Court Refuses to Apply “Divestiture Doctrine” in Denying Creditors’ Committee Stay Pending Appeal

Contributed by Brian Wells
The Weil Bankruptcy Blog frequently writes on issues revolving around equitable mootness (See Equitable Mootness on Life Support: The Third Circuit Further Pares Back the Abstention Doctrine in One2One Communications, Jumpin’ Donuts: Bankruptcy Settlements and the Gifting and Equitable Mootness Doctrines, Once Moot, Always Moot – Second Circuit Adopts Deferential Abuse of Discretion Standard of Review for Equitable Mootness Appeal, and Continental Airlines and Equitable Mootness: Appeals that Never Make It Off the Ground), and stays pending appeals (See Appeal-Proof: Court of Appeals Jurisdiction Over Orders Concerning Stays Pending Appeal, and Calling a Spade a Spade: Judge Refuses to Issue a Stay Pending Appeal of 363 Sale “on the Basis of Smoke and Mirrors) from bankruptcy court orders.  In a recent decision in the Sabine Oil & Gas chapter 11 cases, the United States Bankruptcy Court for the Southern District of New York considered a motion of the Official Unsecured Creditors’ Committee seeking a stay pending appeal from a prior order, in which the bankruptcy court had denied the committee standing to pursue causes of action on behalf of the debtors.  Pending its appeal, the committee sought a stay of confirmation proceedings for any plan that would release the disputed causes of action and, potentially, render its appeal equitably moot.  Although the committee raised a novel argument in support of this relief rooted in the “divestiture doctrine,” the bankruptcy court applied the well-established four-factor test and found that a stay was not warranted.  
The dispute in Sabine follows an earlier decision denying the committee standing to pursue causes of action for the benefit of the debtors’ estates, including claims of constructive and actual fraudulent conveyance, breach of fiduciary duty, recharacterization, and equitable subordination.  The bankruptcy court declined to grant the committee standing to litigate these causes of action, finding that most of them were not colorable, and, for those that were, it was not in the best interests of the estates to pursue them.  The committee appealed.
The committee was concerned, though, that while its appeal was pending the debtors would pursue confirmation of a plan that provided for releases of the causes of action the committee sought to litigate.  To protect its appeal and foreclose any equitable mootness argument over potential confirmation and the consummation of the debtors’ plan, the committee sought a broad stay to protect against any action that might cause the release of certain claims during the pendency of the committee’s appeal.
Jurisdictional Argument
The committee’s primary argument was that a stay should be ordered because the committee’s appeal divested the bankruptcy court of jurisdiction to enter an order releasing the causes of action.  Under the “divestiture doctrine,” a lower court loses its control over an issue or matter that is on appeal.  However, and importantly, the bankruptcy court noted, application of the divestiture doctrine to bankruptcy courts is not a black and white issue.  On the one hand, the doctrine divests a bankruptcy court of jurisdiction to expand upon or alter an order being appealed.  On the other, the doctrine does not divest a bankruptcy court of jurisdiction to enforce or implement the order being appealed, or to decide issues and conduct proceedings different from those involved in the appeal.  The bankruptcy court disagreed with the committee’s position that any subsequent order in the case based upon the order under appeal – such as a confirmation order releasing the subject causes of action – would “alter” that order, instead finding that, at most, such orders would constitute its “implementation.”  Otherwise, courts would face the absurd and untenable situation where a ruling on any issue prior to confirmation would give disappointed litigants the ability to take control of the proceedings and hold up confirmation.
Conventional Analysis
Rejecting the divestiture doctrine argument, the bankruptcy court proceeded to analyze the merits of the requested stay using the conventional, four-prong analysis.  Entry of an order staying proceedings pending appeal is an exercise of the court’s discretion that requires consideration of four separate prongs:

(1) whether the movant will suffer irreparable injury absent a stay,

(2) whether a party will suffer substantial injury if a stay is issued,

(3) whether the movant has demonstrated a substantial possibility, although less than a likelihood, of success on appeal, and

(4) the public interest that may be affected.

The bankruptcy court noted a difference of opinion whether all four factors had to be satisfied, but concluded that under either approach the committee had not made the required showing.
With respect to the first two prongs, which essentially require the movant to show that it would suffer irreparable harm in the absence of a stay greater than any harm suffered by other parties if a stay were granted, the bankruptcy court noted the well-established rule that the risk of equitable mootness, alone, is insufficient to satisfy this requirement.  In any event, the harm to the debtors of halting all confirmation efforts pursuant to the stay left the harm of mootness “insignificant” by comparison.  Although the committee argued that the debtors could avoid the stay by proposing a plan without releasing the disputed causes of action, the bankruptcy court found this an attempt to dictate the terms of the plan and attempt an end-run around the debtors’ exclusive right to propose a plan under the Bankruptcy Code.
For the third prong, which involves reviewing the merits of the appeal from its prior order and finding a “substantial possibility” of the movant’s success on appeal (which, the bankruptcy court noted, is easier to satisfy than showing a “likelihood” of success), the bankruptcy court found it had not been satisfied for the reasons provided in its prior opinion.
For the fourth prong, the bankruptcy court found that the public interest was not affected by the appeal as the outcome would affect the recoveries of private parties, not a public good.  The committee argued that it was losing its right to use the appellate process to ensure the correct application of the law, but the bankruptcy court, unpersuaded, noted that the committee retained its ability to prosecute its appeal and object to a proposed plan of reorganization at the appropriate time.
The Sabine decision stands as a reminder that litigants seeking to appeal a bankruptcy court order face an uphill process and may have difficulty bringing the “moving train” to a stop.  Although the committee did not prevail in its motion, the motion may have served a purpose.  Frequently, courts considering whether an appeal is equitably moot will look to see whether the appellant diligently sought to preserve its rights, for example, by seeking a stay pending appeal.  The committee’s action may not have secured a stay, but nonetheless preserved an argument in the event of a future fight over equitable mootness.
Brian Wells is an Associate at Weil Gotshal & Manges, LLP in New York.