Second Circuit Rules That Equitable Mootness Applies in Chapter 11 Liquidations as Well as Reorganizations
In Beeman v. BGI Creditors' Liquidating Trust (In re BGI, Inc.), 772 F.3d 102 (2d Cir. 2014), the U.S. Court of Appeals for the Second Circuit considered whether the doctrine of "equitable mootness" applied to the appeal of a confirmation order approving a liquidating chapter 11 plan. In a matter of first impression, the court ruled that the standards governing equitable mootness in an appeal of an order confirming a chapter 11 plan of reorganization also apply in the context of a chapter 11 liquidation. The Second Circuit affirmed a district court ruling dismissing an appeal because the appellants failed to overcome the presumption of mootness triggered by "substantial consummation" of a liquidating chapter 11 plan.
"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. Protecting legitimate expectations of innocent stakeholders and the difficulty of "unscrambling the eggs" following the completion of complex restructuring transactions are issues that a court considers when confronted with any challenge to a plan confirmation order. Courts sometimes reject such a challenge (if in the form of an appeal of the confirmation order) as equitably moot because it is simply too late or too difficult to undo transactions consummated under the plan. A court also will dismiss an appeal of a confirmation order as equitably moot if effective relief, even if arguably possible, would be inequitable under the circumstances, given the difficulty of restoring the status quo ante and the impact on all parties involved.
Before deciding whether relief may be granted and what impact that relief may have on the various stakeholders in a chapter 11 case, however, courts often conduct a threshold inquiry as to whether a chapter 11 plan has been "substantially consummated." Section 1101(2) of the Bankruptcy Code provides that substantial consummation 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.
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: (1) whether the appellant sought and/or obtained a stay pending appeal; (2) whether the plan has been substantially consummated; (3) whether the rights of innocent third parties would be adversely affected by reversal of the confirmation order; (4) 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; (5) the likely impact upon a successful reorganization of the debtor if the appellant's challenge is successful; and (6) 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 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."
The Second Circuit reaffirmed the doctrine of equitable mootness in In re Charter Communications, 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 five of the criteria delineated in its previous ruling in Chateaugay. To avoid dismissal on the basis of equitable mootness under Chateaugay, an appellant must demonstrate that:
1. The court can still order some effective relief;
2. Such relief will not affect the re-emergence of the debtor as a revitalized corporate entity;
3. Such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court;
4. The parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings; and
5. The appellant pursued with diligence all available remedies to obtain a stay of execution of the objectionable order if the failure to do so creates a situation rendering it inequitable to reverse the orders appealed from.
Chateaugay, 10 F.3d at 952–53 (internal quotation marks omitted). 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.
Prior to Charter, circuit courts uniformly required the party asserting equitable mootness to bear the burden of proof on appeal. See Thorpe Insulation, 677 F.3d at 880; Search Market Direct, Inc. v. Jubber (In re Paige), 584 F.3d 1327, 1339–40 (10th Cir. 2009); accord Ala. Dep't of Econ. & Cmty. Affairs v. Ball Healthcare-Dallas, LLC (In re Lett), 632 F.3d 1216, 1226 (11th Cir. 2011); Gillman v. Cont'l Airlines (In re Cont'l Airlines), 203 F.3d 203, 210 (3d Cir. 2000).
With respect to the standard applied in reviewing a mootness ruling by a district court or bankruptcy appellate panel, however, the circuits have been split between applying a de novo or abuse-of-discretion standard. Compare Curreys of Neb., Inc. v. United Producers, Inc. (In re United Producers, Inc.), 526 F.3d 942, 946–47 (6th Cir. 2008) (de novo standard); Thorpe Insulation, 677 F.3d at 880 (same); Liquidity Solutions, Inc. v. Winn-Dixie Stores, Inc. (In re Winn-Dixie Stores, Inc.), 286 Fed. App'x 619, 622 & n.2 (11th Cir. 2008) (same); United States v. GWI PCS 1 Inc. (In re GWI PCS 1 Inc.), 230 F.3d 788, 799–800 (5th Cir. 2000) (same), with Charter, 691 F.3d at 483 (abuse-of-discretion standard); Paige, 584 F.3d at 1339–40 (same); and Cont'l Airlines, 203 F.3d at 210 (same).
In BGI, the Second Circuit revisited equitable mootness to consider, as a matter of first impression, whether the doctrine can preclude appeals impacting orders confirming chapter 11 plans that provide for a debtor's liquidation.
Retail bookstore chain BGI, Inc., f.k.a. Borders Group, Inc. ("Borders"), filed for chapter 11 protection in February 2011 in the Southern District of New York. Borders abandoned its efforts to reorganize shortly afterward. In July 2011, the bankruptcy court authorized Borders to liquidate substantially all of its assets. Borders closed the last of its retail branches on September 20, 2011, and stopped accepting gift cards and conducting e-commerce on its website one week later. Gift card redemptions constituted nearly all of Borders' net sales during the last month of the company's operations.
Borders filed a chapter 11 plan of liquidation in November 2011. In addition to providing notice by mail to all known creditors of the claims bar date (June 1, 2011) and the plan confirmation hearing, Borders published notice of the bar date and the confirmation hearing in The New York Times. The bankruptcy court confirmed Borders' plan of liquidation on December 21, directing in its order that the plan would be effective on January 12, 2012.
