The Equitable Mootness Doctrine

Over time, equitable mootness, a court-created doctrine, had been consistently applied and embraced by appellate courts. The doctrine, as it has been applied, provides that appeals from orders confirming Chapter 11 plans will be considered moot ' and thus not subject to appellate review ' if: 1) a plan has been substantially consummated; and 2) granting appellate relief would unravel the plan or be inequitable to third parties relying on the order confirming the plan. Based on, and consistent with, decisions such as that of the U.S. Court of Appeals for the Second Circuit in In re Chateaugay , 94 F.3d 772, 776 (2d Cir. 1996), and the decision of the U.S. Court of Appeals for the Third Circuit in In re Continental Airlines , 91 F.3d 553, 560 (3d Cir. 1996) ( en banc ), the equitable mootness doctrine has been read broadly to create a presumption that if a plan has been substantially consummated, appeals of the confirmation order are equitably moot.

Recently, three separate appellate court decisions, one by the U.S. Court of Appeals for the Ninth Circuit in Grasslawn Lodging v. Transwest Resort Props . ( In re Transwest Resort Props .), 2015 U.S. App. LEXIS 11312 (9th Cir. Ariz. July 1, 2015); and two by the Third Circuit in One2One Communs. v. Quad/Graphics , 2015 U.S. App. LEXIS 12544 (3d Cir. N.J. July 21, 2015) and Tribune Media Company v. Aurelius Capital Management , 2015 U.S. App. LEXIS 14530 (3d Cir. Del. Aug. 19, 2015), highlight the fact that there are differences among the circuit courts with respect to the appropriateness of the equitable mootness doctrine and the presumption of its application. In reasoning and result, these decisions challenge the doctrine and call into question its continued existence. By reason of these decisions, for parties-in-interest and for practitioners, consideration of whether to consummate a Chapter 11 plan while an appeal of the confirmation order is pending should and must be reevaluated.

In re Transwest Resort Properties

In Transwest , the Ninth Circuit held that an appeal of an order confirming a Chapter 11 plan that had been substantially consummated was not equitably moot. In this case, the appellant had diligently but unsuccessfully sought a stay pending appeal. The court concluded that the appeal was not moot because it would be possible for the bankruptcy judge to fashion at least a partial equitable remedy that would only affect the third-party investor that funded the Chapter 11 plan. In reaching its decision, the Ninth Circuit noted that the subject third-party investor, an active and involved participant in the negotiation of the plan, was not the type of innocent third party that the equitable mootness doctrine was designed to protect.

Background

Five related Transwest entities (the Debtors) owned two hotels and defaulted on the secured loans obtained to finance their purchase. The defaulted loans had been acquired by 2007-C1 Grasslawn Lodging (Grasslawn). In 2010, all five Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. The Debtors filed a joint plan of reorganization providing that Southwest Value Partners Fund XV (Southwest) would be the new sole owner of the two operating Debtors for a new investment of $30 million. Pursuant to ' 1111(b)(2) of the Bankruptcy Code, Grasslawn elected to have its entire allowed claim treated as a secured claim. Under the plan, the Debtors proposed to reinstate Grasslawn's loan with restructured repayment terms that included a due-on-sale clause, with an exception between years five and 15 of the loan, as long as certain conditions were met.

Grasslawn objected to confirmation of the plan, asserting that the 10-year exception to the due-on-sale clause would allow Southwest to unfairly negate at least part of its ' 1111(b) election, which was intended to protect secured creditors against the undervaluation and subsequent sale of their collateral. Grasslawn also objected on the grounds that Debtors' plan failed to satisfy one of the plan confirmation requirements under ' 1129(a)(10) of the Bankruptcy Code, which requires the acceptance of an impaired class of claims. The bankruptcy court confirmed the plan over Grasslawn's objections. Grasslawn timely appealed the confirmation order and unsuccessfully sought a stay pending appeal. The district court dismissed Grasslawn's appeal as equitably moot because the plan had been substantially consummated. Further, the district court noted that the confirmation order had been relied upon by third parties and the relief sought by Grasslawn to eliminate the exception to the due-on-sale clause would be inequitable. Grasslawn then appealed to the Ninth Circuit.

Analysis

To determine whether the appeal should be heard or was equitably moot, the Ninth Circuit first considered four factors: 1) whether a stay pending appeal was sought by the appellant; 2) if a stay was sought, whether the plan was substantially consummated; 3) the effect a remedy would have on third parties; and 4) whether the bankruptcy court can craft a fair and equitable remedy without completely unraveling the plan.

