Contributed by Charles Persons
“It’s not that I’m afraid to die, I just don’t want to be there when it happens.” — Woody Allen
It has not been a good run for proponents of equitable mootness in the Third Circuit Court of Appeals. The doctrine, designed to prevent a court “from unscrambling complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract,” has been under significant fire from a growing number of the sitting Third Circuit panels in recent years who have posited it has been applied too offensively for too long. The Third Circuit’s latest decision on the subject, In re One2One Communications, may well represent the death knell for the doctrine in the Circuit.
Beginning with In re Philadelphia Newspapers in 2012 and followed by In re Semcrude in 2013, the Third Circuit pared back equitable mootness, a “judge-made abstention doctrine” designed to provide finality to chapter 11 reorganizations post-confirmation. These two decisions dramatically limited the applicability of the doctrine by heightening the standards for its use, placing the burden of proof on the party seeking dismissal, and requiring the courts within the Third Circuit to consider their “’virtually unflagging obligation’” to exercise the jurisdiction conferred upon them, as opposed to just the public policy favoring finality of a chapter 11 case. However, One2One Communications is more than a simple refinement of the nearly 20-year-old equitable mootness doctrine – it reads more like a plea for someone to put an end to the doctrine. More importantly, with eight of the 12 sitting Third Circuit judges having either written or joined Philadelphia Newspapers, Semcrude, or One2One Communications, it may not be long before the doctrine gives way to something altogether different.
Equitable Mootness Takes off in Continental
The doctrine of equitable mootness is no quirk of the Third Circuit. Indeed, by the time the Circuit adopted the doctrine in its landmark 1996 In re Continental Airlines decision, the concept of equitable mootness was already entrenched in the Ninth Circuit (1981), D.C. Circuit (1986), Fifth Circuit (1988), Eleventh Circuit (1988), First Circuit (1992), Second Circuit (1993), and Seventh Circuit (1993) and would eventually be formally adopted by every Circuit except the Eighth (which hasn’t ruled either way on the issue).
While the facts of Continental have been covered here before, the most enduring outcome of the 7-6 en banc decision was the creation of the Continental Test, a five-factor test to determine whether a post-confirmation appeal of a plan of reorganization should be dismissed as equitably moot. Specifically, the five “prudential” factors are: (1) whether the reorganization plan has been substantially consummated, (2) whether a stay has been obtained, (3) whether the relief requested would affect the rights of parties not before the court, (4) whether the relief requested would affect the success of the plan, and (5) the public policy of affording finality to bankruptcy judgments. The opinion stated that “[a]lthough these five factors have been given varying weight . . . the foremost consideration has been whether the reorganization plan has been substantially consummated.”
The Continental Test was not without its detractors, however, including then-Third Circuit Judge (now Supreme Court Justice) Alito. In Continental, then-Judge Alito wrote a dissent that decried the refusal of an Article III court to entertain a live appeal and the failure of the majority to conduct an independent analysis of the basis of the law. Justice Alito also warned that the doctrine should be “limited in scope and cautiously applied.”
The Third Circuit Pulls Back on Equitable Mootness
Between Continental in 1996 and Philadelphia Newspapers in 2012, the Third Circuit refined its equitable mootness jurisprudence on a case-by-case basis, modestly pulling back the reins on its original ruling where it viewed Continental as being stretched too far. However, these modest refinements gave way to a significant retreat with Philadelphia Newspapers and later SemCrude, when the Third Circuit (and specifically, Judge Ambro, who wrote both opinions) began to pull aspects from Judge Alito’s dissent in Continental and incorporate those into the majority opinion, limiting the use of the doctrine. Nonetheless, the recent decisions never went so far as to consider the constitutional and statutory underpinnings for the equitable mootness doctrine even as it limited its use, perhaps in part because the validity of the doctrine had become so entrenched in the Circuit’s case law.
The somewhat scathing 38-page concurrence from Judge Krause in One2One Communications changes that, concurring in the majority’s application of the Continental test to the facts, but primarily questioning the statutory basis for and overall validity of the doctrine altogether. Indeed, the concurrence, taken together with the majority opinion, reads like an open invitation to end the equitable mootness doctrine entirely.
