United States: Litigation Claimants Get A Second Chance In Bankruptcy Appeal

On June 17, 2014, a three-judge panel of the Third Circuit Court of Appeals¹ vacated a District Court's dismissal order and resuscitated a bankruptcy appeal brought by a group of litigation creditors seeking recourse against the debtors post-confirmation.² The Third Circuit opinion is an important reminder to both debtors and creditors that the doctrine of "equitable mootness" has limits and that confirmation of a plan does not preclude review of post-confirmation actions inconsistent with obligations in the plan.

The debtors, SCH Corp., American Corrective Counseling Services, and ACCS Corp., which had been engaged in the debt collection business, filed for Chapter 11 bankruptcy in the District of Delaware in January 2009. The largest group of unsecured creditors were plaintiffs in pending class actions brought under the Fair Debt Collection Practices Act and similar statutes against the Debtors in California, Florida and Indiana (the "CFI Claimants").³

The bankruptcy plan of liquidation, confirmed with support by the CFI Claimants, allowed for a sale of the Debtors' businesses to a subsidiary of their largest creditor, National Corrective Group ("NCG"). The CFI Claimants rejected an initial plan containing third-party releases preventing them from pursuing NCG post-bankruptcy in exchange for total consideration of approximately $2.5 million.⁴ The amended plan removed those third-party releases and provided for payments by NCG of $200,000 a year for five years (a total of $1 million). The plan allowed NCG to offset payments of certain litigation costs up to $200,000 per year.⁵

Post-confirmation, virtually no distributions were made to unsecured creditors (including the CFI Claimants) even though $200,000 had been distributed under the plan, as NCG asserted set-off rights following litigation initiated by the CFI Claimants' counsel post-bankruptcy against NCG.⁶ NCG also filed disqualification motions against counsel for the CFI claimants for representing CFI Claimants and the plaintiffs in the new California litigation against NCG.⁷ These disqualification motions were successful.

Subsequently, the CFI Claimants sought a range of relief in bankruptcy court, moving for a dismissal of the debtors' bankruptcy cases, enforcement of the terms of the amended plan, and sanctions against NCG, and asserting, inter alia, that the person appointed as disbursing agent and litigation designee, Carl Singley, "acted in bad faith by transferring the Debtors' business to NCG while effectively insulating the new company from liability."⁸

Following a multi-day hearing, the bankruptcy court denied the relief sought.⁹ That order was appealed to the district court. The district court chose not to rule on the merits; rather, the district court dismissed the appeal as "equitably moot" after applying a test for equitable mootness from In re Continental Airlines, 91 F.3d 553, 560 (3d Cir. 1996). The five factors to be considered according to the Continental court include (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."¹⁰ The district court analyzed the factors and determined dismissal was appropriate.¹¹

The Third Circuit in examining whether the district court properly dismissed the appeal as equitably moot, focused on the district court's decision to dismiss the appeal even though the record did not indicate that reversing the plan would result in great difficulty or inequity.¹² The Third Circuit found that "[t]o invoke equity when there is no inequity is counterintuitive." In addition, the Third Circuit found such rationale to be "in tension with the guiding principle that matters should generally be decided on their merits when that is possible."¹³ The Third Circuit also questioned whether the district court had considered the full range of relief sought by the CFI Claimants and the effect of relief granted on third parties, and acknowledged that a merits decision may be necessary because "'[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.'"¹⁴

With the district court's decision vacated and the matter remanded, the CFI Claimants now have the opportunity to argue the merits of why they deserve the requested relief, and the chance to advance their argument about the bad faith transfer of the Debtors' business to NCG to shield liability from litigation claims.

Footnotes

1 The panel included Circuit Judges Thomas L. Ambro, Kent A. Jordan and Jane R. Roth, with Judge Ambro drafting the panel's opinion.

2 In re SCH Corp., 2014 WL 2724606 (3d Cir. June 17, 2014).

3 Id. at *1. A group of plaintiffs with Pennsylvania claims comprised a separate class due to the involvement of an insurance policy.

4 In re SCH Corp., 2013 WL 3380440, at *1 (D. Del. July 8, 2013), order vacated by 2014 WL 2724606 (3d Cir. June 17, 2014).

5 In re SCH Corp., 2014 WL 2724606, at *1. See also In re SCH Corp., 2013 WL 3380440, at *1.

6 In re SCH Corp., 2014 WL 2724606, at *1.

7 Id. at *1-2.

8 Id.

9 Id. at *2.

10 In re Continental Airlines, 91 F.3d 553, 560 (3d Cir. 1996).

11 In re SCH Corp., 2014 WL 2724606, at *2 (quoting In re SCH Corp., 2013 WL 3380440, at *3 (D. Del. July 8, 2013). Importantly, the district court determined that the first factor weighed against dismissal even though the "amended plan has been substantially consummated" because "the record does not indicate that reversing the amended plan would result in 'great difficulty or inequity'" as "there have been no distributions to any unsecured claimants" and "[a]rguably, the only aspects of plan implementation that require reversal are the limited number of distributions that have occurred."

12 Id. at *3 (quoting In re SCH Corp., 2013 WL 3380440, at *3).

13 Id. The Third Circuit, citing the 2013 Semcrude decision, affirmed that "[f]ederal courts have a 'virtually unflagging obligation . . . to exercise the jurisdiction conferred on them'" and that dismissing "in the face of this strong presumption should occur only where granting relief is 'almost certain to produce a perverse outcome.'" Id. (quoting In re Semcrude, L.P., 728 F.3d 314, 320 (3d Cir. 2013)).

14 Id. (quoting In re Semcrude, L.P., 728 F.3d 314, 326-27 (3d Cir. 2013)).

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.