Restructuring

In Momentive Performance Materials, the Second Circuit declined to dismiss as equitably moot the appeals of certain noteholders.  The decision highlights that successfully invoking the doctrine of equitable mootness may be difficult under prevailing case law where plan confirmation issues have been diligently appealed by parties in interest, even when a bankruptcy court has confirmed a complex plan of reorganization and the plan has gone effective.

Background

For context, Momentive Performance Material’s (“MPM”) capital structure included the following debt issuances:

• Subordinated Notes. In 2006, MPM issued $500 million in subordinated unsecured notes (the “Subordinated Notes” and the holders of such notes, the “Subordinated Noteholders”). In 2009, MPM offered holders of Subordinated Notes the option of exchanging their notes for second-lien secured notes at a 60% discount.  Holders of $118 million of the Subordinated Notes accepted the offer, leaving $382 million in outstanding Subordinated Notes.
• Second-Lien Notes. In 2010, MPM issued approximately $1 billion in “springing” second-lien notes (the “Second-Lien Notes” and the holders of such notes, the “Second-Lien Noteholders”).  These notes were unsecured up until MPM redeemed the $118 million of Subordinated Notes, which triggered a “spring,” granting noteholders a second-lien interest in certain collateral.
• Senior-Lien Notes. In 2012, MPM issued two classes of senior notes: $1.1 billion in first-lien secured notes (the “First-Lien” Notes”) and $250 million in 1.5-lien secured notes (the “1.5-Lien Notes” and together with the First-Lien Notes, the “Senior-Lien Notes”).  Under the Senior-Lien Notes indenture, these noteholders were entitled to a “make-whole” premium if MPM opted to redeem the notes prior to maturity.

In 2014, MPM and its affiliated debtors filed chapter 11 proceedings.  MPM subsequently filed a plan of reorganization.  The Subordinated Noteholders and Senior-Lien Noteholders (together, the “Appellants”) opposed this proposed plan.  The Subordinated Noteholders, who did not receive any recovery under the plan, argued that their notes were not subordinate to the Second-Lien Notes under the terms of the governing indentures.  The Senior-Lien Noteholders opposed the plan on grounds that their replacement notes did not provide for the make-whole premium and had an interest rate far below the market rate of interest.

The bankruptcy court confirmed the plan over these objections, which triggered an automatic 14-day stay.  During this time, the Appellants moved in the bankruptcy and district courts to extend the stay pending their appeal, both of which were denied.  MPM’s plan subsequently went effective, with reorganized MPM and its affiliates emerging from chapter 11 under the terms of the confirmed plan of reorganization. The Appellants timely appealed the confirmation order to the district court and eventually to the Second Circuit.  MPM contended that the appeals should be dismissed as equitably moot.

Before diving into the opinion, let’s do a quick refresher on the doctrine of equitable mootness.  You can also check out previous Bankruptcy Blog articles on equitable mootness¹, if you feel so inclined.

What is Equitable Mootness?

The doctrine of equitable mootness is grounded in the case or controversy requirement of Article III of the United States Constitution and, when applied in the bankruptcy context, is guided by equitable considerations.²  The doctrine allows appellate courts to dismiss bankruptcy appeals where, during the pendency of the appeal, events occur that result in the implementation of the relief sought being unfair or unjust, even if effective relief could be fashioned.³

In chapter 11, equitable mootness challenges often arise where, as in Momentive, a party seeks to appeal issues related to a “substantially consummated” chapter 11 plan.⁴  In the Second Circuit, once a plan has been substantially consummated, an appeal of that plan becomes presumptively moot and the burden shifts to the appellant to demonstrate five factors enumerated in In re Chateaugay Corp. to overcome that burden, namely that (i) effective relief can be ordered; (ii) such relief will not affect the debtor’s re-emergence; (iii) the relief will not “unravel intricate transactions”; (iv) the affected third-parties are notified and able to participate in the appeal; and (v) the appellant diligently sought a stay of the reorganization plan.⁵

Although satisfaction of each Chateaugay factor is necessary to overcome the presumption of mootness, reviewing courts have placed great weight on the fifth factor, referring to it as a “chief consideration.”⁶  In fact, the Second Circuit has previously concluded that if stay of a confirmation has been sought relief should be provided so long as it is “at all feasible,” or, in other words, it would not “knock the props out from under the authorization for every transaction that has taken place and create an unimaginable, uncontrollable situation for the Bankruptcy Court.”⁷

Equitable Mootness Arguments in Momentive

1.  MPM’s Arguments in Favor of Dismissing Appeals as Equitably Moot

MPM along with other parties, including Apollo Management LLC and certain affiliated funds (“Apollo”) and the ad hoc committee of Second-Lien Noteholders (collectively, the “Appellees”), asserted that the Appellants failed to demonstrate (i) the Court could grant effective relief without upending critical elements of the compromise underlying the plan, and (ii) reversal of the plan would not cause debilitating financial uncertainty.

First, the Appellees asserted that the plan was the product of a “highly complex economic settlement” between MPM and 85% of the Second-Lien Noteholders.  The Appellees pointed to the fact that certain of the creditor-Appellees played a key role in the bankruptcy by agreeing to (i) accept equity in the reorganized debtor, (ii) backstop and participate in a $600 million rights offering, which raised funding necessary to make distributions under the plan, and (iii) forego a billion-dollar deficiency claim, allowing 100% recoveries for unsecured creditors.  The Appellees noted that if Subordinated Noteholders were to prevail on their subordination appeal, MPM would owe Subordinated Noteholders approximately $382 million, which would either significantly dilute the equity stake that Second-Lien Noteholders received under the plan, and/or require MPM to provide Subordinated Noteholders with additional cash payments.  The Appellees argued that this would effectively impose a different plan of reorganization than the one they had voted in favor of and would deprive them of the benefits of their bargain without an opportunity to reevaluate concessions made, such as allowing general unsecured creditors to be paid in full.