After acknowledging that Grasslawn had been diligent and that substantial consummation of the plan undisputedly occurred, the Ninth Circuit did not follow the Second Circuit's decision holding that substantial consummation creates a presumption that the appeal is moot. See Chateaugay , 94 F.3d at 776. The Ninth Circuit instead held that “[a]lthough substantial consummation is a factor weighing in favor of finding the appeal moot, the law in this circuit requires that we still look at the third and fourth prongs of the equitable mootness test.” Transwest , 2015 U.S. App. LEXIS at *14.

In evaluating the potential effects of granting the relief sought by Grasslawn, the Ninth Circuit determined that the only parties affected were Grasslawn and Southwest. Both were active participants in the negotiation, prosecution and efforts to obtain confirmation of the plan. Specifically, the Ninth Circuit noted that: 1) Southwest participated in the confirmation hearing; 2) the bankruptcy court considered Southwest's pleadings in connection with confirmation of the plan; 3) Southwest and Grasslawn negotiated numerous aspects of the plan documents, including the form of confirmation order and the provisions that are the subject of Grasslawn's objections; and 4) Southwest is a party to Grasslawn's appeal before the Ninth Circuit.

As a result, the court determined that Southwest is not “the type of innocent third party that the equitable mootness doctrine is designed to protect.” Id . at *16. The Ninth Circuit further explained that “when a sophisticated investor such as [Southwest] helps craft a reorganization plan that 'press[es] the limits' of the bankruptcy laws, appellate consequences are a foreseeable result.” Id . at *17 (quoting In re Pac. Lumber , 584 F.3d 229, 244 (5th Cir. 2009)).

Notably, the Ninth Circuit stated that the most important consideration is whether the bankruptcy court can devise equitable relief, even if only partial relief, without completely unraveling the plan. The Ninth Circuit reasoned that if Grasslawn were successful on the merits, some form of equitable relief, even if only partial relief, would be available to Grasslawn ' such as a reduction of the length of the exception to the due-on-sale clause or some form of compensation to Grasslawn in the event a sale occurred during the exception period ' and would not unfairly burden innocent third parties or completely unravel the plan. Accordingly, the court held that Grasslawn's appeal is not equitably moot.

In a dissenting opinion, Judge Milan D. Smith Jr. strongly disagreed with “the majority's conclusion that the equitable mootness doctrine is not meant to protect the interests of a third-party investor in [Southwest's] position.” Id . at *25. Smith noted that the Ninth Circuit has never held that courts can ignore a third party's interests based on such party's participation in the proceedings. Further, Smith explained that “[o]nce [Southwest] agreed to fund the plan, it was only natural that it would be involved in the bankruptcy proceedings, since its investment was the very reason the proposed reorganization was feasible.” Id . Smith argued that courts should encourage third-party investors to rely on confirmation orders and promptly provide funding, as the success of many reorganizations hinge on such prompt funding.

Third Circuit Equitable Mootness Decisions

In One2One , decided on July 21, 2015, the Third Circuit held that the district court abused its discretion in dismissing an appeal from a confirmation order as equitably moot because the debtor's reorganization did not rise to the requisite level of complexity to warrant equitable mootness and the court failed to identify a specific harm to third parties in the event the relief requested in the appeal is granted. To the contrary, in Tribune , decided on Aug. 19, 2015, the Third Circuit upheld a decision by the district court finding that the main part of an appeal of a confirmation was equitably moot because it would be fatal to the consummated plan.

One2One Commc'ns v. Quad/Graphics

In 2012, One2One Communications (the Debtor) filed a petition for relief under Chapter 11 of the Bankruptcy Code. In 2013, the Debtor filed a fourth amended plan and a plan support agreement that provided One2One Holdings, the plan sponsor, with the exclusive right to purchase all the Debtor's equity for $200,000. The Appellant, Quad/Graphics, which held the largest claim against the Debtor, objected to the fourth amended plan on the basis that, among other things, it violated the absolute priority rule. The bankruptcy court confirmed the fourth amended plan over the Appellant's objection and the Appellant timely sought a stay pending appeal, which was denied. The district court dismissed the appeal as equitably moot. The Appellant then appealed to the Third Circuit.

