EKG Heart MonitorThe recent decision of the United States Court of Appeals for the Third Circuit in In re One2One Communications, LLC may radically alter the ability of debtors to escape appeals of confirmed plans for reorganization.  The Third Circuit, which governs the influential Delaware bankruptcy courts, has for almost 20 years embraced the judicially created doctrine of “equitable mootness” as a basis for dismissal of appeals of confirmed plans.  The doctrine, which has no textual foundation in the Bankruptcy Code, allows an appellate court to dismiss an appeal without reaching the merits if failing to do so would produce “a perverse outcome – significant injury to third parties and/or chaos in the bankruptcy court from a plan in tatters.”  In short, equitable mootness allows a debtor to argue that once a plan has been substantially consummated, it is not possible to unscramble the egg or put Humpty Dumpty back together again.

Beginning with the 1996 en banc decision in In re Continental Airlines, 91 F.3d 553 (3d Cir. 1996), the Third Circuit and lower courts in the Circuit frequently have dismissed appeals of cases large and small based on equitable mootness.  In applying the doctrine, the Third Circuit was no outlier as all but one Circuit currently recognizes its application.

In One2One Communications, however, the Third Circuit has significantly undermined equitable mootness and perhaps issued a death knell.  As discussed below, the Court clearly sought to limit the availability of the doctrine to only the most large and complex chapter 11 cases.  But even more significant change may be in the offing.  In a forceful concurring opinion, Judge Cheryl Ann Krause argues that the Circuit should convene an en banc hearing “to consider eliminating, or at the very least, reforming, equitable mootness.”

So what exactly was involved in One2One Communications?  The debtor was a billing services technology company formed as a limited liability company with a single member.  Quad/Graphics, Inc. obtained a $9+ million judgment against the debtor.  The debtor filed for bankruptcy in 2012 and after several years of efforts to confirm a plan of reorganization, the debtor successfully obtained confirmation of its fourth amended plan of reorganization.  The plan was opposed by Quad/Graphics (the appellant before the Third Circuit) which held the largest unsecured claim.  Following a five-day confirmation hearing, the bankruptcy court confirmed the plan.  The appellant sought a stay pending appeal, which was denied.  The debtor moved to dismiss the appeal as equitably moot and the district court granted the motion to dismiss.

On appeal, the Third Circuit reversed.  The Court first addressed Appellant’s request to hold equitable mootness unconstitutional.  The Court declined citing that the en banc Continental Airlines decision was binding precedent that could not be disregarded without an en banc reversal.  The Court next reviewed the five-part Continental Airlines standard for application of equitable mootness:

(1) whether the reorganization plan has been substantially consummated, (2) whether a stay has been obtained, (3) whether the relief requested would affect the rights of parties not before the court, (4) whether the relief requested would affect the success of the plan, and (5) the public policy of affording finality to bankruptcy judgments.

Relying on more recent decisions including In re Philadelphia Newspapers, LLC, 690 F.3d 161 (3d Cir. 2012) and In re Semcrude, L.P., 728 F.3d 314 (3d Cir. 2013), the Court stressed that “the doctrine must be construed narrowly and applied in limited circumstances.  In Philadelphia Newspapers, this Court emphasized that a court only should apply the equitable mootness doctrine . . . in complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract.”  Applying the Continental Airlines standard and relying on the narrow application of the doctrine, the Court concluded that the current appeal was not equitably moot.

The Court compared the facts of Continental Airlines to the present facts.  Continental Airlines involved a merger of 50+ debtors, hundreds of millions of dollars in assets, liabilities and claims, hundreds of thousands of creditors, a $110 million investment in the reorganized debtor and the assumption of leases and contracts worth over $5 billion.  In contrast, One2One Communications involved a single debtor, a single secured creditor with a lien of less than $100,000, only 17 unsecured creditors and a $200,000 investment in the debtor under the plan.  The plan did not involve any new financing, mergers, equity investment or other transactions.

Based on these facts, the Court determined that the plan would not be difficult to unravel and that the reliance by third parties on the finality of the plan was minimal.  Public policy also supported reversing the district court – an appealing party’s statutory right to appellate review carried great weight.  Thus, the Court reversed.

Had the story ended there, the decision might not have been so significant.  If there was ever a case in which a debtor could not satisfy the burden for establishing equitable mootness One2One Communications is probably the case.  However, there may be more drama to come.  Judge Krause’s concurrence and plea for an en banc consideration of the constitutionality of equitable mootness may signal the end of the doctrine altogether.  We will certainly be watching for future decisions both inside and outside the Third Circuit as courts consider Judge Krause’s concurrence and the erosion, if not the outright elimination, of equitable mootness.