9th Cir. Declines to Dismiss Appeal on Equitable Mootness Grounds Despite Substantial Consummation of the Plan

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In JPMCC 2007–C1 Grasslawn Lodging, LLC v. Transwest Resort Props. Inc. (In re Transwest Resort Props., Inc.), 801 F.3d 1161 (9th Cir. 2015), a divided three-judge panel of the U.S. Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) ruled that a creditor’s appeal of a chapter 11 plan confirmation order should not be dismissed on equitable mootness grounds despite the substantial consummation of the subject plan. In so holding, the Ninth Circuit concluded that the appeal was not equitably moot under circuit precedent because the lender had diligently sought a stay, and the bankruptcy court could fashion an equitable remedy to address the lender’s objections without unfairly impacting third parties or undoing the plan. 

To read the full published decision, click here:  http://cdn.ca9.uscourts.gov/datastore/opinions/2015/09/15/12-17176.pdf

FACTUAL BACKGROUND AND PROCEDURAL HISTORY

Five related entities (collectively, the “Debtors”) acquired two resort hotels in 2007.  Two of the Debtors owned and operated the respective hotels (the “Operating Debtors”).  Two of the Debtors (the “Mezzanine Debtors”), in turn, were each the sole owners of the Operating Debtors.  The fifth Debtor (the “Holding Company Debtor”) was the sole owner of the Mezzanine Debtors.  The acquisition was financed with two loans: first, a $209 million loan from JPMCC 2007-C1 Grasslawn Lodging, LLC (“Lender”) to the Operating Debtors secured by liens on the two hotels (the “Mortgage Loan”); and second, a $21.5 million loan from PIM Ashford Subsidiary I LLC (“PIM”) to the Mezzanine Debtors secured by liens on their ownership interests in the Operating Debtors (the “Mezzanine Loan” and, together with the Mortgage Loan, the “Loans”).

The Debtors filed for bankruptcy in 2010 after defaulting on the Loans. By order of the bankruptcy court, the cases were jointly administered. Lender’s claim arising from the Mortgage Loan was allowed in the amount of $247 million.  PIM  filed two proofs of claim totaling $39 million.

The Debtors’ joint plan of reorganization proposed to dissolve the Mezzanine Debtors and cancel their equity interest in the Operating Debtors, thereby extinguishing the collateral for the Mezzanine Loan. The plan contemplated that a new investor, Southwest Value Partners Fund XV, LP (“SWVP”), would invest no less than $30 million and would become the new sole owner of the Operating Debtors. PIM’s treatment under the plan depended on its vote.  If PIM voted against the plan, PIM would receive no distributions thereunder. If, on the other hand, PIM voted to accept the plan, then PIM would be entitled to receive a small percentage of future surplus cash flow.

Lender elected to have its entire allowed claim treated as a secured claim under section 1111(b)(2) (unless otherwise noted all statutory references refer to sections of title 11 of the United States Code).  While the plan reinstated the Mortgage Loan, the Debtors proposed that the loan be paid in monthly interest-only payments with a balloon payment due in 21 years.  The plan also proposed that the Mortgage Loan be restructured to include a due-on-sale clause, but with an exception that the hotels could be sold or refinanced between years five and fifteen of the loan, without the full amount of the loan coming due. 

The separately classified Mortgage Loan and Mezzanine Loan claims comprised two of the ten classes of claims under the plan.  After the plan was proposed, Lender acquired the Mezzanine Loan from PIM.  Lender then voted both of its claims to reject the plan.

Lender’s Two Objections to the Plan

Lender objected to the plan on two grounds.  First, Lender asserted that the ten-year exception to the restructured Mortgage Loan’s due-on-sale clause negated the benefit of its section 1111(b) election.  Lender argued that by enacting section 1111(b), Congress intended to protect secured creditors against the undervaluation of their collateral.  Thus, Lender concluded, the plan’s ten-year exception to the due-on-sale clause could allow the Debtors to sell Lender’s collateral without satisfying its secured claim, thereby eradicating the protections afforded to Lender by section 1111(b).

Second, Lender contended that the Debtors did not satisfy section 1129(a)(10)’s requirement that “at least one class of claims that is impaired under the plan [must have] accepted the plan” in order for the plan to be confirmed.  Lender observed that in cases involving multiple debtors, courts were split on whether section 1129(a)(10)’s requirement applies per plan or per debtor.  Noting that the Mezzanine Debtors did not have any impaired class of creditors voting to accept the plan, Lender urged the bankruptcy court to adopt its “per debtor” interpretation of section 1129(a)(10), and deny confirmation of the plan.

