Since the development of the doctrine of equitable mootness nearly a quarter century ago, courts have struggled to apply it in a way that strikes the appropriate balance between the need to ensure the finality and certainty of a chapter 11 plan for stakeholders, on the one hand, and the need to exercise the court’s jurisdiction and honor the right to appellate review, on the other. In JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props. Inc. (In re Transwest Resort Props., Inc.), 2015 BL 302540 (9th Cir. Sept. 15, 2015), the Ninth Circuit Court of Appeals curbed the application of the equitable mootness doctrine where the appellant diligently sought to stay consummation of the plan. The decision reflects broader concerns over the appropriateness of the doctrine, as well as the ongoing process of refining the circumstances under which it should be applied.
“Mootness” is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. In federal courts, an appeal can be either constitutionally or equitably moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.
In contrast, the judge-fashioned remedy of “equitable mootness” bars adjudication of an appeal when a comprehensive change of circumstances occurs such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis to preclude appellate review of an order confirming a chapter 11 plan. See, e.g., In re LCI Holding Company, Inc., 2015 BL 295784 (3d Cir. Sept. 15, 2015) (stating that doctrine “comes into play in bankruptcy (so far as we know, its only playground) after a plan of reorganization is approved” and ruling that equitable mootness would not cut off the authority to hear an appeal outside the plan context).
Several circuit courts of appeal have formally adopted the doctrine of equitable mootness in considering whether to hear appeals of plan confirmation orders. For example, in Search Market Direct, Inc. v. Jubber (In re Paige), 584 F.3d 1327 (10th Cir. 2009), the Tenth Circuit considered six factors in determining whether the doctrine should moot appellate review of a confirmation order: (i) whether the appellant sought and/or obtained a stay pending appeal; (ii) whether the plan has been substantially consummated; (iii) whether the rights of innocent third parties would be adversely affected by reversal of the confirmation order; (iv) whether the public policy need for reliance on confirmed bankruptcy plans—and the need for creditors generally to be able to rely on bankruptcy court decisions—would be undermined by reversal of the confirmation order; (v) the likely impact upon a successful reorganization of the debtor if the appellant’s challenge is successful; and (vi) whether, on the basis of a brief examination of the merits of the appeal, the appellant’s challenge is legally meritorious or equitably compelling.
Substantially similar tests for equitable mootness have been adopted by the Second, Third, Fifth, and Ninth Circuits. See Frito-Lay, Inc. v. LTV Steel Co. (In re Chateaugay Corp.), 10 F.3d 944 (2d Cir. 1993); Nordhoff Invs., Inc. v. Zenith Elecs. Corp., 258 F.3d 180 (3d Cir. 2001); TNB Fin., Inc. v. James F. Parker Interests (In re Grimland, Inc.), 243 F.3d 228 (5th Cir. 2001);Motor Vehicle Cas. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 671 F.3d 980 (9th Cir. 2012), amended and superseded on denial of rehearing en banc, 677 F.3d 869 (9th Cir. 2012). In In re Philadelphia Newspapers, LLC, 690 F.3d 161, 168–69 (3d Cir. 2012), however, a panel of the Third Circuit adopted a more nuanced approach, holding that the foremost consideration is “whether allowing an appeal to go forward will undermine the plan, and not merely whether the plan has been substantially consummated.”
Section 1101(2) of the Bankruptcy Code provides that “substantial consummation” of a chapter 11 plan occurs when substantially all property transfers proposed by the plan have been completed, the reorganized debtor or its successor has assumed control of the debtor’s business and property, and plan distributions have commenced.
The Second Circuit reaffirmed the doctrine of equitable mootness in In re Charter Commc’ns, Inc., 691 F.3d 476 (2d Cir. 2012), but its ruling deepened a split among the circuits with respect to the standard of review and burden of proof to be applied. In Charter, the Second Circuit held that once a chapter 11 plan has been substantially consummated, an appeal is presumed to be equitably moot unless the appellant can demonstrate that it has met all of the criteria delineated in its previous ruling in Chateaugay—which are substantially similar to the Sixth Circuit’s Paige factors. By appearing to abandon the balancing approach employed by other circuits in this context, the Second Circuit stands alone in presuming that an appeal is equitably moot following substantial consummation of a chapter 11 plan.
