by Cyrus B. Korn­feld*


The doc­trine of equi­table moot­ness grows out of the com­plex­i­ty of bank­rupt­cy pro­ceed­ings. Bank­rupt­cy involves not only the rights of cred­i­tors against debtors, but also com­pet­ing cred­i­tor rights. Chap­ter 11 adds to the com­plex­i­ty, intro­duc­ing the addi­tion­al inter­ests of pub­lic and pri­vate investors. The even­tu­al bank­rupt­cy set­tle­ment that emerges from a Chap­ter 11 process is the result of nego­ti­a­tion among these three par­ties: 1) the debtor cor­po­ra­tion, 2) the cred­i­tors, both vol­un­tary and invol­un­tary, and 3) investors, pub­lic and pri­vate. Each par­ty has unique inter­ests. The alche­my of any giv­en set­tle­ment nego­ti­a­tion will there­fore defy lat­er attempts at analy­sis. Such review by lat­er courts invites notions of “unscram­bling of an egg,” a metaphor used fre­quent­ly in dis­cus­sions of Chap­ter 11.

When the claims of invol­un­tary cred­i­tors against third par­ty debtors have been dis­charged in bank­rupt­cy, to what extent should the doc­trine of equi­table moot­ness enjoin review of those dis­charges? This piece argues that while equi­table moot­ness plays a role in bank­rupt­cy pro­ceed­ings, the doc­trine is prone to abuse, and it must be strict­ly con­trolled by a bal­anc­ing of rights and the system’s inter­est in final­i­ty in bank­rupt­cy. New con­cerns about third par­ty releas­es also mean that in some cas­es courts should look for evi­dence of sophis­ti­cat­ed par­ties exploit­ing the bank­rupt­cy code.

Bankruptcy’s inter­est in final­i­ty also sup­ports the exis­tence of equi­table moot­ness. In bank­rupt­cy, the pow­er of the law and the state inter­venes to restore cred­i­tor con­fi­dence oth­er­wise bro­ken by the debtor’s insol­ven­cy. Investors’ belief in the final­i­ty of bank­rupt­cy set­tle­ment helps sup­port this con­fi­dence. The need for final­i­ty is par­tic­u­lar­ly sig­nif­i­cant in Chap­ter 11, where the pow­er of the state serves to reha­bil­i­tate cor­po­ra­tions and bring them back into sol­ven­cy. Con­tin­u­ing unre­solved issues make invest­ment by new cred­i­tors less like­ly, there­fore defeat­ing the pur­pose of the system.

Com­plex­i­ty.2 Final­i­ty.3 Courts invoke these pow­er­ful rea­sons to sup­port the doc­trine of equi­table moot­ness. It should con­tin­ue to exist. How­ev­er, it’s appli­ca­tion should be mon­i­tored by fac­tors that incor­po­rate third par­ty inter­ests, as well as a new sen­si­tiv­i­ty to cor­po­rate manip­u­la­tion of the bank­rupt­cy process.

*****

Equi­table moot­ness has been affirmed in a major­i­ty of cir­cuit courts and stands up to the chal­lenges that have been lev­eled against it.4 One par­tic­u­lar line of attack has emerged from the appli­ca­tion of “expres­sio unius” rea­son­ing to the bank­rupt­cy code. Bank­rupt­cy courts are not allowed to make “sub­sti­tu­tions of under­ly­ing law.”5 Since equi­table moot­ness appears nowhere in the code,6 some might argue that its appli­ca­tion should be for­bid­den as an unjust exten­sion of the pow­er of bank­rupt­cy courts.7

The pru­den­tial nature of equi­table moot­ness should allay expres­sio unius con­cerns. Despite its name, “equi­table moot­ness” is a pru­den­tial and not an equi­table doc­trine.8 In the case In re City of Detroit, the Sixth cir­cuit explains: “Unlike con­ven­tion­al moot­ness, equi­table moot­ness is not con­cerned with the court’s abil­i­ty or inabil­i­ty to grant relief; it is con­cerned with pro­tect­ing the good faith reliance inter­ests cre­at­ed by imple­men­ta­tion of the bank­rupt­cy plan from being undone after­wards.”9 The doc­trine is not only wide­spread, but it has not been dis­turbed by con­gres­sion­al action since the cre­ation of Chap­ter 11 in 1978. Some might con­sid­er Congress’s silence over such a long peri­od to be an endorse­ment of the sta­tus quo.