Analysis

On appeal, the Appellant asserted that the equitable mootness doctrine is unconstitutional and contrary to the Bankruptcy Code. As a threshold matter, the Third Circuit noted that the court had previously approved the equitable mootness doctrine in the Third Ciruit's 1996 decision in Continental Airlines , 91 F.3d 553, 560. A three-judge panel of the Third Circuit could only decline to follow a prior decision of the Third Circuit without the necessity of an en-banc decision when the prior decision conflicts with a subsequent Supreme Court decision. In that regard, the Appellant argued that the Third Circuit's equitable mootness jurisprudence should be reevaluated in light of the Supreme Court's decision in Stern v. Marshall , 131 S. Ct. 2594 (2011).

Specifically, the Appellant contended that under Stern , a bankruptcy court's ability to enter binding, final judgments in “core” bankruptcy proceedings ' like plan confirmation ' must be subject to district court review on appeal under traditional appellate standards. The Third Circuit rejected this argument, finding that ” Stern did not consider the authority of bankruptcy judges to make final determinations regarding other kinds of claims and counterclaims brought by debtors and creditors, nor did Stern consider whether Article III requires appellate review of a bankruptcy judge's decisions by an Article III judge.” See Transwest , 2015 U.S. App. LEXIS at *10. Accordingly, the Third Circuit held that “[a]bsent en banc reconsideration, we cannot entertain Appellant's challenge to equitable mootness, as Continental remains the law of this circuit.” Id . at *19.

In applying the equitable mootness doctrine, the Third Circuit noted that to determine whether an appeal should be found equitably moot, courts in the Third Circuit consider the following “prudential” factors: 1) whether the reorganization plan has been substantially consummated; 2) whether a stay has been obtained; 3) whether the relief requested would affect the rights of parties not before the court; 4) whether the relief requested would affect the success of the plan; and 5) the public policy of affording finality to bankruptcy judgments. See In re Phila. Newspapers , 690 F.3d 161, 168 (3d Cir. 2012) (citing Continental , 91 F.3d at 560).

The Third Circuit stated that “[t]aken together, these factors require that the equitable mootness doctrine be applied only to 'prevent[] a court from unscrambling complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract.'” Trans-west , 2015 U.S. App. LEXIS at *12 (citations omitted).

The Third Circuit explained that the Debtor's reorganization in this case did not rise to the requisite level of complexity to warrant equitable mootness, as the reorganization only included a $200,000 investment, one secured creditor and 17 unsecured creditors, not including insiders. Nor did the plan provide for new financing, mergers or dissolutions of entities, issuance of stock or bonds, name change, change of business location, change in management or any other significant transactions. In addition, the plan did not involve intricate transactions, the issuance of publicly-traded securities or other aspects that would be difficult to reverse and the Debtor did not present sufficient evidence that the plan would otherwise be difficult to unravel.

The Third Circuit also noted that the district court failed to identify a specific harm to third parties in the event the relief requested in the appeal is granted. While the Appellant argued that allowing the appeal to be heard on the merits would inevitably affect the rights of parties not before the court such as creditors, employees, and third-party workers, the Third Circuit, found this unconvincing as this type of minimal third-party reliance is present in nearly all bankruptcy reorganizations and cannot be characterized as almost certain to cause significant injury to third parties.

Last, the Third Circuit found that the prudential consideration of public policy weighed in favor of providing the Appellant with appellate review of its bankruptcy appeal. Acknowledging that the finality of the bankruptcy court's decision necessarily would be disturbed, the Third Circuit nevertheless recognized a party's statutory right to an appeal and that “[t]he presumptive position remains that federal courts should hear and decide on the merits cases properly before them.” In re Semcrude , 728 F.3d 314, 326 (3d Cir. 2013).

Accordingly, the Third Circuit held that denying the Appellant review now would be distinctly inequitable and that the district court abused its discretion in dismissing the appeal as equitably moot.

The Concurring Opinion

While agreeing with the majority's conclusion, Krause wrote a separate, concurring opinion, urging the Third Circuit to sit en banc , to consider eliminating, or at least modifying, the equitable mootness doctrine. Krause noted that the Third Circuit has “repeatedly admonished that the doctrine applies only to attempts to 'unscrambl[e] complex bankruptcy reorganizations,' and even then “'is limited in scope and should be cautiously applied,'” as well as that it is inapplicable when limited relief is available on appeal.” One2One , 2015 U.S. App. LEXIS at *2 (Krause, C., concurring) (citations omitted).

