridge, LLC, No. 15-1509 (decided Mar. 5, 2018). Several weeks later, the Court issued an important decision in a class action securities case — Cyan, Inc. v. Beaver County Employees Retirement Fund, No. 15-1439 (decided Mar. 20, 2018). I discuss each in turn below.
Lakeridge
Appointed in 2010, Justice Kagan has demonstrated herself to be one of the finest legal writers on the Court. She has shown a facility for legal principles that allows her to explain the law in a highly sophisticated — yet highly readable — manner. And her opinion for the unanimous Court in this case is no exception.
Before resolving this dispute regarding the standard of appellate review that should apply to a bankruptcy court’s finding of “insider” status, Justice Kagan briefly recounted the facts of the case. This case arose out of a single asset real estate bankruptcy, with only two creditors involved — one was U.S. Bank, the other was MBP Equity Partners, which also was the sole owner of the debtor, The Village at Lakeridge, LLC. When it came time to implement a reorganization plan, U.S. Bank objected. As readers may know, a reorganization plan still can be “crammed down” on an objecting creditor, so long as other “non-insider” creditors approve of the plan. Of course, MBP, as the sole owner of Lakeridge, was an “insider” and therefore could not provide the necessary approval. So MBP got creative: A woman, first name Kathleen, who was both a member of MBP’s board and an officer at Lakeridge, approached a man, first name Robert, about buying MBP’s $2.76 million claim against Lakeridge’s bankruptcy estate for $5,000. That way, as a non-insider owner of the claim, Robert could approve the “cram down” plan against the wishes of U.S. Bank.
The twist, however, is that Robert may have hoped to get a little more than a bankruptcy claim on the cheap here — for he and Kathleen were engaged in a romantic relationship at the time. (Regardless of how the claim worked out, for better or worse, one hopes that they are now living happily ever after.) U.S. Bank understandably believed that it was getting fleeced and argued that Robert was in fact an insider because of his relationship with Kathleen. The bankruptcy court disagreed, finding that Robert was a non-insider and that, therefore, his approval could support the cram down plan.
U.S. Bank appealed and sought what is known as “de novo review,” which means that the appellate court looks at the law and all of the facts anew, without giving any deference to the conclusions of the lower court. Justice Kagan rejected U.S. Bank’s arguments, explaining that the bankruptcy court’s determination that Robert had purchased the claim in an “arm’s length” transaction — and therefore was not an insider — was subject to reversal only if that determination was clearly erroneous. This standard of review incorporates due deference to the lower court’s on-the-ground experience in the case. In other words, the lower court has presided over the presentation of the evidence, has heard the witnesses, and has the closest and deepest understanding of the record.
The upshot is that banks and other institutional creditors must be aware that bankruptcy courts’ determinations on these matters are unlikely to be disturbed on appeal. The clearly erroneous standard is a high hurdle. This case also emphasizes the importance of being keenly aware of the relationships (even romantic ones) that exist between debtors and other creditors, as those relationships ultimately may play key roles in the proceedings.
Cyan
Justice Kagan again wrote for the unanimous Court in this securities case, which presented the question whether certain class actions brought under the Securities Act of 1933 may be heard in state, rather than federal, courts. The answer, as Justice Kagan explained in this masterful opinion, is yes.
Generally speaking, the Securities Act requires companies offering securities to the public to make full and fair disclosure of relevant information. (Its first cousin, the Exchange Act of 1934, regulates not the offering but the trading of securities.) In a somewhat unusual move, in the original legislation, Congress vested state courts with jurisdiction over claims arising under the federal Securities Act (e.g., claims alleging that a company failed to make full and fair disclosure of relevant information). For various policy reasons, Congress decided that investors should be able to come into state court and allege violations of the Securities Act and that state court judges should have the power to adjudicate those claims.
A series of amendments in the 1990s, however, sought to curb perceived abuses by plaintiffs’ lawyers in the securities setting. These amendments limited certain types of claims, imposed additional burdens on plaintiffs, and — relevant here — raised the specter that investors with Securities Act claims would no longer be able to seek redress in state courts. Indeed, the defendant in this case, Cyan, Inc., a telecommunications company, made that very argument — i.e., that the amendments to the Securities Act stripped state courts of jurisdiction to hear Securities Act claims and that, therefore, the plaintiffs, who had purchased shares of Cyan stock in an IPO, could not proceed in California state court.
As noted above, Cyan’s arguments failed. Justice Kagan explained that the statutory text plainly left intact Congress’s original decision to vest state courts with jurisdiction over claims brought under the Securities Act. Justice Kagan picked apart the statute piece by piece, identifying in granular detail the precise reasons in support of the judgment. The somewhat convoluted statutory scheme — Justices Alito and Gorsuch in fact referred to it as “gibberish” at oral argument in the case — becomes much understandable in this tour de force of textualism. It is difficult to read this opinion without being reminded repeatedly of the late Justice Scalia, who perhaps deserves the most credit for ushering in this current era of textualism.
Those concerned with managing risk related to securities offerings must be attuned to the scope of the Securities Act and the claims that it authorizes — including where those claims may be brought. State courts frequently are much more favorable forums than federal courts for plaintiffs, and this decision solidifies that those more favorable forums are available for Securities Act plaintiffs. But don’t blame the Court — Congress made it that way.
Finally, a comment on what could have been at the Court: At the end of February, the Court heard oral arguments in a case that, at the time, had the potential to be one of the most important decisions of the term — United States v. Microsoft Corporation, No. 17-2 (argued Feb. 27, 2018). This case had been more visible in the news than the run-of-the-mill financial services case. Indeed, it is not exactly a financial services case. Nevertheless, it had great implications for banks and other institutions that have international footprints. A federal law known as the Stored Communications Act authorized the federal government to demand, through a warrant, electronic data from an electronic service provider, like Microsoft. In this case, the federal government had established probable cause to believe that an individual was using an MSN.com email account to engage in narcotics trafficking. A judge signed the warrant for the information related to the email account, and Microsoft was served at its headquarters in Washington state.
Microsoft was willing to comply with the warrant to the extent that it sought information relating to the account itself — for such account-identification records are maintained here in the United States. The contents of the emails, however, are stored in a data center in Ireland. (Some time ago, Microsoft made the business decision to store certain of this data in Ireland; still, the company retains the power to bring that data back to the United States.) And Microsoft declined to bring the data back to the United States, arguing that the federal government does not have the power through a warrant to order it to bring records from a foreign country back into the United States. In technical legal terms, Microsoft argued that a warrant requiring production of information stored abroad would constitute an impermissible extraterritorial application of the Stored Communications Act. The government, of course, strenuously disagreed.
This case had the potential to be a fascinating one — how far can the federal government stretch its authority over data stored in the cloud under statutes that were written before the cloud ever existed? But, alas, it appears that the case will be mooted by legislation. The President recently signed legislation, known as the CLOUD Act, that would allow warrants for data stored abroad but also would provide important procedural protections for electronic service providers. The law would effectively eliminate the dispute between Microsoft and the government in this case, meaning that the Court likely will dismiss it without issuing a decision. Microsoft, for one, is pleased with the CLOUD Act, as it provides a level of certainty that plainly was lacking under the Stored Communications Act.
Charles W. Prueter is a trial and appellate lawyer at Waller Lansden Dortch & Davis, LLP, in Birmingham. He can be reached by email at charles.prueter@wallerlaw.com. Comments and questions are welcome.