Next, the Appellees urged that a recalibration or redistribution remedy would “unravel intricate transactions” so as to disrupt every transaction that had taken place since confirmation of the plan.  The Appellees pointed to the rights offering that had taken place and noted that trading of reorganized MPM’s stock had commenced, among other things.  The Appellees also asserted that implementing a recalibration or redistribution remedy would be difficult, as an entirely new plan would need to be confirmed.

Finally, the Appellees asserted that concessions made during plan negotiations were instrumental to MPM’s reorganization and could not be reversed without ruining the prospects of a successful future following emergence from chapter 11.  The Appellees warned that renewed negotiations would cast a cloud of uncertainty over MPM’s financial viability and operations, and they argued that a successful subordination appeal would require an extensive and time-consuming valuation hearing to determine the extent that Second-Lien Noteholders were secured.

2.  Subordinated Noteholder Arguments Against Dismissing Appeals as Equitably Moot

The Subordinated Noteholders argued that effective relief could be fashioned through a recalibration or redistribution, in that the Court could order (i) Second-Lien Noteholders to turn over distributions made to them under the plan, (ii) MPM to provide additional distributions such as cash payments or debt issuances, or (iii) a combination of both.

The Subordinated Noteholders first attacked the Appellees’ argument that the relief requested would unravel the plan, stating that a recalibration of recoveries was not inequitable as it would restore a lawful balance between creditor groups.  The Subordinated Noteholders challenged the notion that the plan was the result of a highly complex settlement, pointing to the fact that the rights offering was quite lucrative, that general unsecured claims were worth only two percent of the Second-Lien Noteholders’ claims, and that paying smaller creditors for their goodwill was normal in large chapter 11 cases.

The Subordinated Noteholders also expressed doubts that financial destabilization would occur given that relief could come from a recalibration of distributions to Second-Lien Noteholders rather than from MPM simply owing Senior Subordinated Noteholders $382 million.  Finally, the Subordinated Noteholder Appellants pointed to the fact that they had diligently sought stay of the confirmation order in three courts and alleged that the appellees had thrown up “roadblock after roadblock” to prevent a speedy resolution of the issues in dispute.  Accordingly, the Appellants argued that the fifth Chateugay factor pointed decisively in their favor and that it would be inequitable for the Second Circuit to decline to exercise its jurisdiction to decide the appeal.

3.  Key Arguments of Senior Secured Noteholders Against Dismissing Appeals as Equitably Moot

The Senior Secured Noteholders also highlighted that they had diligently sought a stay of the confirmation order and that the Court could fashion all of the relief required by recalibrating the interest rate on replacement notes, which would not unwind any of the plan effective date transactions.  They pointed out that the relief they sought was directly provided for in the plan and, therefore, part of the highly complex settlement negotiated by Appellees.  With respect to the diminished value of equity, First-Lien Appellants asserted that MPM had assumed that risk and noted that the disclosure statement had warned of lower equity value than anticipated in the event that MPM was required to pay a greater interest rate on replacement notes or a make-whole premium.  Finally, the First-Lien Appellants asserted that paying a greater cramdown interest rate or make-whole premium would not force MPM back into bankruptcy, as MPM had testified to the plan’s feasibility even if such things were to occur.

The Second Circuit’s Holding

The Second Circuit agreed with the lower courts and denied MPM’s request to dismiss the appeals as equitably moot.  The Court found that, in light of the limited scope of the remand ordered and the scale of MPM’s reorganization, it did not believe the plan would unravel or the prospects of MPM’s emergence from chapter 11 would be threatened.  The Court found that the only recalibration required was to evaluate the interest on the replacement notes to Senior-Lien Noteholders.⁸  Notably, the Court highlighted the fact that Appellants immediately objected to several provisions in the plan and diligently sought a stay of the confirmation order.  The Second Circuit noted that lower courts that were intimately familiar with MPM’s financial situation, though not making any determinative ruling, had stated that the risk of equitable mootness did not seem great with respect to either the Senior Subordinated Noteholders or Senior-Lien Noteholders.

Closing Thoughts

Momentive provides useful insight on the second and third Chateaugay factors ((2) relief will not affect the debtor’s re-emergence and (3) relief will not “unravel intricate transactions.”)  As outlined above, MPM argued for a doom-and-gloom scenario where the plan would unravel and MPM’s prospects for success would nose-dive if a recalibration or redistribution were required.  This was in hopes that the Second Circuit would come to a similar conclusion as it did in In re Charter Commc’ns Inc.⁹ In Charter, the Second Circuit found that a settlement between a majority equity holder and a group of bondholders formed a critical component of a pre-negotiated chapter 11 plan, and that the settlement could not be altered to remove third-party releases and compensation provided to the equity holder under plan without throwing the viability of the plan into doubt.¹⁰

Charter and Momentive thus appear to stand on opposite ends of the spectrum with respect to the second and third Chataeugay factors.  In both cases, appellant(s) had diligently sought a stay of the confirmation order (the “chief” Chateaugay factor).  The difference was that the court in Charter believed the second and third factor were sufficiently manifest to strike down the appeal as equitably moot.  In Momentive, however, the ability to recalibrate or redistribute recoveries under the plan and relatively minor impact such recalibration would cause in light of the scale of the case was not enough to persuade the Court that the prudential doctrine of equitable mootness should be invoked.

Parties considering equitable mootness challenges during plan appeal battles in the Second Circuit would be wise to consider these two cases to evaluate where they stand on the spectrum and the merits of their cases, especially in large chapter 11 cases, where parties are represented by sophisticated counsel who likely acted diligently in seeking a stay of the plan of reorganization.