Bankruptcy courts often dismiss appeals of chapter 11 plans when granting the relief requested in the appeal would undermine the finality and reliability of the corresponding plans, a doctrine known as Equitable Mootness. Over the past several years, certain circuits criticized the doctrine for its lack of statutory basis and effect of avoiding review on the merits.1
A recent Third Circuit decision indicated that, despite these concerns, Equitable Mootness is still alive and well, and rejected an argument that an appellate court can avoid Equitable Mootness by allowing “individualized relief” (i.e., where the appellate court allows an appellant recoveries in excess of other creditors in the same class under a chapter 11 plan). However, a concurring opinion by one of the Third Circuit judges highlights continuing concerns regarding the effect of the doctrine on individual appellants and the more general development of bankruptcy jurisprudence.
In In re Nuverra Environmental Solutions, Inc. v. Hargreaves, Case No. 18-3084, 834 Fed. Appx. 729 (3d Cir. Jan. 6, 2021), Nuverra Environmental Solutions, Inc. and its affiliated debtors (collectively, “Nuverra” or the “Debtors”) confirmed a chapter 11 plan over the objection of David Hargreaves, a holder of unsecured notes. The Debtors’ enterprise value was calculated at $302.5 million at plan confirmation, while the Debtors’ total prepetition and postpetition secured debt totaled approximately $500 million, entitling the Debtors’ unsecured claims to no recoveries under the Bankruptcy Code.
As required by the Bankruptcy Code, the Debtors’ plan created classes of claims for plan voting and distribution purposes. Class A6, which Hargreaves belonged to, received securities and cash equal to 6% of the face value of their notes. Meanwhile, Class A7, comprised of trade creditors with debts arising from the Debtors’ day-to-day operations, received payment in full. The payment in full was characterized by the parties as a “gift” to be paid by the Debtors’ secured creditors, who would own the Debtors post –emergence and accordingly sought to maintain ongoing business relationships with the Debtors’ trade creditors.
Class A6 voted to reject the plan and Hargreaves filed an objection, claiming improper classification of claims and unfair discrimination in the treatment of Class A6 compared to the treatment of Class A7. The Bankruptcy Court confirmed the plan over Hargreaves’ objection, finding that Class A6 was out of the money no matter what treatment Class A7 received, and that Class A7’s claims arose out of the day-to-day operations of the Debtors.
Hargreaves filed his notice of appeal to the District Court on July 25, 2017, the same day that the Bankruptcy Court confirmed the plan. He filed an emergency motion for stay of the confirmation order the next day. The District Court denied the stay request on August 3, 2017, and the plan went effective on August 7, 2017. Two months later, the Reorganized Debtors filed a motion to dismiss Hargreaves’ appeal as equitably moot. The District Court agreed and dismissed Hargreaves’ appeal on August 21, 2018. Hargreaves timely appealed the District Court’s dismissal to the Third Circuit.
At this point, the plan was already substantially consummated and practically could not be unwound. Hargreaves argued, however, that the Third Circuit could grant him a full individual recovery while leaving the plan in place, and while all other members of Class A6 received no additional recoveries because they did not exercise their rights to object to the plan or appeal entry of the confirmation order. The Reorganized Debtors argued that individualized relief would be contrary to the Bankruptcy Code and that Hargreaves could not obtain any relief because his appeal was equitably moot.
In its majority opinion, the Third Circuit affirmed the District Court’s decision. The Third Circuit restated the basic elements of Equitable Mootness analysis: (1) whether the confirmed plan has been substantially consummated, and (2) if granting the relief requested in the appeal would “fatally scramble the plan” or significantly harm those who relied on the plan.
The Court recognized that the plan had been substantially consummated, and noted that both parties agreed that granting relief for Hargreaves would fatally scramble the plan unless Hargreaves could receive an enhanced individual recovery. The Court’s analysis therefore focused on whether such individual recovery was permissible under the Bankruptcy Code.
The Court first dismissed as irrelevant Hargreaves’ argument that the relatively “small” sum of his individual recovery justified relief. In doing so, the Court noted that the key question is whether the Bankruptcy Code permits any enhanced payments, regardless of their amount, to an appellant.
