A district judge in Houston decided that an appeal from confirmation of a chapter 11 plan was not equitably moot, even though reversal could mean redistribution of the new debtor’s equity.

The debtor, a software developer, negotiated a restructuring support agreement before filing with the holders of 80% of the first- and second-lien notes. The plan eliminated $1.6 billion in secured debt. Unsecured creditors were to be paid in full.

First-lien holders took back debt and had the right to receive new equity at a discount in an equity rights offering. Second-lien holders were slated to receive new equity.

To supply the cash required to operate the reorganized business and to confirm and consummate the plan, a majority of the lenders backstopped the equity rights offering. In return, the majority were to receive some of the new equity.

A minority of the lenders objected to the plan because they had not been given the opportunity to participate in the backstop. They contended that the plan violated Section 1123(a)(4), which requires the same treatment for every claim in a class.

The bankruptcy court confirmed the plan. The minority filed an appeal. Waiting several days, the minority filed a motion for a stay pending appeal in the district court. District Judge Andrew S. Hanen denied the stay motion, finding, among other things, that the appellants lacked a likelihood of success on appeal.

Following denial of the stay motion, the debtor and the majority lenders filed a motion to dismiss the appeal as equitably moot. Judge Hanen denied the motion in an opinion on October 23.

The Origins of Equitable Mootness

Accepted in “virtually every circuit,” Judge Hanen said that equitable mootness was “a concept in bankruptcy law that has existed for approximately four decades,” going back to a decision from the Ninth Circuit in 1981. Although widely used, he said that courts have “cautioned against its widespread use.”

In the Fifth Circuit, Judge Hanen said that equitable mootness “is looked at with great scrutiny, especially when it involves appeals concerning the rights of secured creditors.”

To establish equitable mootness, Judge Hanen said that the debtor must show that (1) the plan was not stayed pending appeal; (2) the plan was substantially consummated; and (3) reversal “would either affect the rights of third parties or the success of the Plan.” In the case on appeal, he said that the first two requirements were “certainly met.”

The minority lenders were complaining on appeal that they had not been given an opportunity to invest in the equity backstop, for which they would have had a better recovery on their claims. The minority argued that the majority could be ordered to sell some of the extra equity to the minority.

No Stay and Substantial Consummation

The debtor and the majority argued on appeal that the lack of a stay pending appeal per se weighed in favor of dismissal.

Judge Hanen said that the injury to the minority “seems plainly remedial with either a monetary award or a redistribution of the equity allocation and would not require an unwinding of the plan that would affect the debtor.” For that reason, he said that “denying the stay in this case weighs against” dismissal. [Emphasis in original.]

Substantial consummation “weighs in favor of equitable mootness,” Judge Hanen said, because the plan “certainly has been substantially consummated.”

Partial Relief Is a Big Deal

Citing the Fifth Circuit, Judge Hanen said that “[n]umerous courts” have held that the availability of partial relief would not disturb a reorganization. “In short,” he said, equitable mootness “is improper” if the “Court can fashion a remedy without upsetting the reorganization.” [Emphasis in original.]

Were he to order the majority to sell a portion of the new equity to the minority, Judge Hanen said there would be “no need to upset the Plan or the actions of third parties.” Consequently, he said that the third factor “weighs heavily against a finding of equitable mootness.”

Judge Hanen denied the motion to dismiss for equitable mootness.

Observations

Equitable mootness is a prudential doctrine running against the Supreme Court’s recent pronouncements that federal courts have a “virtually unflagging obligation” to exercise Article III jurisdiction. See, e.g., Colorado River Water Conservation Dist. v. U.S., 424 U.S. 800, 817 (1976); and F.B.I v. Fikre, 601 U.S. 234, 240 (March 19, 2024).

In equitable mootness cases, there is always an extant case or controversy conferring constitutional jurisdiction. In appeals like this, the question not about jurisdiction; the question is whether there is an available remedy.

Equitable mootness has retarded the development of bankruptcy law. Were there no such doctrine, critical questions like those answered by the Supreme Court last term in Purdue would have been resolved decades earlier. Indeed, the different composition of the Court in prior years might have led to a different result, given that Purdue was 5/4.

Because there will be constitutional jurisdiction, this writer would have appellate courts dispense with equitable mootness and rule on the merits. Often, the merits is an easier question than equitable mootness.

In the event of reversal, the appellate court could remand for the bankruptcy court to decide whether there is an available remedy, possibly partial. After all, deciding whether there is an available remedy sounds like a factual question that should be addressed in the trial court, which is already vastly more familiar with the case.

The foregoing opinions are those of the writer, not ABI.