Ninth Circuit Rulings on Equitable Mootness in Transwest and Sunnyslope Impact Third Party Investors
Monday, April 18, 2016

The doctrine of equitable mootness provides that Chapter 11 reorganization plans will be deemed moot, and therefore not subject to appellate review, if a plan has been substantially consummated and granting appellate relief would impair the rights of innocent third parties relying on the confirmation order.  Since the development of the court-created mootness doctrine nearly a quarter century ago, courts have grappled with applying it in such a way as to strike an adequate balance between the need for finality, and the need to exercise the court’s jurisdiction and preserve the right to appellate review.  The standard interpretation in bankruptcy was that once the debtor took definitive steps to put the Chapter 11 plan in place (i.e., “substantial consummation”), and the objecting creditor neglected to gain a stay of the plan confirmation order pending appeal, then any appeal was presumed to be “equitably moot” and therefore subject to dismissal by the appellate court.

However, in the recent case of JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props. Inc. (In re Transwest Resort Props., Inc.), 801 F.3d 1161 (9th Cir. 2015), a divided panel of the U.S. Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) ruled that, despite substantial consummation of the subject plan, a creditor’s appeal of a Chapter 11 plan confirmation order should not be dismissed on equitable mootness grounds.  In so holding, the Ninth Circuit applied a four-part test to determine that the creditor’s appeal was not equitably moot: (1) whether the appellant sought a stay pending appeal; (2) whether substantial consummation of the plan occurred; (3) whether the relief sought would affect third parties not before the court; and (4) whether the relief sought would entirely unravel the plan.  The Ninth Circuit held that, although substantial consummation is a factor that weighs in favor of equitable mootness, the law requires that the court still examine the third and fourth prongs of the equitable mootness test.

In reversing the district court’s dismissal of an appeal and remanding to the district court for disposition of the merits, the Ninth Circuit held that review of the creditor’s appeal would not unfairly affect third parties or completely unwind the plan.  Specifically, regarding the issue of third party rights, the court determined that the third party at hand was not the type of innocent party that was meant to be protected.  Rather, the third party was a sophisticated investor that funded the plan, and was vocal and active throughout the bankruptcy case, and should have known that appellate review was possible.  Finally, reasoned the majority, the bankruptcy court could devise equitable relief without entirely unraveling the plan.  Even the opportunity for partial relief would render the appeal not moot.

In a dissenting opinion, Judge Milan D. Smith, Jr. argued that the court’s ruling was grossly inequitable to the third-party plan sponsor.  According to Judge Smith, the majority’s decision will deter future investment in reorganizing debtors, thereby diminishing the value of bankruptcy estates, disadvantaging creditors and hindering reorganization efforts.  Judge Smith instead maintained that considerable weight should be rendered to substantial consummation of a plan and further advocated that the court place greater weight on promoting finality in the bankruptcy process.

More recently, on April 8, 2016, the Ninth Circuit issued its opinion in First Southern Ntl. Bank v. Sunnyslope Housing Ltd. Partnership (In the Matter of: Sunnyslope Housing Ltd. Partnership), No. 12-17241 (9th Cir. 2016), which further extended its holding in Transwest.  Reversing the district court’s judgment affirming the bankruptcy court’s confirmation of a Chapter 11 plan, the Ninth Circuit held that the creditor’s appeal was not equitably moot despite the fact that funding for the reorganization plan had been furnished by an equity investment from a third-party investor, and the plan had been substantially consummated.  The court concluded that the plan was based on an improper valuation of a creditor’s secured interest in real property and that the debtor had improperly been permitted to exercise the cram down provisions of section 506(a) of the Bankruptcy Code and retained the property at issue in exchange for a new payment plan that permitted the debtor to pay the creditor an amount equal to the present value of the secured claim at the time of bankruptcy.  The debtor argued that the value of the creditor’s secured interest should be determined with certain affordable housing restrictions in place, but the Ninth Circuit disagreed.  Instead, the panel held that all of the restrictive covenants and provisions that the debtor sought to invoke to restrict the project to affordable housing and to the decreased rental income that would consequently be collected, resulted from positions that were junior and expressly subordinated to the creditor’s interest.

As in Transwest, the panel in Sunnyslope was unconvinced that the third-party investor was the type of innocent third party intended to be protected by the doctrine of equitable mootness.  Rather, the court found that the third party was a sophisticated investor intimately involved in the development of the plan and was aware that the creditor had filed notices of appeal.  Furthermore, according to the court, the creditor’s failure to seek a stay from the Ninth Circuit could not have given the third party reasonable cause to conclude that the creditor had abandoned its challenge, yet the third party made a conscious decision to proceed nonetheless.  The Ninth Circuit ultimately held that the unraveling of the plan would not have a negative impact on parties intended to be protected by the doctrine.  Accordingly, it reversed and remanded to the district court for further proceedings.

The Ninth Circuit’s holdings in Transwest and Sunnyslope indicate that an equitable mootness analysis continues to be both circuit-driven and fact-dependent.  Ultimately, the Transwest andSunnyslope decisions confirm that under the law of the Ninth Circuit, a plan’s substantial consummation does not establish a presumption of equitable mootness.  Therefore, even where a Chapter 11 reorganization plan has been substantially consummated (regardless of whether or not the appellant sought a stay of the plan’s consummation pending appeal), a court may consider an appeal of the confirmation order on its merits if a remedy could be fashioned that would not entirely unravel the plan or detrimentally impact “innocent” third parties.  Furthermore, the majority inTranswest acknowledges the great discretion that bankruptcy courts have in formulating such a remedy.  Whether that remedy is equitable, however, is contingent upon the structure of the plan, the timing of implementation, and the bankruptcy court’s capacity to fashion relief in such a way as to address the appellant’s justifiable objections without unwinding the plan.

In the U.S. Court of Appeals of the Third Circuit (the “Third Circuit”), however, the scope and applicability of the equitable mootness doctrine is entirely different than in the Ninth Circuit.  On January 11, 2016, Aurelius Capital Management, LP (“Aurelius”) filed its petition for a writ of certiorari in the Supreme Court of the United States.  Aurelius’ petition was in response to a decision arising out of the Third Circuit affirming the dismissal of Aurelius’ appeal of a plan confirmation order entered in a Chapter 11 proceeding despite Aurelius’ objections.  See In re Tribune Media Co., 700 F.3d 272 (3d Cir. 2015).  Remarking that the Supreme Court has never reviewed the equitable mootness doctrine, Aurelius contended that the Supreme Court’s review was necessary to achieve uniformity and a certain measure of restraint to the interpretation and application of the doctrine.  Aurelius’ petition for certiorari, however, was denied.  As a result, the holdings and analyses in Transwest and Sunnyslope should guide the actions of those contemplating an appeal of a confirmation order in the Ninth Circuit.

 

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