Earlier this month – citing the “virtually unflagging obligation” of an Article III appellate court to exercise its subject matter jurisdiction – the Eighth Circuit Court of Appeals decried the pervasive overreliance by district courts on the doctrine “equitable mootness” to duck appeals of confirmation orders.[1] 

In VeroBlue, the bankruptcy court entered an order confirming a plan that awarded control of the reorganized debtor to the majority equity holder, Alder Aqua, Ltd. (the “Sponsor”).[2] Immediately after confirmation of the plan, the pre-petition senior secured lender received $6 million out of a $13.5 million investment by the Sponsor, the Sponsor became the sole shareholder of the reorganized debtor, unsecured creditors received a modest distribution (in exchange for having withdrawn their objection to the plan), and the Sponsor, as the sole shareholder of the reorganized debtors, assumed management.[3] 

FishDish LLP, a minority equity investor, appealed the confirmation order to the United States District Court for the Northern District of Iowa.  It argued that the plan unfairly discriminates among the same class of shareholders, violates the absolute priority rule, was proposed in bad faith, is not in the best interests of the creditors, and is not feasible.  But the district court declined to address the merits of the appeal, invoking the doctrine of equitable mootness.

FishDish appealed that decision to the Eighth Circuit, which began its analysis with a discussion of what equitable mootness is, and what it is not:

The doctrine’s name is misleading. A case is moot, that is, beyond a federal court’s Article III jurisdiction, only if it is impossible for a court to grant any effectual relief whatsoever. There is a big difference between inability to alter the outcome (real mootness) and unwillingness to alter the outcome (‘equitable mootness’).

The equitable mootness doctrine is based on a recognition that even when the moving party is not entitled to dismissal on Article III grounds, common sense or equitable considerations may justify a decision not to decide a case on the merits. Numerous Chapter 11 plan confirmation appeals have been dismissed when, even though effective relief could conceivably be fashioned, implementation of that relief would be inequitable.  If limited in scope and cautiously applied, this doctrine provides a vehicle whereby the court can prevent substantial harm to numerous parties.[4]

However, the Court went on to observe that the doctrine has not been “limited in scope and cautiously applied,” citing favorably to a recent critique in a concurring opinion by Third Circuit Judge Cheryl Ann Krause:

The doctrine was intended to promote finality, but it has proven far more likely to promote uncertainty and delay. Ironically[,] a motion to dismiss an appeal as equitably moot has become ‘part of the Plan.’  [Plan proponents] now rush to implement them so they may avail themselves of an equitable mootness defense[.] Rather than litigate the merits of an appeal, parties then litigate equitable mootness. And even if an appeal is dismissed as equitably moot by a district court, that dismissal is appealed to our Court, often resulting, in turn, in a remand and further proceedings. [. . . ] Without the equitable mootness doctrine, [. . . ] the District Court would have ruled on the merits long ago.[5]

Based on the record before it, the Eighth Circuit concluded that this could be just such a case where the parties attempted to use equitable mootness as a tactic to rush through plan confirmation, rather than as a shield against harm to innocent third parties:

The record on appeal suggests that the Chapter 11 proceedings in this case may have followed that pattern, yet the district court made no such inquiry. Of the $12 million paid under the Plan to creditors [. . . ] from the $13.5 million [. . . ] provided by [Sponsor], one half was paid to [the pre-petition secured creditor], and [the Sponsor] assumed management of the reorganized Debtors. These appellees are not third parties that the equitable mootness doctrine is intended to protect. Moreover, the only transfer that did not take place was [Sponsor’s] commitment to invest substantial working capital. If that did not take place because the reorganized Debtors were preparing for a quick asset sale instead of resuming operations, the case takes on the look of the type of Chapter 11 plan [. . . ] needing review on the merits by an Article III appellate court. And if the confirmed plan must be set aside on the merits, the district court may be able to fashion effective relief for those whose rights were impaired by the plan even if the business assets have been sold to a third-party purchaser relying on the confirmed plan, such as disgorgement of the proceeds. We do not assume how these factual inquiries may be resolved. We decide only that the inquiry must be made.[6]

Refreshingly, the Court gave very specific guidance to the District Court for undertaking that inquiry:

[O]n remand, the district court must make at least a preliminary review of the merits of FishDish’s appeal to determine the strength of FishDish’s claims, the amount of time that would likely be required to resolve the merits of those claims on an expedited basis, and the equitable remedies available -- including possible dismissal -- to avoid undermining the plan and thereby harming third parties.[7]

Finally, the Court concluded its analysis with a warning: 

If equitable mootness [] becomes the rule of appellate bankruptcy jurisprudence, rather than an exception to the Article III based rule that jurisdiction should be exercised, we predict the Supreme Court, having up to now denied petitions for certiorari to review the doctrine, will step in and severely curtail -- perhaps even abolish -- its use[.]