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Third Circuit in SCH Corporation and Delaware District Court in Tribune Emphasize the Importance of Examining the Relief Sought by Appellants When Deciding An Appeal Equitably Moot

In re SCH Corp., 2014 WL 2724606 (3d Cir. June 17, 2014); Wilmington Trust Co. v. Tribune Co. (In re Tribune Co.), 2014 WL 2797042 (D. Del. June 18, 2014) (consolidated appeals)

[Update – As explained below, in 2015 the United States Court of Appeals for the Third Circuit affirmed in part and reserved in part the Delaware District Court’s decision in Tribune.]

In In re Semcrude, L.P., 728 F.3d 314 (3d Cir. 2013), the Third Circuit discussed the analytical framework for evaluating the well-known equitable mootness factors: “(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.”  In re Continental Airlines, 91 F.3d 553, 560 (3d Cir. 1996).  More specifically, the Third Circuit stated that the equitable mootness analysis should proceed in two steps:  first, a determination as to whether the plan has been substantially consummated, and second, an examination as to whether granting the relief requested in the appeal will (i) fatally scramble the plan or (ii) significantly harm third parties who have justifiably relied on plan confirmation.  Semcrude, 728 F.3d at 321.  As emphasized by the Court, “[d]ismissing an appeal as equitably moot should be rare, occurring only where there is sufficient justification to override the statutory appellate rights of the party seeking review.”  Id. at 326-27.  The recent opinions entered in the cases of SCH Corporation and Tribune emphasize these principles, applying them to vacate a Delaware District Court equitable mootness ruling after determining that the lower court did not properly consider the relief sought by the appellants or its effect on the confirmed plan and third-parties (SCH Corporation) and to dismiss certain appeals after finding that the appellants’ proposed remedies would unravel the confirmed plan and inequitably affect third-parties who reasonably relied on the confirmation order (In re Tribune).

In In re SCH Corp., the Third Circuit vacated the District Court’s dismissal of an appeal as equitably moot.  The lower court’s decision was made without the benefit of the Third Circuit’s Semcrudedecision and was found not to have adequately examined the remedies sought by the appellants and the specific effects thereof.  For instance, the District Court found equitable mootness even though the record did not reflect that reversing the plan, as requested by the Appellants, would result “in ‘great difficulty or inequity.’”  According to the Third Circuit, this finding was incorrect because “invok[ing] equity when there is no inequity is counterintuitive.”  Moreover, the Third Circuit found that the District Court may not have considered the alternative, more limited relief sought by the appellants.  Noting that dismissal for equitable mootness should be rare, the Court remanded the appeal to the District Court for reconsideration.

In Tribune, the District Court consolidated multiple appeals filed by Wilmington Trust Company (“Wilmington Trust”), Aurelius Capital Management, LP (“Aurelius”), Law Debenture Trust Company of New York and Deutsche Bank Trust Company (collectively, the “Trustees”), and EGI-TRB, LLC (“EGI”, and together with Wilmington Trust, Aurelius, and Trustees, the “Appellants”) relating to the Bankruptcy Court’s confirmation of Tribune’s Fourth Amended Joint Plan of Reorganization (the “Plan”).  The reorganized debtors moved to dismiss the appeals as equitably moot.  Following the guidelines set forth in the Semcrude decision, the District Court first found that the Plan was substantially consummated.  See 11 U.S.C. § 1101.  More than $8 billion of cash and securities had been distributed to thousands of creditors, and notably, Appellants failed to obtain a stay.  The Court then identified the relief sought by each Appellant and analyzed whether granting such relief would unravel the Plan or cause significant harm to third-parties who relied on the finality of the confirmation order.  For all but one form of relief sought, the Court found that it would and thus, granted in part, and denied in part, the reorganized debtors’ motions to dismiss the appeals.

