United States: First Circuit Limits Scope Of Jevic In Mooting Appeal Of Unstayed Bankruptcy Sale Order

Last Updated: April 19 2018
Article by Caitlin K. Cahow

In Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), the U.S. Supreme Court held that the Bankruptcy Code does not allow bankruptcy courts to approve distributions to creditors in a "structured dismissal" of a bankruptcy case which violate the Bankruptcy Code's ordinary priority rules without the consent of creditors. The highly anticipated ruling prompted speculation as to whether courts would apply the decision more broadly to other bankruptcy-related distributions in connection with, for example, "first day" payments to vendors and employees, or payments to creditors in connection with settlements or asset sales.

Recently, In re Old Cold LLC, 879 F.3d 376 (1st Cir. 2018), the U.S. Court of Appeals for the First Circuit provided some indication that courts will limit Jevic's reach into these other areas, when it refused to apply Jevic to disturb an asset sale under section 363(b) of the Bankruptcy Code. Instead, the court applied section 363(m) of the Bankruptcy Code to render statutorily moot an appellate challenge to a sale to a good faith purchaser.

Mootness

"Mootness" is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. In federal courts, an appeal can be either constitutionally, equitably, or statutorily moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.

By contrast, the judge-fashioned remedy of "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan.

An appeal can also be rendered moot by statute. For example, sections 363(m) and 364(e) of the Bankruptcy Code respectively provide that the reversal or modification on appeal of an order authorizing a sale of assets or financing does not affect the validity of the sale or any debt or lien resulting from the financing if the purchaser or lender acted in "good faith" and no stay of the order pending appeal was obtained.

Jevic and Structured Dismissals

As the Supreme Court noted in Jevic, chapter 11 cases culminate by either confirmation of a plan of reorganization or liquidation that becomes effective; conversion to a chapter 7 case; or dismissal of the case. In the case of dismissal, section 349(b) of the Bankruptcy Code is designed to reinstate as nearly as possible the pre-bankruptcy status quo unless the court orders otherwise "for cause." Prior to Jevic, some courts relied on this provision to approve "structured dismissals" of chapter 11 cases that provide for rights and protections typically seen in chapter 11 plan confirmation orders, including distributions to creditors. In some instances, these distributions deviated from the Bankruptcy Code's priority scheme.

The Supreme Court had an opportunity to weigh in on the legitimacy of structured dismissals and distributions deviating from the Bankruptcy Code's priority scheme in Jevic. In its 6-2 ruling, the Court held that bankruptcy courts may not deviate from the Bankruptcy Code's priority scheme when approving structured dismissals without the consent of creditors (without, however, offering any "view about the legality of structured dismissals in general").

The Court's majority distinguished cases in which courts have approved interim settlements resulting in distributions of estate assets in violation of the priority rules, such as In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007). The majority found that Iridium "does not state or suggest that the Code authorizes nonconsensual departures from ordinary priority rules in the context of a dismissal—which is a final distribution of estate value—and in the absence of any further unresolved bankruptcy issues." In this sense, the majority explained, the situation in Iridium was similar to certain "first day" orders, where courts have allowed for, among other things, payments ahead of secured and priority creditors to employees for prepetition wages or to critical vendors on account of their prepetition invoices.

The majority further explained that "in such instances one can generally find significant Code-related objectives that the priority-violating distributions serve." By contrast, the majority noted, the structured dismissal in Jevic served no such objectives (e.g., it did not benefit disfavored creditors by preserving the debtor as a going concern and enabling the debtor to confirm a plan of reorganization and emerge from bankruptcy). Rather, the majority emphasized, the distributions at issue "more closely resemble[d] proposed transactions that lower courts have refused to allow on the ground that they circumvent the Code's procedural safeguards" (citing, among others, certain section 363 asset sales).

The First Circuit considered whether Jevic's rationale should extend to a section 363(b) asset sale in Old Cold.

