The Ninth Circuit is now more firmly ensconced as a jurisdiction an investor should avoid when bent on buying a company through chapter 11.
In July, a three-judge panel held 2-1 that a buyer who actively participates in reorganization is not an innocent third party protected by the doctrine of equitable mootness, a judge-made rule of law allowing dismissal of an appeal without reaching the merits.
The reorganized company filed a motion for panel rehearing and rehearing en banc. The original three-judge panel withdrew its July opinion and issued a new opinion on Sept. 15, reaching the same result by the same rationale and by the same 2-1 vote. The revised opinion only made matters worse for investors arguing in the future in the Ninth Circuit that a confirmation appeal is moot after consummation of a plan.
The circuit nailed the coffin shut on Oct. 23 by denying the motion for en banc rehearing. No judge even sought a vote regarding en banc rehearing. Some debtors already avoid reorganizing in the Ninth Circuit because that court categorically precludes third-party releases.
The case involved a real estate project in which the lender exercised its option under Section 1111(b) of the Bankruptcy Code to keep the full amount of its lien on the property with an agreed value of $92 million. The due-on-sale clause in the mortgage, coupled with the election, would ordinarily mean that the lender could collect all sale proceeds were the property to be sold after emergence from chapter 11 because the claim was several times the value of the project.
The plan was confirmed over the lender’s objection. It provided that the lender would not receive all sale proceeds that were the project sold between the fifth and fifteenth years after confirmation. The plan was sponsored by a purchaser who was committed to investing $30 million in the property after bankruptcy.
The lender quickly, though unsuccessfully, sought stays of the confirmation order in both the bankruptcy court and the district court. After the district court denied a stay pending appeal, the judge dismissed the appeal on the ground of equitable mootness. The lender was contesting the 10-year hole in the due-on-sale clause.
The lender appealed to the circuit and won in a revised panel opinion on Sept. 15. Writing the opinion for the majority, Circuit Judge Michelle T. Friedland reinstated the appeal and sent it back to the district court to consider the merits and decide how to modify the plan if the lender succeeded in overturning the confirmation order. Because the buyer had already invested to upgrade the property, Judge Friedland said that relief on appeal could be less than reinstatement of the entire due-on-sale clause.
Judge Friedland said the purchaser, despite its obligation to invest $30 million, is not “the type of an innocent third party that the equitable mootness doctrine is meant to protect” because the buyer participated “at every stage of these proceedings.”
Citing the Fifth Circuit’s 2009 opinion in Pacific Lumber, Judge Friedland said that “appellate consequences are foreseeable” when a sophisticated investor crafts a plan that “presses the limits” of bankruptcy law.
Judge Friedland declined to adopt a presumption, used by other circuit courts, that a plan is moot once implemented.
Circuit Judge Milan Dale Smith Jr. dissented, saying the result was “grossly inequitable.” He believes the majority’s opinion “discourages potential investors from relying on the finality of bankruptcy court confirmation orders.”
The majority’s new opinion corrected a mistake in the original July decision, in which the appeals court had said that the investor was a party to the circuit court appeal. Even though it did not participate in the appeal, the majority said the investor still was not an innocent third party protected by equitable mootness, in part because it went ahead with plan confirmation in the face of the lender’s objection.
The Ninth Circuit is now more firmly ensconced as a jurisdiction an investor should avoid when bent on buying a company through chapter 11.