Section 1144 Action Moot after Findings of Substantial Consummation
Reprinted with permission from the October 16, 2015 edition of The Legal Intelligencer. © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).
Just in time for baseball's playoffs, the U.S. Bankruptcy Court for the Southern District of New York delivered the third strike to a persistent but unsuccessful plaintiff seeking revocation of its confirmation order. In Perez v. TerreStar (In re TerreStar), 2015 Bankr. LEXIS 3298 (Bankr. S.D.N.Y. Sept. 29, 2015), the court found, consistent with two prior district court decisions, that the debtors' plan was substantially consummated, rendering the plaintiff's action to revoke confirmation equitably moot. Although the facts and procedural posture of the case are somewhat unusual, the decision offers practitioners a healthy reminder that if they intend to challenge confirmation of a plan, whether pursuant to Section 1144 or by appeal, they must act expeditiously to minimize the risk that the plan will be substantially consummated before their challenge can be adjudicated.
The plaintiff, Aldo Ismael Perez, was a former common shareholder of the debtors, TerreStar Corp. and certain of its affiliates. He actively participated in the bankruptcy case, including unsuccessfully seeking the appointment of an equity committee or examiner and objecting to confirmation of the debtors' plan of reorganization. During the confirmation hearing, the plaintiff raised issues regarding the valuation of certain assets and alleged that insider transactions and fraud had taken place. The court overruled the objections and confirmed the plan, which subsequently became effective roughly four-and-a-half months later. Perez appealed the bankruptcy court's decision not to reconsider denial of his motion for an examiner. He also separately appealed the confirmation order. The district court dismissed both appeals as equitably moot because the debtors' plan had been substantially consummated and the presumption of mootness had not been rebutted.
Two days prior to the first of the district court's two orders dismissing the appeals, Perez filed an action pursuant to Section 1144 of the Bankruptcy Code, seeking revocation of the confirmation order, alleging it was procured by fraud because the debtors violated a duty to disclose certain facts in the plan and disclosure statement. The debtors moved to dismiss the complaint, arguing, among other things, that the complaint was equitably moot because the plan was substantially consummated.
The court began by noting that equitable mootness is a prudential doctrine that is invoked to avoid disturbing a reorganization plan once implemented, recognizing that there is a point beyond which a court cannot order fundamental changes in reorganization actions. A challenge to a confirmed plan is presumed to be equitably moot once a debtor's plan of reorganization has been substantially consummated. Looking to Section 1101(2) of the Bankruptcy Code, the court stated that a plan is considered substantially consummated when (1) all or substantially all of the proposed property transfers in a plan have taken place; (2) the successor company has assumed the business or management of the property dealt with by the plan; and (3) the distributions established in a plan have commenced.
The court also recognized, however, that the presumption of mootness can be rebutted by satisfaction of a five-factor test under the U.S. Court of Appeals for the Second Circuit's precedent: (1) the court can still order some effective relief; (2) such relief will not affect the re-emergence of the debtor as a revitalized corporate entity; (3) such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the bankruptcy court; (4) the parties that would be adversely affected by the modification have notice of the challenge; and (5) the challenging party pursued with diligence all available remedies to obtain a stay of execution of the objectionable order.
Turning then to the plaintiff's revocation action, the court found that it was equitably moot because the debtors' plan had been substantially consummated. The court first observed that just two days after Perez filed his initial complaint, the district court found the plan had been substantially consummated in dismissing as equitably moot Perez's appeal of the bankruptcy court's decision not to reconsider the denial of his motion for the appointment of an examiner. The court then noted that four months later, the district court again found that the debtors' plan was substantially consummated in dismissing as equitably moot Perez's appeal of the bankruptcy court's confirmation order. The bankruptcy court concluded that the district court's findings on substantial consummation and equitable mootness were the law of the case.
The court also independently found that the sum of the debtors' actions since entry of the confirmation order—including issuing new common stock, preparing a required Federal Communications Commission application, finalizing the exit facility and performing the restructuring transactions—complied with the definition of "substantially consummated" under Section 1101 of the Bankruptcy Code. Additionally, because numerous transactions had taken place in reliance on the plan, the complaint was equitably moot as it would be inequitable to revoke the confirmation order for the debtors, creditors, banks and numerous other interested parties.
The court concluded that Perez had failed to rebut the presumption of equitable mootness through satisfaction of the five-factor test under Second Circuit law. With respect to the first three factors, the court found that there was no way it could provide Perez effective relief. Revocation of the confirmation order would require the debtors to claw back over $6 million in payments to creditors, causing problematic common-stock ramifications for preferred shareholders. Additionally, any relief granted would be wholly inequitable, as complicated financial, legal and operational questions would surface, requiring additional review and litigation. Moreover, inquiries into transactions that occurred prior to and since consummation of the plan would create an unmanageable and uncontrollable situation for the court. With respect to the fourth and fifth factors, the court concluded that Perez had failed to give notice of the complaint to all parties that would be adversely affected by revocation. Perez also failed to seek a stay of the plan after entry of the confirmation order. For all of these reasons, Perez had failed to rebut the presumption of equitable mootness upon the substantial consummation of a confirmed plan.
The court also found that, in addition to being equitably moot, Perez's action failed to comply with the statutory requirements of Section 1144. Recognizing that the decision as to whether to revoke a confirmation order pursuant to Section 1144 rests in the sound discretion of the court, the court stated that the statute requires that a revocation order shall "contain such provisions as are necessary to protect any entity acquiring rights in good-faith reliance on the order of confirmation." As such, the court reasoned, if the court is unable to create a revocation order that protects innocent parties that acquired rights in reliance on the confirmation order, the court is barred from revoking the confirmation order, even when procured by fraud. Perez had failed to establish, and the court could see no way, to guarantee the rights of any innocent unsecured creditors that acquired rights in reliance on the court's confirmation order. Moreover, with respect to whether the plaintiff's action was timely, the court noted that Section 1144 requires that a request for revocation of a confirmation order be made "before 180 days after the date of the entry" of the confirmation order. Perez filed the Section 1144 action on the 180th day after the court's confirmation order was entered. The court thus found that, while it was not clear whether Perez complied with the letter of the law by not filing before the 180th day, he certainly failed to comply with its spirit.
The TerreStar decision rests on some unusual facts—two prior district court findings of equitable mootness, and a plaintiff who waited six months after the confirmation order was entered, while multiple transactions central to the confirmed plan were consummated, before filing a Section 1144 action to seek revocation. The decision, however, offers practitioners a useful reminder of the consequences that can be suffered if a decision to challenge a confirmation order is delayed, whether by appeal or pursuant to Section 1144. A party must act diligently and expeditiously to preserve its ability to challenge confirmation, including seeking a stay of the confirmation order if appropriate. Absent doing so, a party risks striking out just like the TerreStar plaintiff, by a finding that the confirmed plan was substantially consummated and the challenge rendered equitably moot.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
Content contributed by attorneys of Troutman Sanders LLP and Pepper Hamilton LLP prior to April 1, 2020, is included here, together with content contributed by attorneys of Troutman Pepper (the combined entity) after the merger date.