The plan was confirmed over Lender’s objections pursuant to the “cram down” provisions of section 1129(b). 

The Appellate Proceedings

Lender filed a notice of appeal four days after the bankruptcy court confirmed the plan.  Lender concurrently filed a motion to stay consummation of the plan pending the appeal, arguing that any failure to grant the stay could result in the appeal being rendered moot.  The Debtors and investor SWVP objected to the stay motion, asserting that Lender had not shown how substantial consummation of the plan would moot Lender’s appeal.  The bankruptcy court denied Lender’s motion for stay, finding the risk of irreparable harm arising from possible mootness to be “speculative, at best.” Lender filed an identical motion in the district court, which was also denied.

After considering the appeal, including Lender’s two objections to the plan, the district court ruled that the appeal was equitably moot because, notwithstanding Lender’s diligent attempt at procuring a stay, the plan had been substantially consummated, third parties (including the investor) had relied on confirmation of the plan, and the relief sought by Lender would therefore be inequitable.

Lender appealed the district court’s decision to the Ninth Circuit.  Finding that Lender’s appeal was not equitably moot notwithstanding the substantial consummation of the plan, a divided three-judge panel of the Ninth Circuit ultimately reversed the district court’s decision and remanded the case for further proceedings.

REASONING

Judge J. Clifford Wallace penned the majority opinion and Judge Michelle T. Friedland concurred. Noting that equitable mootness is a judge-created doctrine by which a court elects not to reach the merits of a bankruptcy appeal, the majority identified four factors for courts to consider when determining whether an appeal is equitably moot:

We will look first at whether a stay was sought, for absent that a party has not fully pursued its rights.  If a stay was sought and not granted, we then will look to whether the substantial consummation of the plan has occurred.  Next, we will look to the effect a remedy may have on third parties not before the court.  Finally, we will look at whether the bankruptcy court can fashion effective and equitable relief without completely knocking the props out from under the plan and thereby creating an uncontrollable situation for the bankruptcy court.

Transwest Resort Properties, supra, 801 F.3d at 1167-68, citing Motor Vehicle Cas. Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 677 F.3d 869, 881 (9th Cir. 2012).  Observing that each of Lender’s two objections would require a separate form of relief, the majority then applied the equitable mootness analysis separately to each objection.

Factor #1: Diligence in Seeking Stay

The Ninth Circuit first evaluated whether a stay was sought.  Citing Thorpe Insulation and its previous decisions in Rev Op Grp. v. ML Manager LLC (In re Mortgs. Ltd.), 771 F.3d 1211 (9th Cir. 2014) and Rev Op Grp. v. ML Manager LLC (In re Mortgs. Ltd.), 771 F.3d 623 (9th Cir. 2014), the majority stressed that courts must be cautious in applying equitable mootness when a party diligently sought a stay—warning that applying the doctrine in such situations could transform the doctrine to one of “inequitable mootness”. The majority then concluded that Lender’s diligence in filing its appeal and seeking a stay strongly militated in favor of appellate review of Lender’s objections.

Factor #2: Substantial Consummation of the Plan

The Ninth Circuit next turned to the question of substantial consummation.  The majority noted that the term “substantial consummation” has been defined in section 1101(2) as:

(A) transfer of all or substantially all of the property proposed by the plan to be transferred;

(B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and

(C) commencement of distribution under the plan.

The majority concluded that the plan was, in fact, substantially consummated because: (i) SWVP had assumed control over the Debtors, (ii) reorganized them by extinguishing the Mezzanine Debtors’ equity interests in the Operating Debtors, and (iii) funded accounts necessary to make disbursements under the plan. The majority, however, expressly rejected the notion that substantial consummation creates a presumption that the appeal is moot—noting that the law of the Ninth Circuit has never included such a presumption.

Factor #3: Impact on Innocent Third Parties

The Ninth Circuit then addressed the penultimate factor—the interests of third parties.  Once again citing to Thorpe Insulation, the majority articulated the third prong of the equitable mootness test as “whether it is possible to [alter the plan] in a way that does not affect third party interests to such an extent that the change is inequitable.” The majority clarified that a third party’s reliance on the plan’s consummation is not sufficient to meet this test. Instead, the majority acknowledged that an appeal might be equitably moot if the specific relief sought bears “unduly” on innocent third parties.