Nevertheless, Krause noted that courts routinely dismiss appeals as equitably moot in even the simplest bankruptcies where appellants have sought modest relief, thus causing unconstitutional “mischief.”

Krause pointed out that when the Third Circuit adopted equitable mootness en banc in In re Continental Airlines , neither the constitutional nor the statutory basis for the doctrine was challenged in that case, and the court was still nearly evenly divided with then-Judge Samuel Alito leading the dissent. He also noted that the Third Circuit had reversed findings of equitable mootness or declined to dismiss appeals as equitably moot no less than seven times.

Krause argued that there is no basis for the doctrine in either the Constitution or the Bankruptcy Code and that it raises serious concerns about the ability of an Article III bankruptcy judge to prevent the review of its decisions in an Article I appellate court. From a policy perspective, Krause also said that the equitable mootness doctrine does not achieve its intended purpose of promoting finality because the finding of equitable mootness can still be appealed. Thus, allowing a lower court to hear an appeal on the merits would dispose of the issues much earlier in the case. Moreover, Krause noted that even if the doctrine was successful in preventing appeals, it would have a deleterious effect on the system of bankruptcy adjudication because it would insulate errors by the lower courts and stunt the development of uniformity in bankruptcy law.

Tribune Media v. Aurelius Capital

On month later, in Tribune , a panel of three different judges of the Third Circuit upheld a decision by the district court finding that the main part of an appeal of Tribune's plan confirmation order involving an objection to a settlement of certain LBO causes of action was equitably moot because the reversal of the settlement would be fatal to the consummated plan. The Third Circuit also reversed and reinstated an appeal from the part of the plan that gave $30 million to a certain class of creditors over the objection of the indentured trustee of Tribune's LBO debt, saying it would not be unfair if that class were forced to disgorge the funds and Tribune's value and thus none of its investors would be affected if the appeal were successful. Of particular note, however, is the concurring opinion of Judges Thomas Ambro and Thomas Vanaskie that address the concerns raised in Krause's concurring opinion in One2One about the viability of the equitable mootness doctrine and their reluctance to discard this tool of equity.

Ambro and Vanaskie do not share Krause's constitutional concerns of the equitable mootness doctrine because “neither the personal rights nor the separation of powers guaranteed by [the Constitution] are infringed when Article III courts decline to hear quite a constricted class of cases seeking relief that would upend cases resolved and plans implemented (often years before) and/or would significantly harm third parties who relied on that resolution and implementation.” Tribune , 2015 U.S. App. LEXIS at *34.

They also assert that the Bankruptcy Code does not bar the doctrine essentially because bankruptcy courts are inherently courts of equity and “the doctrine of equitable mootness recognizes those few situations where the practical harm caused by granting relief would greatly outweigh the benefit.” Id . at *39. As a practical matter, Ambro and Vanaskie note that if the equitable mootness doctrine were eliminated, it is hard to imagine that any complex plan would be consummated until all appeals are terminated which would inhibit equity investments, drive up the cost of credit and encourage lone dissenter holdouts. Id . at *41.

Conclusion

The recent decisions in Transwest and One2One are significant because, contrary to what had become common practice, they highlight that substantial consummation of a plan is not necessarily dispositive of whether an appeal will be found to be equitably moot. The Ninth Circuit's refusal to characterize a third-party investor as the type of innocent third party that the equitable mootness doctrine was designed to protect and the Third Circuit's admonition that equitable mootness should only apply in the context of complex Chapter 11 cases raises significant uncertainty as to when appeals will be dismissed as equitably moot. The greatest potential ramification of these decisions, however, may relate to the debate within the Third Circuit as to the appropriateness of the doctrine. While the concurring opinion of Ambro and Vanaskie in Tribune stresses the value of retaining the equitable mootness doctrine, Krause's concurring opinion in One2One seeks an en-banc review by the full Third Circuit, which may end the equitable mootness doctrine in the Third Circuit and lay the groundwork for the Supreme Court to consider the equitable mootness doctrine on constitutional grounds.

The lesson for debtors, plan sponsors and investors is that confirmation and substantial consummation of a Chapter 11 plan does not eliminate the risk that the confirmation order may be reversed on appeal.

Gary L. Kaplan and Jennifer L. Rodburg are partners and Kalman Ochs is special counsel in Fried, Frank, Harris, Shriver & Jacobson's bankruptcy and restructuring practice.This article also appeared in the New York Law Journal , an ALM sister publication of this newsletter.