Old Cold

Chapter 11 debtor Tempnology, LLC (subsequently renamed Old Cold LLC) (the "Debtor") auctioned off substantially all of its assets pursuant to section 363(b) of the Bankruptcy Code. Only two bidders participated in the auction, Schleicher and Stebbins Hotels LLC ("S&S"), the stalking horse bidder, and Mission Product Holdings, Inc. ("Mission"). S&S was both a secured creditor and the majority stockholder of the Debtor. Mission was a distributor of the Debtor's clothing products and a licensee of the Debtor's intellectual property.

S&S was declared the winning bidder, with a bid consisting of certain prepetition and postpetition secured debt (i.e., a credit bid), assumption of postpetition accounts payable, and assumption of certain prepetition unsecured debt, with cash, inventory, and accounts receivable being retained by the estate.

Following two days of evidentiary hearings, the bankruptcy court approved the sale to S&S. After considering, among other things, whether the sale process provided creditors with the same substantive protections as the plan confirmation process, the court held that the transaction did not subvert chapter 11's substantive creditor protections. It also determined that the absolute priority rule was not implicated because "S&S will not retain its equity interest or receive any distribution on account of it, but is instead purchasing the Debtor's assets." In addition, the court ruled that S&S's assumption of liabilities did not constitute an attempt to circumvent the Bankruptcy Code's prohibition against intra-class discrimination under section 1129(b)(1) and that S&S was entitled to credit bid its secured claim.

Concluding that there was no evidence of misconduct or collusion in the sale process, the court held that S&S was a "good faith purchaser" within the meaning of section 363(m). In its order approving the sale, the court also waived the 14-day stay in Rules 6004(h) and 6006(d) of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules"). This meant that the sale order became effective immediately upon entry. The Debtor and S&S consummated the sale.

Mission appealed, first to the Bankruptcy Appellate Panel for the First Circuit, which affirmed the sale order, and then to the First Circuit.

The First Circuit's Ruling

A three-judge panel of the First Circuit also affirmed. In so ruling, the court followed the majority of circuits that have generally adopted a per se rule that the appeal of a sale order is statutorily mooted if the closing of the sale is not stayed pending appeal.

Mission's principal arguments on appeal were that: (i) there was evidence of collusion, and because S&S was an insider, the bankruptcy court was required to apply "heightened scrutiny" in assessing whether S&S was a good faith purchaser, yet failed to do so; and (ii) Mission was not given adequate notice of the Debtor's request for a waiver of the 14-day stay in Bankruptcy Rules 6004(h) and 6006(d), and accordingly, Mission's failure to obtain a stay of the sale order pending appeal should be excused.

In the alternative, Mission argued that the Supreme Court's decision in Jevic—decided more than a year after the bankruptcy court approved the sale—controlled the outcome of Mission's appeal. According to Mission, because S&S's winning bid provided for the payment of certain unsecured claims (i.e., the prepetition unsecured debt assumed by S&S) before Mission's administrative claims under its distribution and licensing agreement, the sale impermissibly violated the priority rules in contravention of Jevic.

The Debtor countered that Jevic, which on its face addresses only structured dismissals, does not apply to section 363(b) asset sales, which involve potentially "offsetting bankruptcy-related justification[s]" not present in structured dismissals.

The First Circuit declined to consider a Jevic-based challenge to the propriety of the sale, holding that "section 363(m) applies even if the bankruptcy court's approval of the sale was not proper, as long as the bankruptcy court was acting under section 363(b)." The court further emphasized that "[s]ection 363(m) sets forth only two requirements: that there is a good faith purchaser, and that the sale is unstayed." It concluded, "Nothing in Jevic appears to add an exception to this statutory text."

Accordingly, the First Circuit panel affirmed the sale order, concluding that S&S was a good faith purchaser entitled to the protection of section 363(m) and ruling that Mission's "remaining challenges to the sale order are therefore rendered statutorily moot."

Outlook

Old Cold indicates at least the First Circuit's disinclination to apply Jevic expansively in the context of asset sales protected from appellate challenge by section 363(m). It remains an open question as to whether the First Circuit and other courts will be more receptive to a Jevic-based challenge to distributions deviating from the Bankruptcy Code's priority scheme in other contexts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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