Analyzing Lender’s first objection, the majority concluded that the relief requested by Lender—i.e., exclusion of the five to fifteen year exception in the restructured Mortgage Loan’s due-on-sale clause—affects only the division of any appreciation in value of the hotels between the Lender and the Reorganized Debtors (or SWVP, their owner).  In determining that this relief would not “unduly” bear on the investor, the majority noted that SWVP was hardly an “innocent” third party. Instead, the majority reasoned, SWVP had participated in the bankruptcy case by, inter alia, attending the hearings on plan confirmation, negotiating the final form of the confirmation order, and objecting to the stay relief requested by Lender.  Thus, the majority opined, SWVP was not the type of innocent third party that the third prong of its equitable mootness test was crafted to protect.

In considering Lender’s second objection, the majority noted that Lender proposed two forms of alternate relief if it prevailed on its appeal of the bankruptcy court’s interpretation of section 1129(a)(10)—namely, either (i) compensating Lender for the extinguishment of its collateral for the Mezzanine Loans; or (ii) reinstating its liens on the ownership interest in the Reorganized Debtors.  The majority found that the Reorganized Debtors had failed to show how either of Lender’s proposed forms of relief would affect innocent (as opposed to interested) third parties, given that the two forms of relief would alter only the relationship between Lender and the Reorganized Debtors.

Factor #4: Equitable Relief Without Undoing the Plan    

Lastly, the Ninth Circuit considered the potential fall-out from the reversal or modification of the plan confirmation order.  The majority identified the fourth, and “most important,” prong in its equitable mootness test as whether the bankruptcy court could fashion equitable relief without undoing the plan should Lender prevail on the merits of its appeal.  Again relying on Thorpe Insulation, the majority concluded that an appeal is not moot where there are any forms of even partial relief that could be provided without unravelling the plan.

The majority declined to consider the merits of Lender’s first objection, focusing instead on whether the bankruptcy court could provide any equitable relief to Lender on appeal, even if that relief was incomplete.  The majority did, however, articulate two forms of potential partial relief available to Lender if it prevailed on its first objection on appeal: (i) the court could reduce the length of the due-on-sale exception; and (ii) if the sale took place in the exception window, then Lender could receive some percentage of the difference between the balance of the loan and its present value.  In reaching this conclusion, the majority rejected Reorganized Debtors’ argument that such relief would be inequitable, noting that the objecting parties had failed to articulate how such relief would undo the plan.

Examining Lender’s second objection, the majority noted that Lender, as the sole creditor of the Mezzanine Debtors, voted against the plan—which would violate section 1129(a)(10)’s requirement for confirmation if Lender prevailed on this objection on appeal.  The majority observed, however, that if the Mezzanine Loan had been paid in full, that class would have been deemed to have voted for the plan.  Thus, the majority concluded, making that payment (with interest) now could at least offer a partial remedy, and one that would not necessarily undo the plan.

Judge Smith’s Dissent

In his dissenting opinion, Circuit Judge Milan D. Smith, Jr. criticized the majority’s application of the Ninth Circuit’s equitable mootness test on several bases. Citing to the Third Circuit’s In re Continental Airlines decision, 91 F.3d 553 (3d Cir. 1996), Judge Smith first opined that substantial consummation should be the “foremost consideration” in assessing equitable mootness, writing:

[A]s the majority acknowledges, many of our sister circuits have held that substantial consummation creates a presumption of equitable mootness. While we have not recognized such a presumption, nothing in our precedents suggests that we should not accord significant weight to substantial consummation in determining whether an equitable and effective remedy is available.

Id. at 1173 (citations omitted and emphasis in original).

Next, reasoning that “the majority’s decision discourages potential investors from relying on the finality of bankruptcy court confirmation orders,” Judge Smith pointed out that third parties’ reliance on bankruptcy confirmation orders is critical to facilitating workable reorganizations.  Indeed, Judge Smith strongly disagreed with the majority’s conclusion that the equitable mootness doctrine was not designed to protect the interests of a third-party investor like SWVP. The dissent emphasized that there is no indication that SWVP had any connection with the bankruptcy cases until the Debtors approached it to fund the reorganization plan the Debtors had already crafted. Also, observing that SWVP funded the plan approximately three years ago, Judge Smith noted that the majority’s application of the equitable mootness test encourages investors to delay funding post-confirmation improvements until any appeal of the confirmation order is completed.  Noting that such a delay is likely to have a detrimental impact on both creditors and debtors, the dissent concluded that protecting the interests of those who acquire assets in reliance on a confirmed plan increases the price an estate can realize for those assets—thereby benefiting the estate and its creditors.