Over time, equitable mootness, a court-created doctrine, had been consistently applied and embraced by appellate courts. The doctrine, as it has been applied, provides that appeals from orders confirming Chapter 11 plans will be considered moot ' and thus not subject to appellate review ' if: 1) a plan has been substantially consummated; and 2) granting appellate relief would unravel the plan or be inequitable to third parties relying on the order confirming the plan. Based on, and consistent with, decisions such as that of the U.S. Court of Appeals for the Second Circuit in In re Chateaugay , 94 F.3d 772, 776 (2d Cir. 1996), and the decision of the U.S. Court of Appeals for the Third Circuit in In re Continental Airlines , 91 F.3d 553, 560 (3d Cir. 1996) ( en banc ), the equitable mootness doctrine has been read broadly to create a presumption that if a plan has been substantially consummated, appeals of the confirmation order are equitably moot.

Recently, three separate appellate court decisions, one by the U.S. Court of Appeals for the Ninth Circuit in Grasslawn Lodging v. Transwest Resort Props . ( In re Transwest Resort Props .), 2015 U.S. App. LEXIS 11312 (9th Cir. Ariz. July 1, 2015); and two by the Third Circuit in One2One Communs. v. Quad/Graphics , 2015 U.S. App. LEXIS 12544 (3d Cir. N.J. July 21, 2015) and Tribune Media Company v. Aurelius Capital Management , 2015 U.S. App. LEXIS 14530 (3d Cir. Del. Aug. 19, 2015), highlight the fact that there are differences among the circuit courts with respect to the appropriateness of the equitable mootness doctrine and the presumption of its application. In reasoning and result, these decisions challenge the doctrine and call into question its continued existence. By reason of these decisions, for parties-in-interest and for practitioners, consideration of whether to consummate a Chapter 11 plan while an appeal of the confirmation order is pending should and must be reevaluated.

In re Transwest Resort Properties

In Transwest , the Ninth Circuit held that an appeal of an order confirming a Chapter 11 plan that had been substantially consummated was not equitably moot. In this case, the appellant had diligently but unsuccessfully sought a stay pending appeal. The court concluded that the appeal was not moot because it would be possible for the bankruptcy judge to fashion at least a partial equitable remedy that would only affect the third-party investor that funded the Chapter 11 plan. In reaching its decision, the Ninth Circuit noted that the subject third-party investor, an active and involved participant in the negotiation of the plan, was not the type of innocent third party that the equitable mootness doctrine was designed to protect.

Background

Five related Transwest entities (the Debtors) owned two hotels and defaulted on the secured loans obtained to finance their purchase. The defaulted loans had been acquired by 2007-C1 Grasslawn Lodging (Grasslawn). In 2010, all five Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. The Debtors filed a joint plan of reorganization providing that Southwest Value Partners Fund XV (Southwest) would be the new sole owner of the two operating Debtors for a new investment of $30 million. Pursuant to ' 1111(b)(2) of the Bankruptcy Code, Grasslawn elected to have its entire allowed claim treated as a secured claim. Under the plan, the Debtors proposed to reinstate Grasslawn's loan with restructured repayment terms that included a due-on-sale clause, with an exception between years five and 15 of the loan, as long as certain conditions were met.

Grasslawn objected to confirmation of the plan, asserting that the 10-year exception to the due-on-sale clause would allow Southwest to unfairly negate at least part of its ' 1111(b) election, which was intended to protect secured creditors against the undervaluation and subsequent sale of their collateral. Grasslawn also objected on the grounds that Debtors' plan failed to satisfy one of the plan confirmation requirements under ' 1129(a)(10) of the Bankruptcy Code, which requires the acceptance of an impaired class of claims. The bankruptcy court confirmed the plan over Grasslawn's objections. Grasslawn timely appealed the confirmation order and unsuccessfully sought a stay pending appeal. The district court dismissed Grasslawn's appeal as equitably moot because the plan had been substantially consummated. Further, the district court noted that the confirmation order had been relied upon by third parties and the relief sought by Grasslawn to eliminate the exception to the due-on-sale clause would be inequitable. Grasslawn then appealed to the Ninth Circuit.

Analysis

To determine whether the appeal should be heard or was equitably moot, the Ninth Circuit first considered four factors: 1) whether a stay pending appeal was sought by the appellant; 2) if a stay was sought, whether the plan was substantially consummated; 3) the effect a remedy would have on third parties; and 4) whether the bankruptcy court can craft a fair and equitable remedy without completely unraveling the plan.