The Supreme Court has recent­ly qui­et­ed con­sti­tu­tion­al con­cerns about equi­table moot­ness. In Stern v. Mar­shall, the Supreme Court held that bank­rupt­cy courts were review­able by Arti­cle III courts, but it in no way implied that equi­table moot­ness endan­gered Arti­cle III review.10 If present, such a threat would need to rise to the top of any analy­sis under mod­ern prin­ci­ples of Con­sti­tu­tion­al Avoidance.

Attacks have also been made on the uni­ty of cir­cuit approach­es to equi­table moot­ness. Dif­fer­ent cir­cuits apply dif­fer­ent tests to deter­mine when equi­table moot­ness is appro­pri­ate. The Sixth Cir­cuit uses a three-fac­tor test,11 the Fourth Cir­cuit uses a four-fac­tor test,12 and the Third Cir­cuit uses a five-fac­tor test that incor­po­rates inter­est in the final­i­ty in bank­rupt­cy in addi­tion to par­ty-focused con­cerns.13 How­ev­er, all equi­table moot­ness regimes are laid out accord­ing to a bal­ance between the rights of the par­ties sup­port­ing the bank­rupt­cy plan and the rights of the par­ties attack­ing it.14 All dif­fer­ent fac­tor lay­outs essen­tial­ly encap­su­late this essen­tial bal­ance: com­plex par­ty inter­ests in the con­text of the gen­er­al inter­est in final­i­ty,15 and rip­ple effects ema­nat­ing from fur­ther lit­i­ga­tion.16

The fac­tors that courts use to apply equi­table moot­ness bear out this empha­sis on bal­ance. The claims of a chal­leng­ing par­ty are tak­en into account in such analy­ses, with larg­er claims ren­der­ing courts more will­ing to sweep moot­ness aside.17 Large and seri­ous enough claims can prompt the retrac­tion of equi­table moot­ness in cas­es where plain­tiff suc­cess would impinge on the total amount of fund­ing avail­able for the bank­rupt­cy set­tle­ment.18 Courts are less like­ly to apply moot­ness where a giv­en action is part­ible from the whole case.19 There is accep­tance across fac­tor-sys­tems that this bal­ance should include third par­ties to a bank­rupt­cy who have nonethe­less invest­ed in reha­bil­i­tat­ed cor­po­ra­tions.20

*****

The courts have cal­i­brat­ed the appli­ca­tion of equi­table moot­ness using fac­tors. This allows selec­tive use of the doc­trine: build­ing up faith in the final­i­ty of bank­rupt­cy agree­ments, while pro­tect­ing cred­i­tor rights. There is a new con­cern how­ev­er, one that was brought up by the fact pat­tern in the 25th Annu­al Duber­stein Moot Court Com­pe­ti­tion, that deserves a fac­tor all its own. In cas­es where there are 1) dis­charges against third par­ties, 2) for debts incurred to invol­un­tary cred­i­tors, review­ing courts must take into account evi­dence of strate­gic activ­i­ty when decid­ing whether or not to apply equi­table moot­ness to a matter.

Unde­sir­able strate­gic behav­ior is pos­si­ble when debts incurred to invol­un­tary cred­i­tors are dis­charged against rein­vest­ing third par­ties. Sophis­ti­cat­ed par­ties can use the bank­rupt­cy process to have lia­bil­i­ty dis­charged and then use equi­table moot­ness to defend against fur­ther litigation.

