Fifth Circuit Declines to Expand Equitable Mootness Beyond Plan Confirmation

Reluctant to expand the concept of equitable mootness, the Fifth Circuit relied on statutory mootness under Section 363(m) to dismiss an appeal from an order that approved both a sale and a settlement.

The Facts

A chapter 11 trustee had mounted a fraudulent transfer suit aiming to recover a business that the debtor had spun off before bankruptcy. However, the business was failing and had to be sold quickly.

The trustee found a buyer for the business who would pay $15 million, but only if title were marketable and the sale was “free and clear.” Needing to complete the sale without awaiting conclusion of the fraudulent transfer suit, the trustee was compelled to settle with the defendant.

The sale and settlement were structured as follows: The buyer paid the trustee $15 million; the trustee settled with the defendant by paying $8 million to the defendant in return for releases and title to the business, and the trustee used some of the sale proceeds to pay taxes and other encumbrances on the business.

The bankruptcy judge approved the sale and settlement in one order. A creditor with a $500,000 claim had objected to the sale. The creditor appealed but did not seek a stay pending appeal. The district court dismissed the appeal without saying whether dismissal was based on equitable mootness or statutory mootness under Section 363(m).

Section 363(m) provides that the “reversal or modification on appeal of an authorization” of a sale or lease “does not affect the validity of a sale or lease” to a good faith purchaser, whether or not the purchaser knew about the appeal.

Equitable Mootness

In his February 5 opinion, Circuit Judge Gregg Costa first analyzed whether dismissal was proper under the doctrine of equitable mootness, which he distinguished from constitutional mootness.

Calling equitable mootness “controversial,” Judge Costa said that the Fifth Circuit is “more hesitant to invoke equitable mootness than many circuits.” Noting that the trustee had yet to propose a chapter 11 plan, he said that dismissal for equitable mootness “typically” requires confirmation of a plan.

Judge Costa acknowledged that some courts outside the Fifth Circuit employ equitable mootness to dismiss appeals from settlement agreements “in particularly messy cases.” The sale and settlement in the case at hand, he said, “were not sufficiently complex.”

According to Judge Costa, equitable mootness “is aimed at limiting review of complex plans whose implementation has substantial secondary effects.” The case on appeal, he said, “would only affect a few third parties, all of whom participated in the bankruptcy court.”

“This does not appear to be the case to expand equitable mootness into new frontiers,” Judge Costa said.

Statutory Mootness

Although equitable mootness wouldn’t justify dismissing the appeal, statutory mootness was a different story. Judge Costa said that Section 363(m) was designed by Congress “to encourage parties to bid for estate property.”

The creditor argued that Section 363(m) did not apply because the appeal only challenged the distribution of $8 million to the defendant in the fraudulent transfer suit. However, Judge Costa said that the payoff “was an essential feature of the sale,” because the defendant would not have released its claim to the business without the $8 million payment.

Judge Costa dismissed the appeal under Section 363(m) because there was “no way to sever the settlement from the sale; they are mutually dependent.”