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Justices Urged to Review Judge-Made Bankruptcy Appeal Roadblock

Sept. 27, 2021, 10:00 AM

Creditors who feel they got a raw deal in corporate bankruptcies are asking the U.S. Supreme Court to scrap a legal doctrine that judges increasingly are using to block appeals from court-approved Chapter 11 plans.

Federal courts often cite the doctrine of “equitable mootness” to deny appeals from creditors, the U.S. Trustee, or other parties to review bankruptcy plans that have been approved. The judge-made doctrine dictates that once a company starts using the approved plan to restructure and make payments, undoing that process would be both difficult and unfair to both the debtor and other creditors.

Once a plan is approved, “your odds of obtaining review are next to nothing,” said bankruptcy attorney Norman Kinel of Squire Patton Boggs LLP. “That’s not an accident. That’s clearly by design.”

Critics of the doctrine say that courts are relying too heavily on it. Corporate debtors are rushing to put their approved reorganization plans into motion to stop dissenters’ appeal. The result is that creditors lose any means of overturning a potentially unlawful bankruptcy plan that they believe unfairly leaves them out in the cold.

“It’s not clear that the doctrine should exist at all,” said Melissa Jacoby, a bankruptcy law professor at the University of North Carolina at Chapel Hill. “If anything, bankruptcy needs more appellate review, not less.”

Pending Petitions

Investor David Hargreaves is one of a handful of petitioners whose challenges to equitable mootness are before the Supreme Court, awaiting a decision on whether the justices will weigh in.

A creditor of Nuverra Environmental Solutions Inc., Hargreaves was slated to recover roughly 5% on the $450,000 worth of unsecured notes he held. He appealed the oilfield servicer’s plan approval, arguing that the plan unfairly discriminated against him and other noteholders because it paid another group of unsecured creditors in full.

His claims should’ve been treated the same as theirs, Hargreaves argued.

But Hargreaves lost his appeal when the district court applied the equitable mootness doctrine. The court reasoned that undoing the plan would be unfair because the company had already issued and distributed securities in the reorganized business.

Urging the Supreme Court to hear Hargreaves’ case, Jacoby and 20 other bankruptcy law professors said in a filing last month that the justices should “rein in the lower courts’ abdication of their jurisdictional obligations” and “level the playing field in bankruptcy cases.”

National Attention

Purdue Pharma LP’s bankruptcy case could be the tipping point if the Supreme Court passes on the other petitions.

The Justice Department’s bankruptcy watchdog and a few state attorneys general have appealed controversial aspects of the opioid maker’s Chapter 11 plan, including provisions releasing the Sackler family from all future opioid-related litigation.

The DOJ’s U.S. Trustee’s Office has asked the bankruptcy court to block the plan from taking immediate effect while the appeal is pending. If the bankruptcy court denies that request and Purdue starts implementing the plan, the company later could argue that equitable mootness blocks the appeal.

The U.S. Trustee said it doesn’t believe equitable mootness would apply to Purdue’s case. Nevertheless, allowing the company’s plan to go into effect while the confirmation is being appealed means “public confidence in the bankruptcy system may be irredeemably shaken,” the agency said.

Purdue’s case already has federal lawmakers expressing concerns about alleged abuses of the corporate bankruptcy system, including equitable mootness.

During a House Judiciary Committee hearing in July, Chairman Jerrold Nadler (D-N.Y.) expressed dismay that the Sackler family could use the bankruptcy process to escape liability for its role in the opioid crisis “despite the objections of many of their victims.”

Georgetown Law professor Adam Levitin told the committee that “there’s unlikely to be any appellate review because of the equitable mootness doctrine.”

Growing Frequency

Equitable mootness has existed for decades, becoming a fixture shortly after modern bankruptcy rules were created in 1978.

Over time, federal appellate courts have established largely similar sets of selective criteria for when the doctrine can be invoked. The U.S. Court of Appeals for the Eighth Circuit has said equitable mootness should be used “only in extremely rare circumstances,” while other circuits—like the Third and Fifth—have said it should be wielded like a “scalpel.”

But bankruptcy lawyers say it’s on the rise.

“You’re in an uphill battle” to appeal a bankruptcy plan if money already has changed hands, Mayer Brown LLP bankruptcy attorney Aaron Gavant said. “Once the egg is scrambled they’re just less likely, it seems, to want to put things back together.”

Dissenting from the Third Circuit’s majority opinion in Hargreaves’ case, Judge Cheryl Ann Krause said the “narrow” doctrine is intended to be used more like “a scalpel . . . than an axe.”

But now “it is wielded with anything but surgical precision,” she said.

The issue already has some resonance with Justice Samuel Alito, who railed against equitable mootness while serving on the Third Circuit. The doctrine “can easily be used as a weapon” and “places far too much power in the hands of bankruptcy judges,” he wrote in a 2001 decision.

In addition to Hargreaves’ appeal of the Nuverra plan confirmation, the Supreme Court has an opportunity to take up at least two other petitions challenging equitable mootness.

One was filed by a group of investors holding Puerto Rican municipal bonds that were restructured as part of the island’s bankruptcy proceedings. The other involves a Windstream Holdings Inc. vendor challenging its exclusion from receiving payments during the broadband provider’s Chapter 11 case.

Some appellate court judges have expressed dismay over what they say is an expansion of the doctrine, suggesting that the time could be ripe for the Supreme Court to step in.

An Eighth Circuit panel in August ruled that a lower court stretched the doctrine too far. If equitable mootness becomes the rule rather than the exception, “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,” the appeals court said.

To contact the reporter on this story: Alex Wolf in New York at awolf@bloomberglaw.com

To contact the editors responsible for this story: Laura D. Francis at lfrancis@bloomberglaw.com; Roger Yu at ryu@bloomberglaw.com

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