Second Circuit Adopts Abuse of Discretion Standard of Review for Equitable Mootness Decisions

[authors: Christopher J. Updike, Thomas Curtin]

On August 31, 2012, the United States Court of Appeals for the Second Circuit published its first decision expressly adopting an abuse of discretion standard for reviewing equitable mootness determinations by district courts. In In re Charter Communications, Inc., the Second Circuit followed the Third and Tenth Circuits, while also reaffirming the Second Circuit’s rebuttable presumption of equitable mootness upon substantial consummation of a debtor’s plan. The Charter court ultimately held that the presumption applied but was not overcome and therefore dismissed the appeal at issue as equitably moot. In re Charter Commc’ns Inc., 2012 WL 3764706 (2d Cir. Aug. 31, 2012).

Equitable Mootness Revisited

We have recently written about the complexities of the equitable mootness doctrine here. As discussed in that post, courts of appeals are split as to what prudential factors should be considered, what standard of review should be applied, and who has the burden of persuasion.

The Second Circuit’s standard for equitable mootness is fairly well-established: an appeal is presumed equitably moot where the debtor’s plan has been substantially consummated; however, the presumption can be rebutted if each of the following five factors are satisfied – the so-called Chateaugay factors: (1) the court can still order some effective relief, (2) the relief will not affect the re-emergence of the debtor as a revitalized corporate entity, (3) the 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, (4) the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings, and (5) 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 order subject to the appeal. Aetna Casualty & Surety Co. v. LTV Steel Company, Inc. (In re Chateaugay Corp.), 94 F.3d 772, 776 (2d Cir. 1996).

This rebuttable presumption is unique among the circuits and often places the burden on parties opposing equitable mootness rather than those asserting it. As discussed in our previous post, the Third Circuit, on the other hand, recently reiterated its narrow approach towards equitable mootness whereby courts should only apply the doctrine if the appellee can show that the relief requested will “unscramble complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract.” In re Philadelphia Newspapers, LLC, 2012 WL 3038578 (3d Cir. July 26, 2012).

Background

Charter Communications Company Inc., the nation’s fourth largest cable television company and broadband service provider, faced considerable difficulty servicing its $22 billion capital structure when the financial crisis of 2008 ensued. In response, Charter negotiated a prepackaged chapter 11 plan with its creditors with the goal of reinstating its $12 billion senior credit facility with JPMorgan Chase Bank without the need to find alternative financing.

To avoid triggering a default under Charter’s credit agreement with JPM, Charter needed Paul Allen, an investor and chairman of Charter’s board of directors, to retain 35 percent of the ordinary voting power of Charter Communications Operating, LLC, an obligor under the credit agreement, even though most of Allen’s investment would be wiped out. Further, for Charter to preserve over $2.8 billion in net operating losses, Allen would need to forgo exercising exchange rights and to maintain a one percent ownership interest in Charter Communications Holding Company, LLC. In short, Charter’s reorganization depended on Allen’s cooperation.

After “spirited” negotiations, Allen agreed to the concessions in exchange for $375 million. The settlement also provided for a $1.6 billion rights offering, a stepped-up tax basis in a significant portion of Charter’s assets, the purchase of Allen’s preferred shares in CC VIII, a Charter subsidiary, and third-party releases to be incorporated in the plan for Allen and Charter’s management.

Charter and its subsidiaries commenced their bankruptcy cases on March 27, 2009, and the bankruptcy court confirmed the prepackaged plan on November 17, 2009 after a 19-day hearing. The Law Debenture Trust Company of New York, the indenture trustee for certain notes issued by Charter, and R2 Investments, a shareholder, appealed the confirmation order and filed motions with the bankruptcy court and district court seeking a stay pending appeal, which were denied. The plan became effective on November 30, 2009, and implementation began immediately thereafter.

On appeal, the appellants disputed the propriety of the Allen settlement, the valuation of Charter, and the plan’s compliance with the cramdown provisions of the Bankruptcy Code, and they requested that the district court (i) direct Allen to return the payments made under the settlement, (ii) strike the third-party releases bestowed upon Allen and others, and (iii) reverse and remand the confirmation order so that the bankruptcy court can conduct a revaluation of Charter. Allen, Charter, and the unsecured creditors’ committee argued that the relief requested on appeal could not be granted without upsetting the already consummated plan and therefore, the appeals were barred by the doctrine of equitable mootness.

The district court agreed and dismissed the appeals finding that the plan had been substantially consummated and that the appellants had failed to rebut the presumption that the appeals were equitably moot. The court held that the relief requested would undermine the Allen settlement – the cornerstone of the reorganization – and thereby unravel the plan. The appellants then appealed to the Second Circuit.

The Second Circuit’s Decision

In its opinion, the Second Circuit first addressed the standard of review for equitable mootness determinations. Ordinarily, courts of appeals review district court decisions de novo and, in prior equitable mootness decisions, the Second Circuit has simply recited this general standard of review without further discussion. However, some courts have held that because equitable mootness determinations “involve a discretionary balancing of equitable and prudential factors rather than the limits of the federal court’s authority under Article III”, they should be reviewed for abuse of discretion, similar to other matters decided in the district court’s discretion. Nordhof Invs. v. Zenith Elecs. Corp., 258 F.3d 180, 185 (3d Cir. 2001) (quoting In re Continental Airlines, 91 F.3d 553 (3d Cir. 1996)). Persuaded by this logic, the Second Circuit expressly adopted the abuse of discretion standard as well.

There was no dispute that Charter’s plan had been substantially consummated, and accordingly, the Second Circuit next turned to the Chateaugayfactors. The Court noted that the first, fourth, and fifth factors were satisfied with respect to the relief requested on appeal; however, the appellants failed to establish that the relief requested would not affect Charter’s emergence as a revitalized entity and would not require unraveling the plan (the second and third factors).

Specifically, the Court held that “[m]odifying the terms of the Allen Settlement, including striking the releases, would be no ministerial task.” The Allen settlement was the product of an intense multi-party negotiation, and “removing a critical piece of the Allen Settlement – such as Allen’s compensation and the third-party releases – would impact other terms of the agreement and throw into doubt the viability of the entire Plan.” The Court added that the compensation and releases were important to inducing Allen to settle and “Allen may not be willing to give up the benefit he received from the Allen Settlement without also reneging on at least part of the benefit he bestowed on Charter.”

In a similar vein, the Court found that the appellants’ challenges regarding Charter’s valuation and the plan’s satisfaction of the cramdown provisions of the Bankruptcy Code would require overturning the confirmation order, revaluing each of Charter’s subsidiaries, reclassifying creditors, and recalculating distributions – not the type of relief that can be undertaken without knocking the props out from under the plan. Accordingly, the Court held that the district court did not abuse its discretion when dismissing the appeals as equitably moot.

Conclusion

The Charter decision solidifies the Second Circuit as an appellee-friendly jurisdiction when it comes to equitable mootness. Taken together, the Second Circuit’s presumption of equitable mootness and its adoption of the abuse of discretion standard of review make it more likely that appeals will be dismissed as equitably moot and less likely that such dismissals are overturned on appeal. Indeed, after a plan has been substantially consummated, appellants carry the burden of satisfying each of the Chateaugay factors and, if they fail, their odds of prevailing on appeal to the Second Circuit are slim.

[View source.]

Published In: Bankruptcy Updates, Civil Procedure Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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