Business Law

In re John Q. Hammons Fall 2006 (10th Cir. BAP) Impact to third parties and appellants’ failure to seek a stay are critical factors in determining appeal of confirmation order to be equitably moot

The following is a case update analyzing a recent case of interest:

SUMMARY

In CMBS Lenders v. JD Holdings, LLC, and John Q. Hammons Fall 2006, LLC, et al. (In re John Q. Hammons Fall 2006, LLC, et al.), Nos. KS-18-032 and KS-18-069, (10th Cir. BAP Aug. 1, 2018) (Docket No. 37) (“JD Holdings”), the U.S. Bankruptcy Appellate for the Tenth Circuit (the “BAP”) denied the appeals of multiple trustees of commercial mortgage-backed securities (“Appellants”) on the ground of equitable mootness. Appellants held security interests in a number of hotels that were the subject of confirmed chapter 11 bankruptcy plans. They appealed a number of orders, including the plan confirmation orders, on the grounds, among other things, that the plans: (1) did not require the immediate payment of the disputed portion of Appellants’ claims (including default interest), (2) did not require the escrow of sums required to pay the disputed claims; and (3) effected an impermissible substantive consolidation of the chapter 11 debtors. In dismissing the appeals on the ground of equitable mootness, the BAP ruled that reversal would create “nightmarish situation” for creditors who relied on the finality of the confirmed plans and would inevitably postpone reorganization while plan assets and claims would concurrently diminish. A copy of the opinion is available through PACER.

FACTS

John Q. Hammons Fall 2006, LLC and affiliated entities commenced 76 Chapter 11 bankruptcy cases (collectively, the “Debtors”). Together, the Debtors owned 35 hotels and other assets. The 76 bankruptcy cases were not substantively consolidated.

Appellants, creditors in 16 of the 76 bankruptcy cases, made various loans to 15 of the Debtors (the “Debtor Borrowers”) secured by a total of 19 hotels and other collateral. The combined balance of the loans, according to Appellants, exceeded $600 million.

The Debtors and creditor JD Holdings LLC (“JDH”) reached a settlement after years of litigation, subject to approval of the bankruptcy court. The settlement, set forth in a Plan Support Agreement (“PSA”), provided that the Debtors would support plans to be filed by JDH (the “Joint Plans”), and JDH would have an allowed unsecured claim in the amount of $495,938,161. The bankruptcy court confirmed the Joint Plans, which provided that: (1) JDH would purchase the Debtors’ 35 hotels and certain other assets; (2) JDH’s allowed unsecured $495,938,161 claim was subordinated to the claims of all other creditors; (3) JDH would pay in full in cash certain allowed claims on or as soon as practicable after the plan effective date; and (4) JDH would be entitled to acquire the Debtors’ equity interests in approximately 105 entities.

Pursuant to the confirmed Joint Plans, JDH and its affiliates subsequently: (1) paid more than 296 claims in full totaling some $397 million, paid the principal balance of two additional loans in the amount of approximately $252 million, and paid approximately $390 million to Appellants, such payments totaling more than $823 million; (2) acquired management companies that continue to employ thousands of employees at the 35 hotels; (3) acquired 27 of the hotels; and (4) closed on a financing arrangement through which JDH and its affiliates had drawn down approximately $635 million used to pay off mortgage loans on hotels.

Appellants appealed the plan support order and the confirmation order, but they did not seek a stay. Appellants asserted that, with respect to two of its loans with a combined balance of approximately $350 million secured by eight hotels, no steps toward substantial consummation have taken place and those hotels have not yet been transferred to JDH, and that the relief they sought could be crafted without unwinding the Plans or forcing disgorgement of monies paid to third parties by: (1) a remand to bankruptcy court for a trial on the merits of JDH’s $500 million subordinated claim; (2) a mandate requiring JDH to deposit another $30 million into a disputed claim reserve for the benefit of the CMBS lenders; and (3) requiring all defaults be cured prior to any 11 U.S.C. § 1124 reinstatement. The Debtors filed a motion to dismiss the appeals on the ground that they were equitably moot.

Finding that it would be unfair and impracticable to reverse the confirmation order and unwind the Joint Plans, the BAP dismissed the appeals.