After acknowledging that Grasslawn had been diligent and that substantial consummation of the plan undisputedly occurred, the Ninth Circuit did not follow the Second Circuit's decision holding that substantial consummation creates a presumption that the appeal is moot. See Chateaugay , 94 F.3d at 776. The Ninth Circuit instead held that “[a]lthough substantial consummation is a factor weighing in favor of finding the appeal moot, the law in this circuit requires that we still look at the third and fourth prongs of the equitable mootness test.” Transwest , 2015 U.S. App. LEXIS at *14.

In evaluating the potential effects of granting the relief sought by Grasslawn, the Ninth Circuit determined that the only parties affected were Grasslawn and Southwest. Both were active participants in the negotiation, prosecution and efforts to obtain confirmation of the plan. Specifically, the Ninth Circuit noted that: 1) Southwest participated in the confirmation hearing; 2) the bankruptcy court considered Southwest's pleadings in connection with confirmation of the plan; 3) Southwest and Grasslawn negotiated numerous aspects of the plan documents, including the form of confirmation order and the provisions that are the subject of Grasslawn's objections; and 4) Southwest is a party to Grasslawn's appeal before the Ninth Circuit.

As a result, the court determined that Southwest is not “the type of innocent third party that the equitable mootness doctrine is designed to protect.” Id . at *16. The Ninth Circuit further explained that “when a sophisticated investor such as [Southwest] helps craft a reorganization plan that 'press[es] the limits' of the bankruptcy laws, appellate consequences are a foreseeable result.” Id . at *17 (quoting In re Pac. Lumber , 584 F.3d 229, 244 (5th Cir. 2009)).

Notably, the Ninth Circuit stated that the most important consideration is whether the bankruptcy court can devise equitable relief, even if only partial relief, without completely unraveling the plan. The Ninth Circuit reasoned that if Grasslawn were successful on the merits, some form of equitable relief, even if only partial relief, would be available to Grasslawn ' such as a reduction of the length of the exception to the due-on-sale clause or some form of compensation to Grasslawn in the event a sale occurred during the exception period ' and would not unfairly burden innocent third parties or completely unravel the plan. Accordingly, the court held that Grasslawn's appeal is not equitably moot.

In a dissenting opinion, Judge Milan D. Smith Jr. strongly disagreed with “the majority's conclusion that the equitable mootness doctrine is not meant to protect the interests of a third-party investor in [Southwest's] position.” Id . at *25. Smith noted that the Ninth Circuit has never held that courts can ignore a third party's interests based on such party's participation in the proceedings. Further, Smith explained that “[o]nce [Southwest] agreed to fund the plan, it was only natural that it would be involved in the bankruptcy proceedings, since its investment was the very reason the proposed reorganization was feasible.” Id . Smith argued that courts should encourage third-party investors to rely on confirmation orders and promptly provide funding, as the success of many reorganizations hinge on such prompt funding.

Third Circuit Equitable Mootness Decisions

In One2One , decided on July 21, 2015, the Third Circuit held that the district court abused its discretion in dismissing an appeal from a confirmation order as equitably moot because the debtor's reorganization did not rise to the requisite level of complexity to warrant equitable mootness and the court failed to identify a specific harm to third parties in the event the relief requested in the appeal is granted. To the contrary, in Tribune , decided on Aug. 19, 2015, the Third Circuit upheld a decision by the district court finding that the main part of an appeal of a confirmation was equitably moot because it would be fatal to the consummated plan.

One2One Commc'ns v. Quad/Graphics

In 2012, One2One Communications (the Debtor) filed a petition for relief under Chapter 11 of the Bankruptcy Code. In 2013, the Debtor filed a fourth amended plan and a plan support agreement that provided One2One Holdings, the plan sponsor, with the exclusive right to purchase all the Debtor's equity for $200,000. The Appellant, Quad/Graphics, which held the largest claim against the Debtor, objected to the fourth amended plan on the basis that, among other things, it violated the absolute priority rule. The bankruptcy court confirmed the fourth amended plan over the Appellant's objection and the Appellant timely sought a stay pending appeal, which was denied. The district court dismissed the appeal as equitably moot. The Appellant then appealed to the Third Circuit.