One2One Communications was a billing services technology company in chapter 11, while Appellant Quad/Graphics Inc. was its largest unsecured creditor, with a $9.3 million claim from a prepetition judgment against the Debtor. All other unsecured claims, held by a total of 17 claimants, totaled $1.3 million. After three failed attempts to put together a plan of reorganization, the Debtor filed its fourth amended plan in January 2013, which provided a plan sponsor the exclusive right to purchase 100% of the Debtor’s equity directly from the equityholders for $200,000. A distribution of $1.25 million would be provided to unsecured creditors over the course of seven years.
The Appellant objected to confirmation on the grounds that the plan violated the absolute priority rule by allowing equity to retain property without paying the unsecured creditors in full. After a five-day confirmation hearing, the bankruptcy court for the District of New Jersey confirmed the fourth amended plan over the objection of the Appellant. The confirmation order was automatically stayed for 14 days under Bankruptcy Rule 3020(e), during which time the Appellant moved for a stay pending appeal. The stay was denied by the bankruptcy court, and the District Court and Third Circuit similarly denied emergency applications to stay confirmation of the plan. By the time the parties briefed the District Court on merits of the appeal, the plan had been consummated for over three months. Upon the Debtor’s motion, the District Court dismissed the appeal as equitably moot.
The Appellant appealed the dismissal of its District Court appeal to the Third Circuit. In an unprecedented move, the Appellant not only argued that the District Court abused its discretion based on the facts of the case by dismissing the appeal as equitably moot, it further argued that the doctrine of equitable mootness is unconstitutional on the grounds that it is contrary to the Bankruptcy Code and vests non-Article III courts with the ability to render final, non-appealable orders in violation of the Supreme Court’s ruling in Stern v. Marshall.
The Majority Opinion
The majority opinion opened its analysis with the premise that the three-judge panel did not have sufficient authority to decline to follow the Continental holding unless that decision conflicted with a Supreme Court decision. To “reevaluate” the Continental holding and its adoption of the doctrine of equitable mootness, the Third Circuit would need to be sitting en banc. The Court continued, limiting the Stern opinion to the concept that “bankruptcy judges do not have the constitutional authority to adjudicate a claim that is exclusively based upon a legal right grounded in state law,” but adding that “Stern did not consider the authority of bankruptcy judges to make final determinations regarding other kinds of claims and counterclaims brought by debtors and creditors, nor did Stern consider whether Article III requires appellate review of a bankruptcy judge’s decisions by an Article III judge.” The majority opinion would reiterate that its hands were tied with respect to the applicability of the equitable mootness doctrine in its conclusion, stating, “[a]bsent en banc reconsideration, we cannot entertain Appellant’s challenge to equitable mootness, as Continental remains the law of this circuit.”
Unable to address the appropriateness of the equitable mootness doctrine, the One2One Communications Court turned to the Continental equitable mootness analysis itself. Here, the majority continued the Circuit’s recent precedent of limiting the applicability of equitable mootness, eventually reversing the dismissal and remanding to the District Court so that the lower court might perform its “‘virtually unflagging obligation’ to exercise the jurisdiction conferred upon [it].”
Looking to the first Continental factor – whether the plan has been substantially consummated – the One2One Communication court relied on Philadelphia Newspapers and held that “courts have considered ‘whether allowing an appeal to go forward will undermine the plan, and not merely whether the plan has been substantially consummated under the Bankruptcy Code’s definition.’” The deference to Philadelphia Newspapers drives home the Third Circuit’s departure from the Continental ruling, which not only referred to the first factor as the most important, but considered only the Bankruptcy Code definition of “substantial consummation” in coming to its decision.