Finally, Judge Smith disagreed with the majority’s conclusion that the bankruptcy court could fashion truly equitable relief without disrupting the plan. In contrast to the majority, the dissent examined each of Lender’s two objections on the merits, and concluded that through its appeal, Lender requested relief more favorable than the prepetition terms of its loans. Specifically, Judge Smith observed that the Mortgage Loan did not contain a due-on-sale provision in the first place. The dissent also noted that the collateral securing repayment of the Mezzanine Loan was worthless, as it consisted of the Mezzanine Debtors’ ownership interest in the “deeply insolvent” Operating Debtors.  To the extent Lender’s Mezzanine Loan had value due to its ability to veto the plan, the dissent concluded that the availability of such relief did not justify wholly upsetting the plan. 

AUTHOR’S COMMENTARY

This opinion provides substantial guidance to those considering, or opposing, an appeal of a plan confirmation order. First, as confirmed by the majority, a creditor’s failure to seek a stay of the plan’s consummation pending appeal is a significant consideration of whether an appeal might be deemed as equitably moot.  While it is not certain that an appeal will be rendered moot if the appellant fails to seek a stay, Transwest Resort Properties confirms that an appellant should strongly consider seeking such a stay so as not to run afoul of the first factor in the Ninth Circuit’s equitable mootness test. 

Importantly, the Transwest Resort Properties decision also affirms that under the law of the Ninth Circuit a plan’s substantial consummation does not create a presumption of equitable mootness. Thus, even where the plan has been substantially consummated (whether or not a stay was sought), a court may consider an appeal of the confirmation order on its merits if an equitable remedy could be fashioned without unwinding the plan, and that remedy does not unduly impact “innocent” third parties.  It is also noteworthy that the majority, as well as the Thorpe Insulation court, recognizes the “great discretion” bankruptcy courts have in devising such a remedy.  See Thorpe Insulation, 677 F.3d at 883.

The majority confirms that where a creditor is appealing confirmation of a plan but only seeks money, it is generally not impossible to provide a remedy. See alsoPlatinum Capital, Inc. v. Sylmar Plaza, L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070, 1074 (9th Cir. 2002) (“Even if the plan has been substantially consummated, because Platinum’s claim is only for monetary damages against solvent debtors, this is not a case in which it would be impossible to fashion effective relief.”).  Whether that remedy is equitable, and whether and to what extent that remedy might detrimentally impact third parties, however, depends on the structure of the plan, the timing for its implementation, and the bankruptcy court’s creativity in devising relief that addresses the appellant’s colorable objections without unravelling the plan.

Still, more definitive guidance on the scope and applicability of the equitable mootness doctrine may be forthcoming. On January 11, 2016, Aurelius Capital Management, LP (“Aurelius”) filed its petition for a writ of certiorari in the Supreme Court of the United States.  Aurelius’ petition arises from the Third Circuit Court of Appeals’ decision affirming the dismissal of Aurelius’ appeal of the plan confirmation order entered in the Tribune Media Company chapter 11 proceedings over its objections. See In re Tribune Media Co., 799 F.3d 272 (3d Cir. 2015). Noting that the Supreme Court has never reviewed the judge-made equitable mootness doctrine, Aurelius argues that the Supreme Court’s review “is urgently needed to bring uniformity (and some measure of restraint)” to the interpretation and application of this doctrine.  (Petition, p. 2.)  Unless and until the Supreme Court grants Aurelius’ petition for certiorari, however, the Ninth Circuit’s ruling and reasoning in Transwest Resort Properties decision should guide the actions of those considering an appeal of a plan confirmation order in this circuit.

These materials were written by Monique Jewett-Brewster of Hopkins & Carley, APLC in San Jose, California (mjb@hopkinscarley.com).  Ms. Jewett-Brewster is a past Co-Chair of the Insolvency Law Committee, and a current member of the Business Law Section’s Executive Committee.  Editorial contributions were provided by ILC member Michael T. Delaney of Baker & Hostetler, LLP in Los Angeles. 

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Best regards,

Insolvency Law Committee

Co-Chair
Leib Lerner 
Alston & Bird LLP
Leib.Lerner@alston.com

Co-Chair
Corey Weber 
Brutzkus Gubner Rozansky Seror Weber LLP
cweber@brutzkusgubner.com

Co-Vice Chair
Asa S. Hami 
SulmeyerKupetz, A Professional Corporation
ahami@sulmeyerlaw.com

Co-Vice Chair
Reno Fernandez 
Macdonald Fernandez LLP
Reno@MacFern.com