Analysis

On appeal, the Appellant asserted that the equitable mootness doctrine is unconstitutional and contrary to the Bankruptcy Code. As a threshold matter, the Third Circuit noted that the court had previously approved the equitable mootness doctrine in the Third Ciruit's 1996 decision in Continental Airlines , 91 F.3d 553, 560. A three-judge panel of the Third Circuit could only decline to follow a prior decision of the Third Circuit without the necessity of an en-banc decision when the prior decision conflicts with a subsequent Supreme Court decision. In that regard, the Appellant argued that the Third Circuit's equitable mootness jurisprudence should be reevaluated in light of the Supreme Court's decision in Stern v. Marshall , 131 S. Ct. 2594 (2011).

Specifically, the Appellant contended that under Stern , a bankruptcy court's ability to enter binding, final judgments in “core” bankruptcy proceedings ' like plan confirmation ' must be subject to district court review on appeal under traditional appellate standards. The Third Circuit rejected this argument, finding that ” Stern did not consider the authority of bankruptcy judges to make final determinations regarding other kinds of claims and counterclaims brought by debtors and creditors, nor did Stern consider whether Article III requires appellate review of a bankruptcy judge's decisions by an Article III judge.” See Transwest , 2015 U.S. App. LEXIS at *10. Accordingly, the Third Circuit held that “[a]bsent en banc reconsideration, we cannot entertain Appellant's challenge to equitable mootness, as Continental remains the law of this circuit.” Id . at *19.

In applying the equitable mootness doctrine, the Third Circuit noted that to determine whether an appeal should be found equitably moot, courts in the Third Circuit consider the following “prudential” factors: 1) whether the reorganization plan has been substantially consummated; 2) whether a stay has been obtained; 3) whether the relief requested would affect the rights of parties not before the court; 4) whether the relief requested would affect the success of the plan; and 5) the public policy of affording finality to bankruptcy judgments. See In re Phila. Newspapers , 690 F.3d 161, 168 (3d Cir. 2012) (citing Continental , 91 F.3d at 560).

The Third Circuit stated that “[t]aken together, these factors require that the equitable mootness doctrine be applied only to 'prevent[] a court from unscrambling complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract.'” Trans-west , 2015 U.S. App. LEXIS at *12 (citations omitted).

The Third Circuit explained that the Debtor's reorganization in this case did not rise to the requisite level of complexity to warrant equitable mootness, as the reorganization only included a $200,000 investment, one secured creditor and 17 unsecured creditors, not including insiders. Nor did the plan provide for new financing, mergers or dissolutions of entities, issuance of stock or bonds, name change, change of business location, change in management or any other significant transactions. In addition, the plan did not involve intricate transactions, the issuance of publicly-traded securities or other aspects that would be difficult to reverse and the Debtor did not present sufficient evidence that the plan would otherwise be difficult to unravel.

The Third Circuit also noted that the district court failed to identify a specific harm to third parties in the event the relief requested in the appeal is granted. While the Appellant argued that allowing the appeal to be heard on the merits would inevitably affect the rights of parties not before the court such as creditors, employees, and third-party workers, the Third Circuit, found this unconvincing as this type of minimal third-party reliance is present in nearly all bankruptcy reorganizations and cannot be characterized as almost certain to cause significant injury to third parties.

Last, the Third Circuit found that the prudential consideration of public policy weighed in favor of providing the Appellant with appellate review of its bankruptcy appeal. Acknowledging that the finality of the bankruptcy court's decision necessarily would be disturbed, the Third Circuit nevertheless recognized a party's statutory right to an appeal and that “[t]he presumptive position remains that federal courts should hear and decide on the merits cases properly before them.” In re Semcrude , 728 F.3d 314, 326 (3d Cir. 2013).

Accordingly, the Third Circuit held that denying the Appellant review now would be distinctly inequitable and that the district court abused its discretion in dismissing the appeal as equitably moot.

The Concurring Opinion

While agreeing with the majority's conclusion, Krause wrote a separate, concurring opinion, urging the Third Circuit to sit en banc , to consider eliminating, or at least modifying, the equitable mootness doctrine. Krause noted that the Third Circuit has “repeatedly admonished that the doctrine applies only to attempts to 'unscrambl[e] complex bankruptcy reorganizations,' and even then “'is limited in scope and should be cautiously applied,'” as well as that it is inapplicable when limited relief is available on appeal.” One2One , 2015 U.S. App. LEXIS at *2 (Krause, C., concurring) (citations omitted).