The opinion also followed the Philadelphia Newspapers’ precedent of collapsing the fourth Continental factor (whether the relief requested would affect the success of the plan) into the first factor. Conflating these two factors into the requirement that “a court should consider whether allowing an appeal to go forward will undermine a plan,” the Court found two reversible errors made by the District Court in its dismissal. First, the District Court had found that the Appellant offered no option that would allow a grant of relief without unravelling the plan entirely. This, the Third Circuit ruled, improperly placed the burden of dismissal on the Appellants, rather than the Debtor. Second, and more importantly, the Court held that “courts are obligated to consider not only whether granting the requested relief would require reversal of the plan, but also whether the plan could be retracted without great difficulty and inequity.” Noting the lack of publically traded debt or securities issues by the Debtor pursuant to the plan, that the Debtor had only one secured creditor whose claim was worth less than $100,000, and that the plan did not provide for “new financing, mergers or dissolutions of entities, issuance of stock or bonds, name change, change of business location, change in management or any other significant transactions,” the Court held that “this case did not involve a sufficiently complex bankruptcy reorganization such that dismissal on the basis of equitable mootness would be appropriate.”
Further, the majority did more than just reiterate the Third Circuit’s recent equitable mootness holdings, it also built off those opinions to further limit the doctrine. Following Continental, cases that are dismissed for equitable mootness frequently provide a laundry list of post-confirmation transactions that would be difficult to unravel. The Debtor sought to provide the Court with a similar laundry list, but the transactions described failed to impress the Third Circuit. Again pointing out the lack of complexity in the case, the Court stated, “[t]hese [post-confirmation] transactions, including the investment by the Plan Sponsor, the commencement of distributions, the hiring of new employees and entering into various agreements with existing and new customers are likely to transpire in almost every bankruptcy reorganization where the appealing party is unsuccessful in obtaining (or fails to seek) a stay.”
Similarly, the Debtor sought to play up the reliance of third parties on its confirmed plan, including creditors, employees, and third-party workers. The Court was similarly unmoved, stating “[t]his type of minimal third-party reliance is present in nearly all bankruptcy reorganizations and cannot be characterized as almost certain to cause significant injury to third parties.” This lack of complexity, coupled with the Appellant’s repeated (though failed) attempts to obtain appellate review, were enough to persuade the Court to overturn a dismissal for equitable mootness once again.
For all the precedential value the majority opinion has in emphasizing the importance of “complex transactions” to further narrow the applicability of equitable mootness, it is the concurrence of Judge Krause – the newest member of the Third Circuit – that may be the most influential in the long term. In a thorough and often strongly-worded 38-page review of the doctrine of equitable mootness, Judge Krause lays out the arguments for why “the time has come to reconsider whether it should exist at all, and, if we conclude it should, to reform it substantially.”
Judge Krause sets the tone and purpose of the concurrence in the second sentence, stating in no uncertain terms, “I do not believe we should persist in our failed attempts to cabin this legally ungrounded and practically unadministrable ‘judge-made abstention doctrine.’” The primary arguments laid out in the concurrence are that (i) the district courts have continued to misconstrue the equitable mootness case law; (ii) that there is no basis in the Bankruptcy Code or Constitution for the doctrine; (iii) that the jurisdictional statutes and the Supreme Court’s recent Wellness International decision undermine any support for the doctrine; and (iv) contrary to its intended purpose, equitable mootness does not actually promote finality in bankruptcy cases and indeed stunts the development of uniform bankruptcy case law. The concurrence urges the eradication of the doctrine, but concludes, in the alternative, with four suggestions for a wholesale reformation of equitable mootness.
First, noting that the Third Circuit has “reversed findings of equitable mootness or declined to dismiss appeals as equitably moot no less than seven times” since Continental, the concurrence laments that the District Court’s application of the doctrine to the present case “epitomizes the problem. . . [t]hat another thoughtful and diligent District Judge has misconstrued our case law as permitting the abdication of jurisdiction in these circumstances reflects a doctrine adrift and in need of reconsideration by our Court.” Rather than being used only to prevent substantial harm to numerous parties where the reorganization involves intricate transactions, as the concurrence argues the Continental court intended, “[w]hat Continental Airlines spawned is a different species altogether.”
