Equitable Mootness and Forum Shopping

A few weeks ago, the Supreme Court denied cert in a case called Law Debenture Trust Co. v. Charter Communications, Inc. (No. 12-847). The issue was whether the Second Circuit had correctly applied the doctrine of equitable mootness to an appeal in the Charter Communications bankruptcy. Paul Allen -- yes, that Paul Allen -- held an ownership stake in Charter that should have been worth approximately zero because that is usually the value of an ownership stake in a bankrupt company.

Charter, however, needed to retain Allen's voting interest in the company to avoid a default in its senior credit facility with J.P. Morgan and also to preserve net operating losses. By the time negotiations were over, Allen had $375 million, Charter's purchase of his preferred stock in a Charter subsidiary, a liability release, and other consideration. The junior creditors complained the deal violated the absolute priority rule, the requirement in chapter 11 that creditors be paid in full before shareholders receive anything. Allen responded that it was a perfectly cromulent deal because he was being paid to help out Charter and not because he was a shareholder. The legal dispute revolved around the meaning of "on account of" in § 1129(b)( bb76uyhj09-=09g hewa*a[0g zzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzz . . . .

I'm sorry. I fell asleep on my keyboard as I was writing that. The same thing happened the first time I heard about this case. The hermeneutics of the phrase "on account of" do not excite. And, all sides to the dispute have the resources to hire competent attorneys to defend their interests. Nevertheless, I was persuaded to join an academics' amicus brief urging the Supreme Court to take the case. I still think the Court goofed by not taking the case, and the complex, soporific effects of the issues may be exactly a part of the larger problem. The case had important implications for the bankruptcy system as a whole, making this blog post the second in a two-part series on unintended consequences.

The Second Circuit never reached the underlying merits of the case. Instead, the court deemed the creditors' challenge of the lower court ruling to be equitably moot. (Aside -- "Equitably Moot" would be a great name for a band.) A basic application of the doctrine might be an appeal in a chapter 11 where a large number of trade creditors got small dollar payments. If the plan is overturned on appeal, then would it not be practicable to seek return of all these small payments. The appeals court would say it was therefore not going to get involved and call its reasoning "equitable mootness." A common explanation of the doctrine is that an appeals court will not hear an appeal in a chapter 11 where consummation of the plan has gone so far that is not possible to "unscramble the eggs" and return parties to the status quo before the plan was confirmed.

What started out as a narrow doctrine, however, has become a much broader one. Some appeals courts have gone so far as to hold that appeals from a chapter 11 plan that has been substantially consummated are presumed to be equitably moot. In the Charter Communications case, the appeals court would have seem to be able to grant relief by just ordering the payment of money from Allen back to the bankruptcy estate. An appellate court reversal for sure would have had adverse consequences for the prospects of Charter's chapter 11 case, but the point of equitable mootness should not be to shield chapter 11 plans from adverse consequences where these consequences are otherwise dictated by the bankruptcy law. The doctrine was never intended as an end run around generally applicable principles of bankruptcy law.

Institutional pressures and basic human tendencies also probably play a role. When an appellate court, including the Supreme Court, gets a challenge to confirmation in a large chapter 11, the issues often will look very messy. Generalist judges, most all of whom are not expert in bankruptcy matters, will have to review what is essentially a complex corporate deal. At least one side to the dispute will be warning of dire economic consequences should a ruling not fall in their favor. The equitable mootness doctrine is a very tempting way to sit it out and let the matters fall where the supposedly more expert bankruptcy court left them. Also, disposing of a chapter 11 appeal on equitable mootness grounds can be a quick way to get a case off the docket in an era of increasing judicial case loads.

The unintended consequence is that the equitable mootness doctrine has become an increasingly important way that the locus of decision-making power gets further shifted down to local bankruptcy courts. One of the core concerns about forum shopping in large chapter 11s is that local bankruptcy courts are exactly the institutional players that have the incentives to shape local law so as to attract cases to their districts. Where possibly debtor-friendly rulings on chapter 11 plans in local bankruptcy courts might serve as an inducement to forum shopping, an expansive equitable mootness doctrine prevents the appellate courts from harmonizing the law across circuits.

The cert petition in Charter Communications was a chance for the Supreme Court to pare back the equitable mootness doctrine. It would not have ended chapter 11 forum shopping, but it would have been a useful step in the right direction. The case now becomes a lost opportunity for the Court. 

Comments

[Adam]

Bob, as usual, your post embiggens my understanding of the law.