The Supreme Court Signals It May Be Time to Address the Equitable Mootness Doctrine

On April 19, 2023, the Supreme Court issued an opinion arising out of the Sears bankruptcy case that suggests the Court may be willing to address the equitable mootness doctrine if the right case arises. This could be good news for the petitioners in a recently filed petition for writ of certiorari in the dispute between U.S. Bank National Association and Windstream Holdings, Inc., arising out of Windstream’s chapter 11 case. In that petition, U.S. Bank asks the Court to eliminate or modify the equitable mootness doctrine. In Windstream, as in many other recent bankruptcy cases, the plan proponents raced to consummate the reorganization plan—with billions of dollars changing hands in reliance on the plan—while objectors’ appeals were still pending. If the Supreme Court accepts the Windstream petitions and narrows, or even eliminates, equitable mootness, it could significantly alter the way contested bankruptcy cases get resolved.

Section 363(m) Is Not Jurisdictional

The Supreme Court's unanimous opinion relates to a dispute between MOAC Mall Holdings LLC (“MOAC”) and Transform Holdco LLC (“Transform”)¹ that arose out of the Sears bankruptcy case. In its bankruptcy, Sears sold substantially all of its assets to Transform. The Bankruptcy Court order approving the sale permitted Transform to designate leases that it wanted to assume as part of the sale. One such lease was for a Sears location in the Mall of America, owned by MOAC, which Transform subsequently designated for assignment. MOAC objected to Transform’s designation on the basis that Sears had not shown adequate assurance of future performance by the assignee as required by Bankruptcy Code section 365(f)(2)(B). The Bankruptcy Court overruled the objection and approved the assignment and MOAC appealed to the District Court.

In the District Court, in response to concerns that Transform would consummate the lease assignment while the appeal was pending, Transform agreed that it would not argue that the appeal was barred by Bankruptcy Code section 363(m). Section 363(m) provides that an unstayed appeal of an order approving a sale to a good faith purchaser cannot be unwound on appeal. When the District Court reversed the Bankruptcy Court’s decision, Transform belatedly raised section 363(m) in a motion for rehearing and argued that because it was jurisdictional (and thus could not be waived), the District Court was compelled to dismiss the appeal for lack of jurisdiction. “Appalled” by the apparent gamesmanship, the District Court found that its hands were tied and dismissed the appeal. On further appeal, the Second Circuit affirmed the District Court’s dismissal.

On appeal to the Supreme Court, the Court reversed the Second Circuit, finding that section 363(m) was not jurisdictional and thus could be waived by a litigant. Here, because Transform only raised section 363(m) in a motion for rehearing, the District Court was not compelled to dismiss the appeal. The Supreme Court, therefore, vacated the dismissal and remanded the case to the Bankruptcy Court for further proceedings.

Equitable Mootness Considered

Transform raised equitable mootness as an alternative grounds to affirm the Second Circuit’s decision, and while not the focus of the Supreme Court’s analysis, its rejection of this argument may prove the most impactful in the long run. Equitable mootness is a common law abstention doctrine that permits “appellate courts to dismiss bankruptcy appeals when, during the pendency of an appeal, events occur such that even though effective relief could conceivably be fashioned, implementation of that relief would be inequitable.” Apollo Glob. Mgmt., LLC v. Bokf, NA (In re MPM Silicones, L.L.C.), 874 F.3d 787, 804 (2d Cir. 2017). For example, it may be inequitable to unwind part of a plan of reorganization after it has been confirmed and consummated, when parties relied upon an unstayed confirmation order to close a complex business transaction. In fact, in the Second Circuit, there is a presumption that “a bankruptcy appeal is . . . equitably moot when the debtor’s reorganization plan has been substantially consummated.”² In re BGI, Inc., 772 F.3d 102, 108 (2d Cir. 2014). As a result, appellants end up in a race to either stay bankruptcy court orders (many times unsuccessfully) or have their appeal decided prior to the consummation of the debtor’s plan of reorganization, while plan proponents race to implement a plan of reorganization before the appeal could be adjudicated.³