The concurrence then considers the lack of statutory authority for the entire concept with a rhetorical question, “[s]o what is the constitutional or statutory anchor for declining to exercise jurisdiction over bankruptcy appeals dubbed ‘equitably moot’? Simply put, there is none.” The concurrence considers the “virtually unflagging obligation” to exercise jurisdiction described by Justice Alito, and then discusses Supreme Court decisions with “narrow and deeply rooted abstention doctrines.” “Those [abstention] doctrines, much like the doctrine of forum non conveniens, proceed from the premise that ‘[i]n rare circumstances, federal courts can relinquish their jurisdiction in favor of another forum.” Judge Krause argues that failure to exercise jurisdiction where there is no other forum is “not abstention; it’s abdication.”
Judge Krause’s concurrence then turns to the argument by the Debtor that the doctrine is permitted under the jurisdictional statutes of the U.S. Code, specifically 28 U.S.C. § 1334(c)(1), which permits the district courts from abstaining from hearing a proceeding “in the interest of justice.” With another rhetorical question, Judge Krause dismisses this argument, asking “how is it ‘just’ to bar a potentially meritorious appeal when an appellate court—after hearing the merits of the appeal—instead could use its equitable authority to fashion a limited remedy while still protecting third parties that may be harmed if a plan is undone?” The concurrence then discusses the jurisdiction issue under the penumbra of the recent Wellness International opinion. Quoting that opinion, the concurrence notes that Article I adjudicators, like bankruptcy judges, may decide claims submitted by consent of the parties “‘so long as Article III courts retain supervisory authority over the process.’” Equitable mootness, Judge Krause argues, “drastically weakens that supervisory authority” because it “not only allows bankruptcy court decisions to avoid review, but also enable bankruptcy judges to insulate their decisions from review at their discretion.”
In its final rationale against the doctrine of equitable mootness, the concurrence challenges the purported efficacy of the doctrine itself, stating, “[t]he doctrine was intended to promote finality, but it has proven far more likely to promote uncertainty and delay.” Judge Krause observes that the doctrine creates an entire additional layer of appellate issues that are raised by plan proponents first – rather than allowing objecting parties to simply move forward with an appeal on the merits. The present case serves as the concurrence’s proof, noting that the One2One Communications appeal is being decided nearly two years after plan confirmation, and now will return to the District Court to be heard on the merits. “Without the equitable mootness doctrine . . . the District Court would have ruled on the merits long ago.” The concurrence argues there are unintended consequences to the failure to rule on the merits as well, namely that a dismissal on equitable mootness grounds prevents the appellate courts from considering more bankruptcy issues on their merits.
These four rationales underpin why the concurrence urges the elimination of the doctrine, which Judge Krause reasons can be better dealt with through crafting limited remedies. However, the concurrence also offers an alternative vision for a “reformed” equitable mootness doctrine, one that “delineate[s] its contours more precisely and provide[s] clearer guidance to the district courts on its appropriate use.” Judge Krause suggests the Third Circuit could (i) place greater weight on the appellant’s attempts to obtain a stay, “perhaps permitting dismissal only where an appellant does not seek one;” (ii) clarify what constitutes significant harm to third parties and define when their reliance is justifiable; (iii) reconsider the standard of review, changing the standard from ‘abuse of discretion’ to ‘de novo;’ and (iv) require that the appellate court take a “quick look at the merits” of the challenge to determine if it is “legally meritorious or equitably compelling.”
The impact of the One2One Communications decision will only be determined as courts in the Third Circuit begin to put its holdings into practice. On the one hand, it may stand only to emphasize the need for complex, post-confirmation transactions. Such a result would be less of an expansion of recent equitable mootness case law, and more of a reiteration of some of the post-Continental opinions, like Zenith. On the other hand, if Judge Krause’s concurrence is given similar weight to Judge Alito’s dissent in the Continental, then it may not be long before equitable mootness is no longer viable in the Third Circuit. In either case, the message to District Courts in the Third Circuit from the One2One Communications panel is clear – consider the appeal before you carefully before abstaining from the exercise of jurisdiction for equitable mootness, or you will likely see the case back in your court before long.