Yesterday, we covered the Serta Simmons decision, where the Fifth Circuit decided that the company’s uptier financing before bankruptcy was not a permissible “open market purchase” and thereby violated the Excluded Lenders’ rights to ratable treatment.

Today, we cover the Fifth Circuit’s narrowing of the doctrine of equitable mootness, thereby allowing the appeals court to set aside confirmation of the debtor’s consummated chapter 11 plan at the cost of millions of dollars to some secured creditors.

Equitable Mootness Doesn’t Protect Parties to the Appeal

Yesterday, we reported how the debtor’s confirmed chapter 11 plan gave the Prevailing Lenders an indemnification by the debtor for any losses or liabilities they might incur for having participated in the prebankruptcy uptier financing. As we also reported yesterday, the Fifth Circuit decided that the uptier financing violated the rights of the Excluded Lenders.

The Prevailing Lenders argued that equitable mootness barred the appeals court from setting aside confirmation and granting relief to the Excluded Lenders.

Circuit Judge Andrew S. Oldham began his discussion of equitable mootness by calling it a “judge-created doctrine of pseudo-abstention,” not a matter of “real mootness” that “implicates our jurisdiction under Article III.”

Under Fifth Circuit authority, Judge Oldham said that equitable mootness turns on three factors: (1) whether there was a stay; (2) whether the plan was substantially consummated; and (3) whether granting relief would affect either the rights of parties not before the court or the success of the plan.

The plan had been substantially consummated, but the Excluded Lenders failed to obtain a stay pending appeal three times. Judge Oldham said that the Fifth Circuit “never said that the failure to obtain a stay mandates finding an appeal equitably moot.”

Considering the rights of parties not before the court, Judge Oldham said that nixing the indemnification

would affect [the debtor], which would no longer be on the hook for liability related to the 2020 Uptier, as well as those holders of super-priority debt who participated in the Uptier (i.e., the Prevailing Lender plaintiffs). The former would benefit from excision; the latter would not. But both are present here.

In terms of affecting the plan, Judge Oldham said that the debtor “would face an easier future without a massive liability hanging over its head. So it is also unclear how excision [of the indemnification] would threaten the success of the Plan.”

The debtor and the Prevailing Lenders contended that the appeals court could not excise the indemnification “without unwinding the entire Plan and triggering a whole new confirmation proceeding.” Responding, Judge Oldham said, “[O]ur precedent does not indicate that the remedy of excision requires thus.” Citing In re Highland Cap. Mgmt. LP, 48 F.4th 419, 430-31 (5th Cir. 2022), he added, “we have said just the opposite.”

Given that removing indemnification would help the debtor, Judge Oldham said that “excision does not toll doom for the Plan, and the third factor properly weighs against equitable mootness.”

Beyond the three factors pertaining to equitable mootness, the Prevailing Lenders contended that removing indemnification would be unfair because, as Judge Oldham said, they “agreed to support the Plan only because of the settlement indemnity.”

Without indemnification, Judge Oldham recounted how the Prevailing Lenders said “they would have exacted some other consideration from [the debtor].” Accordingly, he said, they “contend it is unfair for this court to excise the indemnity now without letting them go back to the drawing board, which we cannot do without upending the Plan.”

Judge Oldham gave the argument what he called “a full-throated rebuttal.”

Were he to invoke equitable mootness, he said that “the appellees’ argument would effectively abolish appellate review of even clearly unlawful provisions in bankruptcy plans. Parties supporting such provisions could always argue they would have done things differently if they had known the provisions would later be excised.”

“From the moment the Prevailing Lender plaintiffs agreed to a controversial indemnity arising out of a contentious transaction,” Judge Oldham said, “they could foresee the adverse consequences of an unfavorable appellate ruling.”

Declining to dismiss the appeals as equitably moot, Judge Oldham said, “We will not save such sophisticated parties from the consequences of their actions.”

Jevic Doomed the Plan’s Indemnification

Having decided that the appeals were not equitably moot, Judge Oldham turned to the question of whether “the Plan’s inclusion of the indemnity was an impermissible end-run around the Bankruptcy Code.”

Citing Section 502(e)(1)(B), Judge Oldham said that “the bankruptcy court must disallow any contingent claim for reimbursement where the claiming entity is co-liable with the debtor.” In fact, the Prevailing Lenders had filed proofs of claim based on their indemnification rights under the 2016 loan agreement, but they had agreed to disallow the claims under Section 502(e)(1)(B).

Judge Oldham said that the Prevailing Lenders “resurrected the pre-petition indemnity as a settlement indemnity.” [Emphasis in original.] However, he said it was a “mistake” when the bankruptcy court approved the new indemnification as part of a settlement underlying the plan. It was, he said, “an impermissible end-run around § 502(e)(1)(B)’s disallowance of contingent claims for reimbursement.”

To the Prevailing Lenders’ contention that the indemnity was a settlement permissible under Section 1123(b)(3)(A), Judge Oldham said that “Czyzewski v. Jevic Holding Corp., 580 U.S. 451 (2017)[,] is . . . directly applicable to these appeals.” He “decline[d] to read § 1123(b)(3)(A) as an escape hatch from the Code’s explicit disallowance of certain claims.” [Recall that Jevic set aside a so-called structured dismissal that violated the rules of priority.]

Judge Oldham therefore held “that the Plan indemnity was an impermissible end-run around the Code.”

The Indemnity Violated Equal Treatment

Even if the indemnity in the plan was a permissible settlement under Section 1123(b)(3)(A), Judge Oldham explained why “its inclusion in the Plan violated the Code’s requirement of equal treatment.” He said that the value of the indemnity “varied dramatically” depending on whether or not the lender had participated in the uptier financing.

For the Prevailing Lenders, Judge Oldham said that “the indemnity was potentially worth millions or even tens of millions of dollars.” But for lenders who were not in the uptier, he said that “the indemnity was worth little or even nothing.” He therefore held that “the Plan indemnity constituted impermissible unequal treatment.”

The Remedy and the Admonition

Excising “the offending indemnity in . . . the Plan,” Judge Oldham reversed “the bankruptcy court’s final order confirming the Plan insofar as it approved the Plan’s indemnity relating to the 2020 Uptier.”

Judge Oldham said that the company’s 2020 uptier “was the first major uptier . . . . But it was far from the last.”

“Though every contract should be taken on its own, today’s decision suggests that such exceptions will often not justify an uptier,” Judge Oldham said.

Observations

Recall that Judge Oldham said, “We will not save such sophisticated parties from the consequences of their actions.”

Judge Oldham’s words should instill caution, if not fear, in the hearts of those contemplating chapter 11 plans in the Fifth Circuit with questionable provisions.

The bankruptcy court in Houston is considering a Johnson & Johnson subsidiary’s third stab at a chapter 11 plan dealing with talc liability. If a plan is confirmed, an appeal presumably will find its way to the Fifth Circuit.

Does Judge Oldham’s Serta Simmons opinion suggest that the Fifth Circuit might have a skeptical approach to a case that was twice dismissed in the Third Circuit on opinions by one of the circuits’ foremost authorities on chapter 11?