In a case of first impression, the Second Circuit recently held that the doctrine of equitable mootness is applicable in appeals arising from Chapter 11 liquidations and affirmed the decision of the Southern District of New York to dismiss the appeals of three decisions in the Chapter 11 liquidation proceedings of the former book retailer Borders.
A Primer on Equitable Mootness
The equitable mootness doctrine allows a district court to dismiss a bankruptcy appeal when the district court determines that although relief could be provided, implementation of the relief would be inequitable. In the Second Circuit, the appeal of a bankruptcy decision is presumed to be “equitably moot” when the debtor’s plan of reorganization has been substantially consummated. The Bankruptcy Code defines substantial consummation 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.”
In an appeal involving a substantially consummated plan of reorganization in the Second Circuit, an objecting party, however, can overcome the presumption of equitable mootness if it can satisfy a five factor test. Under this test, the objecting party must show that:
- the court can still order some effective relief;
- such relief will not affect the reemergence of the debtor as a revitalized corporate entity;
- such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court;
- the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings; and
- the appellant pursued with diligence all available remedies to obtain a stay of execution of the objectionable order, if the failure to do so creates a situation rendering it inequitable to reverse the orders appealed from.
If an objecting party fails to demonstrate any of these factors, the appeal will be dismissed as equitably moot.
Case Background—In re BGI, Inc.
Before the Second Circuit in In re BGI, Inc. were challenges to three decisions in the Chapter 11 liquidation proceedings of Borders by individual Borders’ gift card holders: (1) the denial of two appellants’ motion to file an untimely proof of claim, (2) the rejection and discharge of one appellant’s untimely proof of claim and (3) the denial of all three appellants’ motion to certify a class of holders of Borders’ gift cards. An underlying question in each of the three decisions was whether Borders had provided sufficient notice to gift card holders by publishing notice of the bar date to file claims in The New York Times. The bankruptcy court denied the motions and rejected the untimely proof of claim determining that the gift card holders were “unknown” creditors—Borders had no reasonable means for ascertaining the addresses or identities of gift card holders—and therefore notice of the bar date to file claims by publication was proper. Moreover, the bankruptcy court concluded that the Borders’ Chapter 11 liquidation plan had been substantially consummated because the liquidation trust had already made distributions of $17 million. Thus in the bankruptcy court’s opinion, allowing untimely proofs of claim and certifying a class of gift card holders would have a disastrous effect on the liquidation, particularly final distributions. The appellants appealed the decisions to the District Court and the District Court dismissed the appeals as equitably moot.
The Second Circuit Decision
As an initial matter, the Second Circuit held, for the first time, that the equitable mootness doctrine applies to appeals arising from Chapter 11 liquidation proceedings. The Second Circuit determined that there was no principled reason for the equitable mootness doctrine to not apply in Chapter 11 liquidation proceedings. Similar to Chapter 11 reorganizations, significant resources are exhausted in Chapter 11 liquidation proceedings including judicial resources and the time and efforts of the debtor and creditors to develop an acceptable plan. Additionally, in liquidation as in reorganization, equity would caution against the disruption of a substantially consummated plan. The Second Circuit also noted that the Fifth, Eighth and Tenth Circuits have applied the equitable mootness doctrine in appeals arising from Chapter 11 liquidation proceedings.
The Second Circuit next considered whether the District Court properly determined that the appellants’ appeals were equitably moot. The Second Circuit held that the lower courts did not err in determining that Borders’ liquidation plan had been substantially consummated because all relevant property was transferred to the liquidation trust and the trust had made $17 million in distributions. The Second Circuit further agreed with the District Court’s determination that the appellants failed to satisfy at least two factors of the five-factor test. First, the appellants failed to demonstrate that parties who could be adversely affected by the appeal—general unsecured creditors who could be stripped of their entire recovery if the class of gift card holders was certified—received notice of the appeal. Second, the appellants failed to demonstrate that they had pursued their claims with all diligence because the appellants did not appear at the confirmation hearing, did not file objections to the plan and did not appeal the confirmation order nor seek a stay of the plan’s effective date. Accordingly, the Second Circuit affirmed the District Court’s decision to deny the appeals as equitably moot.
The Second Circuit’s decision has resolved any ambiguity in the Second Circuit as to whether the equitable mootness doctrine applies to appeals arising from Chapter 11 liquidation proceedings. Accordingly, creditors to Chapter 11 liquidation proceedings should learn from the appellants in In re BGI, Inc. and take affirmative steps during the Chapter 11 liquidation proceeding to ensure that their rights to appeal are preserved.