While the Second Circuit continues to embrace equitable mootness, other courts have expressed more skepticism of the doctrine. Justice Alito, for example, famously expressed disfavor of equitable mootness when he sat on the Third Circuit, noting that “equitable mootness doctrines can easily be used as a weapon to prevent any appellate review of bankruptcy court orders confirming reorganization plans” and thus imbues bankruptcy judges with excessive power.⁴ The Ninth Circuit at least partially embraces Justice Alito’s views on this issue, finding it would be inequitable if “a party’s claims, although diligently pursued, are equitably moot because of the passage of time, before the party had a chance to present views on appeal.”⁵ If a party did seek a stay, even if a party isn’t successful in obtaining one, then the Ninth Circuit will attempt to remedy “appellate claims that can be remedied by some reasonable means without totally dislodging the [ ] plan,”⁶ whereas the Second Circuit likely will not.

As an alternative to the 363(m) argument, Transform argued that appeal was equitably moot because only the debtor (Sears) could invoke Bankruptcy Code section 549 to unwind the leasehold assignment. Because Sears waived that right and the deadline to invoke section 549 had by then expired, the Supreme Court could not fashion effective relief even if it reversed the lower court decisions, the touchstone of equitable mootness. The Supreme Court, citing its prior opinion in Chafin,⁷ rejected that argument, however, on the basis that mootness is generally disfavored. It noted that MOAC “simply seeks typical appellate relief” and that the mere possibility that effective relief may not be achievable is not a basis to invoke equitable mootness. As a result, the Supreme Court stated that it was not appropriate for an appellate court to make factual findings as to whether Transform is correct that no relief remains legally available to MOAC under the bankruptcy code before any lower court does so.

Windstream Petition Squarely Presents Equitable Mootness

The Supreme Court’s ruling in MOAC suggests that they are skeptical of equitable mootness and may be willing to strike down, or at least narrow, the doctrine should the opportunity present itself. It just so happens a cert petition was filed recently in a dispute arising out of the Windstream bankruptcy that may give the Supreme Court the opportunity to do just that. There, U.S. Bank appealed a confirmation order and asks the Supreme Court to either reject the doctrine entirely,⁸ or, in the alternative, to modify the doctrine to resolve circuit splits by (1) clarifying that whether appellant sought a stay of the reorganization plan should only be a factor and not a requirement to have diligently sought a stay,⁹ and (2) shifting the burden of proof to the party seeking a dismissal of an appeal on equitable mootness grounds.¹⁰

U.S. Bank serves as indenture trustee for bondholders holding more than US$1 billion in unsecured notes who were left without any recovery under Windstream’s confirmed plan of reorganization. U.S. Bank appealed the plan confirmation order, arguing that the Bankruptcy Court erred in confirming the plan because (1) the plan unfairly paid secured creditors more than the aggregate value of their collateral and adequate protection claims at the expense of unsecured creditors,¹¹ and (2) the proceeds of certain settlement payments to the debtors were unencumbered assets that should have been distributed to unsecured creditors.¹² U.S. Bank also sought from the Bankruptcy Court a stay of the confirmation order from the bankruptcy court. The Bankruptcy Court denied the stay on the grounds that U.S. Bank could not demonstrate irreparable harm and there was a strong public interest in proceeding to conclude and permitting the plan to go effective. The District Court then denied a motion to expedite the appeals and the plan went effective while the appeals were pending.

Once the plan went effective, Windstream successfully argued that the District Court should dismiss the appeals on equitable mootness grounds.¹³ The Second Circuit, following established Second Circuit precedent, affirmed the dismissal because the plan was substantially consummated and thus presumed moot. The Second Circuit also agreed with the District Court that U.S. Bank could not overcome that mootness presumption because U.S. Bank did not diligently seek a stay of the plan confirmation order.¹⁴

U.S. Bank’s cert petition with the Supreme Court thus squarely puts the viability of equitable mootness before the Supreme Court. Windstream’s opposition to the cert petition is due May 24, 2023. The Supreme Court will likely decide whether to accept the cert petition in the fall. If accepted, we expect a decision some time in the first half of next year. We will continue to monitor this case as it develops.