With respect to Aurelius’s appeal, Aurelius targeted the so-called “DCL Settlement”—the cornerstone of the Plan—which resolved certain causes of action against senior lenders related to a leveraged buyout (“LBO”) in exchange for monies that were distributed to creditors pursuant to the Plan and which assigned non-settled LBO causes of action to a trust for the future benefit of creditors. Under the Plan, certain creditors were able to choose between a distribution of only cash or a mix of cash and future trust litigation interests on account of their claims.

According to Aurelius, the settlement monies generated by the DCL Settlement were insufficient and, if the appeal was successful, the Court could require the reorganized debtors to shoulder any liabilities arising from the LBO-claims, allow the LBO-claims to move forward against the senior lenders, or modify the Plan’s distribution scheme for the benefit of Aurelius and other similarly situated noteholders.  However, the Court disagreed, holding that the proposed remedies would unravel the Plan.  If held liable for the LBO-claims, a liability amounting to approximately 22% of the total $7 billion Plan, the purpose of the Plan (i.e., Tribune’s discharge of prepetition debt) would be nullified.  Moreover, rescinding the DCL Settlement releases, allowing claims to go forward against the senior lenders, and modifying the Plan’s distribution waterfall to creditors would vitiate bargained-for, integral parts of the settlement, and ultimately lead to the reversal of the Plan.

The Trustees’ appeal centered on an intercreditor dispute, in which the Trustees contended that the Plan violated certain subordination agreements and improperly disbursed $29 million.  As a remedy, the Trustees proposed that the reorganized debtors disburse $29 million to their constituencies, creditors disgorge improper distributions, or the Court modify the trust’s ultimate distribution waterfall and redirect non-settled LBO-recoveries to them.  The Court found that these remedies would inequitably impact third-parties who relied on the finality of the confirmation order.  First, forcing a second $29 million distribution would harm the reorganized debtors’ new creditors and shareholders.  Second, disgorgement was determined impractical because the distributions were made to over 700 creditors and comprised of a mixture of both cash and trust interests.  Finally, the Court found that modifying the distribution waterfall would inequitably impact third-parties not present before the Court, namely those creditors who relied on the finality of the confirmation order to select between a cash payment or an interest in the litigation trust.

In their appeal, Wilmington Trust and EGI challenged certain bankruptcy court rulings that led to the subordination of their debt, and requested the Court modify the litigation trust distribution waterfall as a remedy.  Like the Trustees’ appeal, the Court rejected Wilmington Trust and EGI’s proposal because it would adversely and inequitably affect numerous parties not before the Court who relied on the confirmation order.  Alternatively, however, EGI argued that the Court continue the subordination of its claims to all creditors’ claims except for a specifically defined subset of creditors known as the “PHONES” who also appealed the confirmation order, asserting that they did not rely on the correctness of the confirmation order.  The District Court agreed, finding that this form of limited relief was not equitably moot.

[Update – On August 19, 2015, the United States Court of Appeals for the Third Circuit affirmed the Delaware District Court’s equitable mootness finding with respect to Aurelius’s appeal.  However, it reversed with respect to the Trustees’ appeal, finding that their appeal would neither fatally scramble the Plan nor significantly harm third parties.  More specifically, the Court found that, if the Trustees’ appeal was successful, the required remedy – a restructuring of Plan distributions between two classes – could be implemented either through a court-ordered disgorgement against a readily identifiable set of creditors or through the redirection of future distributions.  The Court also found that, while hundreds of creditors may have relied on the confirmation order and payouts made thereunder, such a reliance would not be legally justifiable if the Trustees prevailed on their appeal because such creditors would not be lawfully entitled to the distributions they received.  As held by the Court, “[i]t would be unfortunate from the[ir] perspective . . . to require disgorgement, but, if they were never entitled to that money in the first place, it is not unfair, and mootness must be fair (equitable in legalese) to be invoked.”  In re Tribune Media Co., 799 F.3d 272, 283 (3d Cir. 2015)]