Nevertheless, Krause noted that courts routinely dismiss appeals as equitably moot in even the simplest bankruptcies where appellants have sought modest relief, thus causing unconstitutional “mischief.”

Krause pointed out that when the Third Circuit adopted equitable mootness en banc in In re Continental Airlines , neither the constitutional nor the statutory basis for the doctrine was challenged in that case, and the court was still nearly evenly divided with then-Judge Samuel Alito leading the dissent. He also noted that the Third Circuit had reversed findings of equitable mootness or declined to dismiss appeals as equitably moot no less than seven times.

Krause argued that there is no basis for the doctrine in either the Constitution or the Bankruptcy Code and that it raises serious concerns about the ability of an Article III bankruptcy judge to prevent the review of its decisions in an Article I appellate court. From a policy perspective, Krause also said that the equitable mootness doctrine does not achieve its intended purpose of promoting finality because the finding of equitable mootness can still be appealed. Thus, allowing a lower court to hear an appeal on the merits would dispose of the issues much earlier in the case. Moreover, Krause noted that even if the doctrine was successful in preventing appeals, it would have a deleterious effect on the system of bankruptcy adjudication because it would insulate errors by the lower courts and stunt the development of uniformity in bankruptcy law.

Tribune Media v. Aurelius Capital

On month later, in Tribune , a panel of three different judges of the Third Circuit upheld a decision by the district court finding that the main part of an appeal of Tribune's plan confirmation order involving an objection to a settlement of certain LBO causes of action was equitably moot because the reversal of the settlement would be fatal to the consummated plan. The Third Circuit also reversed and reinstated an appeal from the part of the plan that gave $30 million to a certain class of creditors over the objection of the indentured trustee of Tribune's LBO debt, saying it would not be unfair if that class were forced to disgorge the funds and Tribune's value and thus none of its investors would be affected if the appeal were successful. Of particular note, however, is the concurring opinion of Judges Thomas Ambro and Thomas Vanaskie that address the concerns raised in Krause's concurring opinion in One2One about the viability of the equitable mootness doctrine and their reluctance to discard this tool of equity.

Ambro and Vanaskie do not share Krause's constitutional concerns of the equitable mootness doctrine because “neither the personal rights nor the separation of powers guaranteed by [the Constitution] are infringed when Article III courts decline to hear quite a constricted class of cases seeking relief that would upend cases resolved and plans implemented (often years before) and/or would significantly harm third parties who relied on that resolution and implementation.” Tribune , 2015 U.S. App. LEXIS at *34.

They also assert that the Bankruptcy Code does not bar the doctrine essentially because bankruptcy courts are inherently courts of equity and “the doctrine of equitable mootness recognizes those few situations where the practical harm caused by granting relief would greatly outweigh the benefit.” Id . at *39. As a practical matter, Ambro and Vanaskie note that if the equitable mootness doctrine were eliminated, it is hard to imagine that any complex plan would be consummated until all appeals are terminated which would inhibit equity investments, drive up the cost of credit and encourage lone dissenter holdouts. Id . at *41.

Conclusion

The recent decisions in Transwest and One2One are significant because, contrary to what had become common practice, they highlight that substantial consummation of a plan is not necessarily dispositive of whether an appeal will be found to be equitably moot. The Ninth Circuit's refusal to characterize a third-party investor as the type of innocent third party that the equitable mootness doctrine was designed to protect and the Third Circuit's admonition that equitable mootness should only apply in the context of complex Chapter 11 cases raises significant uncertainty as to when appeals will be dismissed as equitably moot. The greatest potential ramification of these decisions, however, may relate to the debate within the Third Circuit as to the appropriateness of the doctrine. While the concurring opinion of Ambro and Vanaskie in Tribune stresses the value of retaining the equitable mootness doctrine, Krause's concurring opinion in One2One seeks an en-banc review by the full Third Circuit, which may end the equitable mootness doctrine in the Third Circuit and lay the groundwork for the Supreme Court to consider the equitable mootness doctrine on constitutional grounds.

The lesson for debtors, plan sponsors and investors is that confirmation and substantial consummation of a Chapter 11 plan does not eliminate the risk that the confirmation order may be reversed on appeal.

Gary L. Kaplan and Jennifer L. Rodburg are partners and Kalman Ochs is special counsel in Fried, Frank, Harris, Shriver & Jacobson's bankruptcy and restructuring practice.This article also appeared in the New York Law Journal , an ALM sister publication of this newsletter.