More recently, in Beeman v. BGI Creditors’ Liquidating Trust (In re BGI, Inc.), 772 F.3d 102 (2d Cir. 2014), the Second Circuit ruled that the standards governing equitable mootness in connection with an appeal of an order confirming a chapter 11 plan of reorganization also apply in the context of a chapter 11 liquidation. The court of appeals affirmed a ruling dismissing an appeal because the appellants failed to overcome the presumption of mootness triggered by substantial consummation of a liquidating chapter 11 plan.
The Ninth Circuit revisited the doctrine of equitable mootness in Transwest.
Transwest Resort Properties, Inc., and its affiliates (collectively, “Transwest”) acquired resort hotels in Hilton Head, South Carolina, and Tucson, Arizona, in 2007. The acquisition was financed by a $209 million mortgage loan at the operating entity level and $21.5 million in mezzanine financing provided to certain nonoperating affiliates (the “mezzanine loan debtors”) and secured by the stock of the operating entities.
After defaulting on the loans, Transwest filed for chapter 11 protection in 2010 in the District of Arizona. At the time of the filing, the mortgage loan had been acquired by JPMCC 2007-C1 Grasslawn Lodging, LLC (“JPMCC”), and the mezzanine loan had been acquired by PIM Ashford Subsidiary I LLC (“PIM”). JPMCC filed a proof of claim in the case for $299 million (later allowed at $247 million), while PIM asserted a claim for $39 million. The hotel properties were valued at no more than $92 million.
JPMCC acquired the mezzanine loan from PIM shortly after Transwest filed its chapter 11 plan. JPMCC also elected to have its claims secured by the mortgage loan treated as fully secured under section 1111(b) of the Bankruptcy Code.
Under the joint plan: (i) the mortgage loan would be restructured to require monthly interest-only payments for 21 years followed by a balloon payment, subject to a “due-on-sale” clause with a 10-year exception whereby the hotels could be sold during the period from five to 15 years after the plan’s effective date without triggering the obligation to repay the loan; (ii) the Transwest borrowers obligated to repay the mezzanine loan would be dissolved; (iii) no distribution would be made in respect of the claims based on the mezzanine loan, unless PIM voted in favor of the plan, in which case it would receive a small distribution from the reorganized Transwest’s future cash flow; and (iv) the reorganized Transwest debtors would be acquired by Southwest Value Partners Fund XV, LP (“SWVP”) in exchange for a $30 million investment.
JPMCC voted to reject the plan (with respect to its claims based on both the mortgage loan and the mezzanine loan) and objected to confirmation. Although a class of the Transwest operating debtors’ unsecured creditors voted to accept the plan, there was no accepting impaired class of the mezzanine loan debtors. JPMCC argued that the 10-year exception to the due-on-sale provision impaired its section 1111(b) election because JPMCC’s now fully secured claim would not be satisfied from any sale proceeds during that 10-year window. It also claimed that the plan confirmation requirements should be applied on a debtor-by-debtor rather than a per-plan basis and that, because no impaired class of creditors of the mezzanine loan debtors had accepted the joint chapter 11 plan, it could not be confirmed under section 1129(a)(10) of the Bankruptcy Code.
The bankruptcy court overruled JPMCC’s objections and confirmed the plan. Both the bankruptcy court and the district court denied JPMCC’s timely motions for a stay of the confirmation order pending appeal. The district court subsequently dismissed the appeal as equitably moot because the plan had been substantially consummated and third parties had relied on the confirmation order. JPMCC appealed to the Ninth Circuit.
The Ninth Circuit’s Ruling
The Ninth Circuit reversed.
The court of appeals applied the four-part test previously articulated inThorpe Insulation, which considers: (i) whether the appellant diligently pursued its rights by seeking a stay of the confirmation order; (ii) whether the plan has been substantially consummated; (iii) the effect a remedy may have on third parties not before the court; and (iv) whether the bankruptcy court “can fashion effective and equitable relief without completely knocking the props out from under the plan and thereby creating an uncontrollable situation for the bankruptcy court.”
Although Transwest’s chapter 11 plan had been substantially consummated, the Ninth Circuit explained, JPMCC was diligent in seeking an appeal and a stay of the confirmation order, which “cuts strongly in favor of appellate review.” The court rejected the argument that, in accordance with the Second Circuit’s rulings in Chateaugay and Charter, JPMCC’s appeal should be presumed to be equitably moot due to substantial consummation of the plan. “Our circuit’s articulation of the equitable mootness test,” the Ninth Circuit wrote, “has never included such a presumption.”