Imag­ine, as in the Duber­stein fact pat­tern, a large cor­po­ra­tion that pro­duces per­son­al com­put­ers. Such a cor­po­ra­tion would no doubt have a divi­sion for design­ing and pro­duc­ing bat­ter­ies for its com­put­ers. Imag­ine that this cor­po­ra­tion spun off its bat­tery divi­sion as a pri­vate cor­po­ra­tion, and even­tu­al­ly divest­ed itself of enough own­er­ship to avoid alter-ego lia­bil­i­ty. Bat­ter­ies can have undis­cov­er­able defects that only emerge after months of use and wide­spread dis­tri­b­u­tion. These defects can be cat­a­stroph­ic. With such a cor­po­rate struc­ture, how­ev­er, all of the lia­bil­i­ty for a defect would rest with the bat­tery pro­duc­er. This is an out­come of cor­po­rate law, not bank­rupt­cy law, yet bank­rupt­cy extends fur­ther pro­tec­tion to the now third-par­ty, for­mer par­ent cor­po­ra­tion from the claims of invol­un­tary cred­i­tors. By reen­ter­ing at the bank­rupt­cy stage, the third par­ty can obtain dis­charges against itself: head­ing off pre­lim­i­nar­i­ly any lia­bil­i­ty that might accrue to it. Lever­ag­ing its pow­er and finan­cial resources, the third par­ty cor­po­ra­tion can bar­gain hard for far less than it would nor­mal­ly have been forced to pay in a tra­di­tion­al lia­bil­i­ty proceeding.

The Sec­ond Cir­cuit has already remarked on the poten­tial for abuse in non-debtor release.21 The Third Cir­cuit has also barred the usage of equi­table moot­ness in review of mass-torts cas­es.22 These courts’ sen­si­tiv­i­ty reflects the need for a new fac­tor pro­tect­ing from cor­po­rate coercion.

Large, sophis­ti­cat­ed par­ties have already made use of the bank­rupt­cy code to escape lia­bil­i­ty sys­tem­at­i­cal­ly in the past,23 and they could use such prin­ci­ples to their advan­tage against invol­un­tary cred­i­tors in the future. Allow­ing equi­table moot­ness to be used strate­gi­cal­ly would con­tribute to a dis­turb­ing trend in which cor­po­rate lia­bil­i­ty became eas­i­er and eas­i­er to shrug off through bank­rupt­cy, but pri­vate debt became increas­ing­ly dif­fi­cult for pri­vate cit­i­zens to dis­charge.24

There must be a new fac­tor to check this strate­gic behav­ior, one direct­ly focused on manip­u­la­tion of the sys­tem by sophis­ti­cat­ed par­ties in cas­es of third par­ty dis­charge. No con­sumer makes a cor­po­rate bank­rupt­cy cal­cu­la­tion when set­ting out to buy a lap­top bat­tery. Such con­sumers should not be effec­tive­ly pre­vent­ed from engag­ing in lit­i­ga­tion down the line because of an iron­clad com­bi­na­tion of cor­po­rate sep­a­ra­tion, third par­ty dis­charge, and equi­table moot­ness. Lia­bil­i­ty for explod­ing bat­ter­ies should not be decid­ed in a bank­rupt­cy set­tle­ment process. Such cas­es should be placed in the area of mass torts—where they belong.


* In this post, Cyrus B. Korn­feld (‘18) uses his expe­ri­ence at the Saint John’s Duber­stein Moot Court Com­pe­ti­tion to dis­cuss the dynam­ics of equi­table moot­ness in Chap­ter 11 bank­rupt­cy. The fact pat­tern in the 2017 Saint John’s Duber­stein com­pe­ti­tion involved a third par­ty dis­charge on tort claims aris­ing from an explod­ing bat­tery. The com­pa­ny that man­u­fac­tured the bat­ter­ies, Pad­co, had become insol­vent and had filed for Chap­ter 11 bank­rupt­cy, pre­vent­ing full recov­ery by invol­un­tary cred­i­tors. As part of the bank­rupt­cy 1) Pad­co merged into a sol­vent com­pa­ny, Gad­get, and 2) hun­dreds of mil­lions of dol­lars of bonds were raised to pay for the merg­er and the launch of a new line of prod­ucts. The bank­rupt­cy agree­ment paid the tort cred­i­tors 10% of their assessed claims. Appel­lant, Megan Kuzienews­ki, and a minor­i­ty of oth­ers refused to accept the pay­ment, but were vot­ed down by a major­i­ty with­in the class pur­suant to the mechan­ics of Chap­ter 11. Crit­i­cal­ly, the dis­charge of lia­bil­i­ty applied not only to tort cred­i­tors’ claims against Pad­co (the com­pa­ny in bank­rupt­cy), but to Gad­get as well. The defec­tive bat­ter­ies were pro­duced at a time when Gad­get held a major­i­ty posi­tion in Pad­co, though stayed enough out of its affairs to not war­rant a pierc­ing of the cor­po­rate veil. Kuzienews­ki chal­lenged the set­tle­ment reached, and sought to sue accord­ing to a nov­el the­o­ry of lia­bil­i­ty. The author wrote and argued on whether moot­ness should apply to litigation.