¹ A copy of this opinion may be found at https://www.supremecourt.gov/opinions/22pdf/21-1270_3204.pdf.

² To overcome this presumption the Second Circuit requires an appellant to show all five of the following factors: “(i) effective relief can be ordered; (ii) relief will not affect the debtor’s re-emergence; (iii) relief will not unravel intricate transactions; (iv) affected third-parties are notified and able to participate in the appeal; and (v) [the] appellant diligently sought a stay of the reorganization plan.” In re MPM Silicones, L.L.C., 874 F.3hd 787, 804 (2d Cir. 2017).

³ See In re One2One Communications, LLC, 805 F.3d 428, 446 47 (3d Cir. 2015) (Krause, J., concurring) (noting that “[p]roponents of reorganization plans now rush to implement them so they may avail themselves of an equitable mootness defense.”).

⁴ Nordhoff Investments v. Zenith Electronics, 258 F.3d 180, 192 (3d Cir. 2001) (Alito, J., concurring). See also, In re Continental Airlines, 91 F.3d 553, 567 83 (3d Cir. 1996) (Alito, J., dissenting).

⁵ In re Thorpe Insulation Co., 677 F.3d 869, 881 (9th Cir. 2012).

⁶ Id. If appellant sought a stay, then the Ninth Circuit will look at (i) “whether the plan has been substantially consummated,” (ii) “whether third party rights have intervened” such that “modification of the plan would bear unduly on the innocent,” and (iii) “whether the bankruptcy court on remand may be able to devise an equitable remedy.”Id.at 881 83.

⁷ The Supreme Court wrote in Chafin that a “case becomes moot only when it is impossible for a court to grant any effectual relief whatever to the prevailing party . . . . As long as the parties have a concrete interest, however small, in the outcome of the litigation, the case is not moot” (citing Mills v. Green, 159 U.S. 651, 653). Chafin v. Chafin, 568 U.S. 165, 172 (2013).

⁸ Arguing, among other things, that under the framework set forth in the Constitution, it is for Congress alone to place limits on the matters that are to be heard by Article III courts with respect to bankruptcy matters and their review.

⁹ Whether appellant has diligently sought a stay is the “chief consideration” in the Second Circuit’s analysis of the equitable mootness factors. In re Metromedia Fiber Network, Inc., 416 F.3d 136, 144 (2d Cir. 2005).

¹⁰ Because the Second Circuit presumes equitable mootness upon substantial consummation of the plan, it is the appellant who bears the burden of proof in overcoming this presumption. See In re BGI, Inc., 772 F.3d at 108.

¹¹ The bankruptcy court rejected U.S. Bank’s objection, finding that there was no unencumbered value to distribute to unsecured creditors given the value of the secured creditors’ pre-petition and adequate protection liens and superpriority adequate-protection claims.

¹² The bankruptcy court rejected this objection as well, finding that more senior classes of creditors had a lien on the settlement proceeds by virtue of a general lien on intangibles since the case derived from the settlement constituted proceeds of a litigation claim.

¹³ Windstream argued that vacating, reversing, and remanding the confirmation order would require “unscrambling” the plan of reorganization that was already consummated and would harm the debtors’ chance of emerging from bankruptcy and undo many complex financial transactions related to the plan.

¹⁴ U.S. Bank argues that seeking a stay sooner than they did would have been futile as it would have been unable to demonstrate irreparable harm given consummation required months of regulatory approvals, although the Second Circuit dismissed this argument as forfeited since it wasn’t raised at the district court level.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John J. Rapisardi, an O’Melveny partner licensed to practice law in New York, Daniel S. Shamah, an O’Melveny partner licensed to practice law in New York, and Adam P. Haberkorn, an O’Melveny counsel licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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