Certain holders of unredeemed gift cards (the "GC Claimants") filed a motion on January 4, 2012, for authority to file untimely proofs of claim, arguing that they had not received adequate notice of the bankruptcy case or the bar date. They later moved the court to certify a class of all holders of Borders gift cards issued prepetition, but they never sought a stay of the effective date of the chapter 11 plan of liquidation.
The bankruptcy court denied both motions in August 2012. The court held that: (i) the GC Claimants were "unknown" creditors because their "status as possible creditors was not known or reasonably ascertainable" by Borders; (ii) as "unknown" creditors, the GC Claimants were entitled only to publication, rather than actual, notice of the bar date; and (iii) the GC Claimants' failure to file timely proofs of claim was not "excusable neglect" under Rule 9006(b)(1) of the Federal Rules of Bankruptcy Procedure. The court also denied as moot the motion for class certification.
In so ruling, the court found that Borders' chapter 11 plan had been substantially consummated because the liquidating trust established under the plan had already distributed approximately $17 million to holders of administrative and priority claims. According to the court, "[A]llowing [the GC Claimants] to file late claims and certifying a class of Gift Card holders would have a disastrous effect on the remainder of [Borders' estate] and the final distributions of the Plan." The GC Claimants appealed the bankruptcy court's rulings to the district court.
In October 2012—more than 10 months after confirmation of the plan—the GC Claimants sought a stay of interim distributions to creditors pending the district court's adjudication of their appeal. The bankruptcy court denied the motion. The district court later dismissed the GC Claimants' appeal of the bankruptcy court's previous rulings denying late-filed claims and class certification as being equitably moot. Among other things, the district court noted that "[e]ven though Appellants did not appeal confirmation of the Distribution Plan, their requested relief is tantamount to a collateral attack because of the drastic changes to the distributions that would be implicated." See Beeman v. BGI Creditors' Liquidating Trust (In re BGI, Inc.), 2013 BL 165932, *12 n.12 (S.D.N.Y. May 22, 2013). The GC Claimants then appealed to the Second Circuit.
The Second Circuit's Ruling
A three-judge panel of the Second Circuit affirmed. Initially, the court ruled, as a matter of first impression, that the doctrine of equitable mootness applies to appeals arising from chapter 11 liquidations as well as reorganizations:
We see no principled reason, in a Chapter 11 liquidation proceeding, for denying a court discretion to apply the doctrine of equitable mootness and the corresponding Chateaugay analysis. In such a liquidation, affected parties may have devoted months of time and resources toward developing an acceptable plan; creditors with urgent needs may have been stayed from accessing assets and funds to which they are entitled; and extensive judicial resources may have been consumed. In liquidation as in reorganization, substantial interests may counsel in favor of preventing tardy disruption of a duly developed, confirmed, and substantially consummated plan.
The Second Circuit found support for its conclusion in several published and unpublished rulings from other circuits. See, e.g., Schaefer v. Superior Offshore Int'l, Inc. (In re Superior Offshore Int'l, Inc.), 591 F.3d 350 (5th Cir. 2009); Zegeer v. President Casinos, Inc. (In re President Casinos, Inc.), 409 Fed. App'x 31 (8th Cir. 2010); Sutton v. Weinman (In re Centrix Fin. LLC), 355 Fed. App'x 199 (10th Cir. 2009); Drawbridge Special Opportunities Fund, L.P. v. Shawnee Hills, Inc. (In re Shawnee Hills, Inc.), 125 Fed. App'x 466 (4th Cir. 2005); Hicks, Muse & Co. v. Brandt (In re Healthco Int'l, Inc.), 136 F.3d 45 (1st Cir. 1998); Fitzgerald v. Ninn Worx SR, Inc. (In re Fitzgerald), 428 B.R. 872 (9th Cir. B.A.P. 2010).
The Second Circuit then ruled that the district court did not abuse its discretion in dismissing the GC Claimants' appeals as equitably moot. According to the Second Circuit: (i) the bankruptcy court's finding that the chapter 11 plan had been substantially consummated was not clear error, because, as of the effective date, Borders had transferred its property to the liquidating trust and the trust had distributed $17 million to creditors; and (ii) the district court did not abuse its discretion in finding that the GC Claimants failed to satisfy at least two of the Chateaugay factors—i.e., ensuring adequate process for parties who would be adversely affected (factor 4) and demonstrating their own diligence in obtaining a stay pending appeal (factor 5).
The Second Circuit explained that the GC Claimants failed to establish that general unsecured creditors, who could be stripped of their recovery if the class were certified, received notice of the appeal. Moreover, the court emphasized, having failed to participate in the plan confirmation proceedings or to appeal or seek a stay of the confirmation order, the GC Claimants did not "pursue their claims with all due diligence." Notably, the record reflected that at least one of the GC Claimants consulted counsel regarding his or her claims more than two weeks prior to the confirmation hearing but did not participate in the proceedings.
To the extent that any ambiguity existed in the Second Circuit regarding application of the doctrine of equitable mootness to appeals arising from chapter 11 liquidation proceedings, BGI definitively dispels it. Interestingly, the court expressly left for "a future panel of our Court the question of whether a district court may also invoke equitable mootness in the context of a Chapter 7 liquidation."
The principal thrust of the ruling, however, is directed more toward the consequences of failing to take appropriate and timely action—a strategic blunder on the part of the GC Claimants that could readily have been avoided. The GC Claimants could have participated in the plan confirmation proceedings or sought a stay of the effective date of the plan, yet chose to do neither.