REASONING

The Tenth Circuit has set forth a six-part test for determining whether an appeal is equitably moot. Under this test,

[A] court should decline to hear an appeal of a bankruptcy court’s decision where the answers to the following six questions indicate that reaching the merits would be unfair or impracticable: (1) Has the appellant sought and/or obtained a stay pending appeal?[1] (2) Has the appealed plan been substantially consummated? (3) Will the rights of innocent third parties be adversely affected by reversal of the confirmed plan? (4) Will the public-policy need for reliance on the confirmed bankruptcy plan—and the need for creditors generally to be able to rely on bankruptcy court decisions—be undermined by reversal of the plan? (5) If appellant’s challenge were upheld, what would be the likely impact upon a successful reorganization of the debtor? And (6) based upon a quick look at the merits of appellant’s challenge to the plan, is appellant’s challenge legally meritorious or equitably compelling?

Stay Not Sought. With respect to the first factor, Appellants argued that courts give little weight to it. In response, the BAP, citing In re Paige, 584 F.3d 1327, 1341 (10th Cir. 2009), noted that the failure to seek a stay “‘often make[s] it unfair for the court to grant relief—especially if that relief may affect third parties,’” and found that the factor weighed in favor of finding the appeals equitably moot.

Substantial Consummation. As to the second factor, the BAP stated that if the Joint Plans were considered a single plan, they had been substantially consummated. Alternatively, if the Joints Plans were considered separate plans, they had not been substantially consummated. Without resolving the question, the BAP ruled that this factor was not dispositive. Impact on Innocent Third Parties. This third factor was “of the foremost concern” to the BAP’s analysis and, accordingly, received the most attention. The Court determined that this factor “strongly” weighed in favor of equitable mootness, observing:

It would be inequitable to reverse the Plan Support Order and the Confirmation Order, and thereby deprive JDH of the $500 million subordinated claims, the immediate assumption of the contracts and leases needed to operate the hotels and other material consideration it received in exchange for its compromise in settlement, and at the same time still bind JDH to its obligations under the PSA and confirmed Joint Plans. A reversal on appeal would necessitate vacating the Confirmation Order, the disgorgement of over $800 million by more than 270 creditors, and the transfer of 27 hotels back to the Debtors with the myriad of extremely complex problems that would entail.

Public Policy and Impact on Reorganization. The BAP, considering these factors together, ruled that they “strongly” weighed in favor of a finding of equitable mootness. Reiterating its finding that it would be inequitable to deprive JDH of the material parts of its bargain while still requiring it to honor its obligations, the BAP opined that reversal would require unwinding the Joint Plans. This, it held, “would create a nightmarish situation for creditors who relied in good faith on the finality of the Joint Plans and for the bankruptcy court. Further, unwinding of the Joint Plans would inevitably postpone reorganization during which time plan assets and plan claims would likely diminish….”

The (Very) Quick Look. The BAP dispatched this factor summarily stating that: “[a]t this pre-briefing stage of the proceedings, we have not thoroughly or adequately evaluated the merits of Appellants’ claims, and a ‘quick look’ at the merits does not alter the court’s equitable mootness analysis.”

AUTHOR’S COMMENTARY

The Hammons case is a cautionary tale for parties who fail to seek a stay of the order being appealed. Although the Tenth Circuit does not take as strict a view of a party’s failure to seek a stay as some others (including the Ninth Circuit), Appellants’ failure bolstered the Court’s focus on the impact on third parties—a factor that appears to have determined the outcome. It is yet another example of a court’s unwillingness to help those who do not help themselves.

[1] The Court of Appeals for the Ninth Circuit utilizes a four-step test similar to that applied by the Tenth Circuit but takes a stronger view of the failure to seek a stay. See, e.g., discussion at Hewlett-Packard Fin. Servs. Co. v. Alternative Graphics, Inc. (In re Alternative Graphics, Inc.), BAP No. CC-14-1193-DTaKu, 2015 Bankr. LEXIS 3696, *21 (B.A.P. 9th Cir. Oct. 29, 2015). Here, HP Financial did not seek a stay pending appeal and has thus “flunked the first step.” In re Roberts Farms, Inc., 652 F.2d at 798. Granted, the Ninth Circuit has not held that an appeal of this sort is always moot if the appellant fails to seek a stay. See Rev Op Grp. v. ML Manager LLC (In re Mortgs. Ltd.) (“Mortgages I”), 771 F.3d 1211, 1216 (9th Cir. 2014) (noting “tension” in Ninth Circuit authorities concerning this issue). Therefore, consideration of the remaining steps is appropriate.

These materials were written by Diane Stanfield of Alston & Bird LLP, in Los Angeles, California (diane.stanfield@alston.com). Editorial contributions were provided by ILC member Michael W. Davis of Brutzkus Gubner in Woodland Hills, California (mdavis@bg.law).

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