Turning to that question, the Court held that Hargreaves’ individual recovery at a rate higher than recoveries of other creditors in Class A6 was not permitted by the Bankruptcy Code. In particular, the Court found that enhanced recoveries for an appellant (a) would violate Bankruptcy Code § 1123(a)(4)’s restriction on preferential treatment of members within a class and (b) is inconsistent with Bankruptcy Code § 1129(b)(1)’s prohibition on unfair discrimination between classes under a plan. As noted by the Court, a creditor’s objection under § 1129(b)(1) to treatment of other classes’ claims under a plan is inherently an objection that would benefit and apply to all other creditors in the same plan class as the objecting creditor because § 1129(b)(1) only relates to treatment between entire classes of creditors. The Court further noted that Hargreaves could not have requested individualized relief at the confirmation hearing due to § 1123(a)(4)’s prohibition on disparate treatment of members within the same plan class, and that allowing Hargreaves on appeal to seek different relief would encourage parties to take inconsistent positions in the bankruptcy court and later on appeal.2
Judge Krause concurred with the denial of the appeal, but on different grounds. In her concurring opinion, Judge Krause rejected the application of the Equitable Mootness doctrine to the case, calling it an “ill-advised expansion” of a doctrine that, if used at all, should be used narrowly. She instead held that the Debtors would win the appeal even if the Court rejected Equitable Mootness arguments to instead analyze other substantive legal questions posed by the appeal.
In so holding, Judge Krause questioned the majority’s conclusion that the Bankruptcy Code prohibits individualized plan treatment for an appellant creditor. While Judge Krause agreed with the majority’s holding that the Bankruptcy Code does not generally permit disparate treatment of creditors within a plan class, she contended that the majority did not sufficiently analyze Hargreaves’ contention that disparate treatment is permissible in an appeal because non-appealing class members effectively agreed to potentially disparate recoveries when they chose not to object to, or appeal the confirmation of, the plan.
Judge Krause further noted that the majority’s denial of the appeal on Equitable Mootness grounds precluded the Court from considering other substantive arguments—such as whether senior creditors may gift recoveries to a subset of junior claims with the same priority as other junior claims, whether unfair discrimination objections should focus on the process or the outcome of a plan, and what are the limits on separately classifying similarly ranked claims—and developing bankruptcy jurisprudence accordingly in derogation of the Court’s duty to promote its development.
Finally, in a footnote, Judge Krause criticized the lower courts’ refusal to stay implementation of the Debtors’ plan pending appeal and asserted that predicating appellate review on a lower court’s willingness to issue a stay pending appeal raises “serious constitutional and practical concerns.”
This was not the first time that Judge Krause took issue with the existence and application of the Equitable Mootness doctrine. In 2015, Judge Krause drafted the concurrence in In re One2One Communications, LLC, in which she argued the time had come to reconsider whether Equitable Mootness should exist at all or should be substantially reformed.
However, Judge Krause’s concurrence in Nuverra highlights the difficulty plan objectors face when appealing plan confirmation. As a litigant before the bankruptcy court, Hargreaves appears to have done everything he needed to do procedurally by filing his objection, appeal, and motion for stay in a timely manner. By the District Court’s denial of his motion for stay, the Reorganized Debtors’ plan was permitted to move forward to substantial consummation, and Hargreaves’ appeal was, for all intents and purposes, lost to Equitable Mootness at that moment.
Notwithstanding Judge Krause’s concerns, Equitable Mootness is still a healthy doctrine in the Third Circuit, as evidenced by the majority opinion. This appears consistent with recent decisions of other circuit courts, such as René Pinto-Lugo, et al. v. Financial Oversight and Management Board of Puerto Rico, et al., Case No. 19-1181 (1st Cir. Feb. 8, 2021) (dismissing appeal of plan of adjustment confirmation in Puerto Rico bankruptcy) and In re Windstream Holdings, Inc., Case No. 20-1275-bk (2d Cir. Feb. 18, 2021) (dismissing unsecured creditors’ appeal of order permitting payment of debtors’ critical vendors).