Addressing the remaining Thorpe Insulation factors, the court reasoned that, if JPMCC were to prevail on its argument that the exception to the due-on-sale clause improperly impaired its section 1111(b) election, only JPMCC, reorganized Transwest, and SWVP would be materially affected by the resulting change in the allocation of any sale proceeds of the hotels. The Ninth Circuit noted that SWVP participated in every stage of the chapter 11 proceedings, including deliberations concerning the treatment of JPMCC’s claims under a plan. For this reason, SWVP, the Ninth Circuit wrote, is “not an innocent third party” that reasonably relied on the confirmation order, but “a sophisticated investor” for which “appellate consequences are a foreseeable result,” particularly because SWVP helped to draft a chapter 11 plan that “ ‘press[es] the limits’ of the bankruptcy laws” (quoting Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229, 244 (5th Cir. 2009)).
Finally, the Ninth Circuit ruled that partial relief could be granted to JPMCC without “knocking the props out from under the plan.” The court wrote, “Even if the relief would be only partial, where equitable relief, though incomplete, is available, the appeal is not moot” (internal citation omitted). The court reasoned that: (i) the bankruptcy court could reduce the duration of the exception to the due-on-sale clause or direct that, if a sale occurred during the window, JPMCC would be entitled to a portion of the difference between the remainder of the total loan amount and the loan’s present value; and (ii) if JPMCC, as the holder of the mezzanine loan, were to receive even a partial distribution under the plan in respect of its $39 million claim, the payment “may not eliminate the § 1129(a)(10) objection altogether, but would at least offer a partial remedy.”
In a dissenting opinion, circuit judge Milan D. Smith, Jr., argued that the court’s ruling “ignores the realities of the marketplace” and discourages future investment in restructuring enterprises. According to Judge Smith, by discouraging investment during the bankruptcy process, the court’s ruling also decreases the value of bankruptcy estates, thereby disadvantaging creditors and hampering reorganization efforts. Instead, he suggested, the court should place greater emphasis on the value of promoting finality in the bankruptcy process.
Judge Smith objected to the court’s emphasis on partial relief, noting that a nominal remedy is always available. If the nominal relief described by the court were deemed “effective and equitable relief” as required under the equitable mootness doctrine, he wrote, “no case would ever be equitably moot” (internal citation omitted).
Transwest illustrates some of the challenges faced by courts when applying the equitable mootness doctrine to appeals of chapter 11 plan confirmation orders. On the one hand, courts recognize the importance of promoting reliance on confirmed plans to encourage successful restructurings. On the other, avenues for appellate review must be protected.
In Transwest, the Ninth Circuit was reluctant—and ultimately refused—to apply the doctrine where the appellant took all reasonable steps to seek a stay of the confirmation order and where the plan was not so complex that uninvolved third parties would be harmed. The court also rejected the Second Circuit’s strict approach of imposing a presumption of mootness upon substantial consummation.
In a broader sense, the ruling reflects growing concern among courts (especially in the Third Circuit) regarding overbroad application of the equitable mootness doctrine, with recent calls to limit the doctrine and, in some cases, eliminate it altogether, particularly where the parties affected by the appeal are well aware of the potential for reversal. See, e.g., JPMCC 2006-LDP7 Miami Beach Lodging, LLC v. Sagamore Partners, Ltd. (In re Sagamore Partners, Ltd.), 2015 BL 280922, *7 (11th Cir. Aug. 31, 2015) (stating that equitable mootness applies only when “effective relief is no longer available” and ruling that requiring the debtor to pay default-rate interest under a substantially consummated plan was effective relief); In re One2One Commc’ns, LLC, 2015 BL 232065, *5 (3d Cir. July 21, 2015) (declining to hold that the doctrine is unconstitutional or “contrary to the Bankruptcy Code,” but ruling that the doctrine must be construed narrowly and should be applied only in complex reorganizations when the appellant should have acted before the plan became “extremely difficult to retract” (quoting In re Phila. Newspapers, LLC, 690 F.3d 161, 169 (3d Cir. 2012));United States v. Buchman, 646 F.3d 409, 411 (7th Cir. 2011) (noting that the Seventh Circuit does not follow the doctrine of equitable mootness in bankruptcy law); Pac. Lumber Co., 584 F.3d at 240 (a court should apply doctrine “with a scalpel rather than an axe” and may “fashion whatever relief is practicable” instead of declining review simply because full relief is not available).