“The Meaning of Moot is a Moot Point” – Paul Evans, the Guardian

The United States Court of Appeals for the Sixth Circuit recently held that parties arguing mootness under section 363(m) of the Bankruptcy Code must establish that the appellate court is unable to grant effective relief without impacting the validity of the sale.  In so doing, the Sixth Circuit rejected the per se interpretation of section 363(m) adopted by a majority of circuits.

Facts

In 2014, Susan Brown filed a voluntary petition under Chapter 7 of the Bankruptcy Code.  In her bankruptcy petition, Brown disclosed her ownership of a Michigan residence valued at $170,000, but subject to secured mortgage claims in the amount of $219,000.  Since Brown had no equity in the residence, she stated her intent to surrender the residence to the bankruptcy estate, and did not claim any exemptions for the value of her redemption rights under Michigan Comp. Law § 600.3240.

The Chapter 7 trustee of Brown’s bankruptcy estate subsequently sought the Bankruptcy Court’s permission to sell Brown’s residence for $160,000 and to distribute the proceeds among Brown’s creditors. Brown objected to the Chapter 7 trustee’s request to sell the residence and sought to amend her initial petition to claim exemptions for the value of the redemption rights she enjoyed under Michigan law. The Bankruptcy Court granted the trustee permission to sell the residence and denied Brown’s requested exemptions.

Brown appealed the Bankruptcy Court’s order approving the sale to the United States District Court for the Eastern District of Michigan, which affirmed the decision. Brown then appealed to the United States Court of Appeals for the .

The Decision

At the outset, the trustee argued that the Sixth Circuit lacked jurisdiction to hear Brown’s appeal on two grounds: (1) the case was moot on constitutional, statutory and equitable grounds; and (2) Brown lacked appellate standing because she lacked a pecuniary interest in the distribution of the sale proceeds.

With respect to mootness, section 363(m) of the Bankruptcy Code provides that appeals from a bankruptcy court’s decision to grant the trustee authority to sell certain property are moot if the appellant has failed to obtain a stay from the bankruptcy court’s order and the trustee has already conveyed the property to a bona fide purchaser for value. The Sixth Circuit acknowledged that “a majority of our sister circuits construe section 363(m) as creating a per se rule automatically mooting appeals for failure to obtain a stay of the sale at issue.” Given that Brown failed to obtain a stay from the Bankruptcy Court’s order, the “majority interpretation” of section 363(m) would suggest that Brown’s appeal is moot.

However, despite the majority rule, a “minority interpretation” has been adopted by the Third and Tenth Circuits which requires the party alleging mootness to prove an additional element: that the reviewing court is unable to grant effective relief without impacting the validity of the sale.  See In re ICL Holding Co., 802 F.3d 547 (3d Cir. 2015); In re C.W. Mining Co., 641 F.3d 1235 (10th Cir. 2011).

After careful analysis, Sixth Circuit adopted the minority approach of the Third and Tenth Circuits. The Court reasoned that such approach is “the superior interpretation” of section 363(m) because: (i) it accommodates the section’s clear preference of upholding the validity of bankruptcy sales without restricting the appellant’s right to contest errors of law made by the bankruptcy court; and (ii) is in line with the plain language of section 363(m), which does not explicitly prevent a reviewing court from redistributing proceeds from a sale. The Sixth Circuit held that since Michigan law permits imposition of a constructive trust over the proceeds from the sale of Brown’s residence, the Sixth Circuit could order relief without disturbing the sale. Accordingly, the Sixth Circuit held that Brown’s appeal was not moot.

With respect to standing, the trustee argued that Brown lacked standing because she owned no equity in the residence and, thus, was not directly and adversely affected pecuniarily by the sale. The Sixth Circuit rejected this argument, holding that since the effect of the bankruptcy court’s order was to deprive Brown of her purportedly exempted share of the sale proceeds, she was adversely affected pecuniarily by the sale order and thus had standing to appeal.

Although the Sixth Circuit rejected the trustee’s arguments with respect to mootness and standing, the Sixth Circuit nonetheless affirmed the Bankruptcy Court’s order in favor of the trustee.  Relying on its previous decision in Baldridge v. Ellmann (In re Baldridge), 553 F. App’x 598 (6th Cir. 2014) and decisions within the Third and Ninth Circuits, the Sixth Circuit held that the Bankruptcy Code does not support an exemption on the basis of state law redemption rights in a piece of property if the proceeds from the sale of that property are insufficient to satisfy prior obligations owed to secured creditors.  See also Simonson v. First Bank of Greater Pittston (In re Simonson), 758 F.2d 103 (3d Cir. 1985); Drummond v. Urban (In re Urban), 375 B.R. 882 (B.A.P. 9th Cir. 2007).  Consequently, because Brown owned no equity in the residence, the Sixth Circuit affirmed the Bankruptcy Court’s denial of Brown’s request for exemptions.

Practical Considerations:

While the Sixth Circuit’s decision affirming the sale order in In re Brown may not be particularly surprising, the Sixth Circuit’s adoption of the “minority interpretation” of mootness with respect to section 363(m) is particularly notable, and attorneys involved in appeals of sale orders should be aware that a growing number of circuits require appellees arguing mootness to establish that the reviewing court is unable to grant effective relief without impacting the validity of the sale. Given that states typically have enacted laws permitting imposition of a constructive trust over sale proceeds, In re Brown suggests that it may be challenging for a party to establish mootness under the minority interpretation.