2. See, e.g., In re Chateau­gay Corp., 988 F.2d 322, 325 (2d Cir. 1993).

3. See, e.g., In re Zenith Elec­tron­ics Corp., 329 F.3d 338, 347 (3d Cir. 2003).

4. See, e.g., In re Metro­me­dia Fiber Net­work, Inc., 416 F.3d 136, 142 (2d Cir., 2005); In re Diet Drugs, 582 F.3d 524, 552–53 (3d Cir. 2009); In re Pac. Lum­ber Co., 584 F.3d 229, 241, 243 (5th Cir. 2009); In re City of Detroit, Michi­gan, 838 F.3d 792, 798 (6th Cir. 2016); In re Tran­swest Resort Prop­er­ties, Inc., 801 F.3d 1161, 1172 (9th Cir. 2015); In re Paige, 584 F.3d 1327, 1336 (10th Cir. 2009).

5. Raleigh v. Ill. Dept. of Rev­enue, 530 U.S. 15, 24–25 (2000).

6. See 11 U.S.C. § 364(e).

7. Id.

8. See Lex­mark Int’l, Inc. v. Sta­t­ic Con­trol Com­po­nents, Inc., 134 S. Ct. 1377, 1388 (2014).

9. In re City of Detroit, Michi­gan, 838 F.3d 792, 798 (6th Cir. 2016).

10. See Stern v. Mar­shall, 131 S.Ct. 2594, 2599 (2011).

11. See City of Detroit, 838 F.3d at 798 (“(1) whether a stay has been obtained; (2) whether the plan has been ‘sub­stan­tial­ly con­sum­mat­ed’; and (3) whether the relief request­ed would sig­nif­i­cant­ly and irrev­o­ca­bly dis­rupt the imple­men­ta­tion of the plan or dis­pro­por­tion­ate­ly harm the reliance inter­ests of oth­er par­ties not before the court,”).

12. See Behrmann v. Nat’l Her­itage Found., 663 F.3d 704, 713 (4th Cir. 2011) (“(1) whether the appel­lant sought and obtained a stay; (2) whether the reor­ga­ni­za­tion plan or oth­er equi­table relief ordered has been sub­stan­tial­ly con­sum­mat­ed; (3) the extent to which the relief request­ed on appeal would affect the suc­cess of the reor­ga­ni­za­tion plan or oth­er equi­table relief grant­ed; and (4) the extent to which the relief request­ed on appeal would affect the inter­ests of third parties.”).

13. See In re Philadel­phia News­pa­pers, LLC, 690 F.3d 161, 170 (3d Cir. 2012). (“(1) whether the reor­ga­ni­za­tion was ‘sub­stan­tial­ly con­sum­mat­ed,’ (2) whether a stay has been obtained, (3) whether the relief would affect the rights of non-lit­i­gat­ing par­ties, (4) how relief would affect the suc­cess of the bar­gain struck, and (5) the pub­lic pol­i­cy of the final­i­ty of bankruptcy.).

14. See, e.g., In re Paige, 584 F.3d 1327, 1336 (10th Cir. 2009).

15. See, e.g., In re Philadel­phia News­pa­pers, LLC, 690 F.3d 161, 170 (3d Cir. 2012). “(1) whether the reor­ga­ni­za­tion was ‘sub­stan­tial­ly con­sum­mat­ed,’ (2) whether a stay has been obtained, (3) whether the relief would affect the rights of non-lit­i­gat­ing par­ties, (4) how relief would affect the suc­cess of the bar­gain struck, and (5) the pub­lic pol­i­cy of the final­i­ty of bankruptcy.”

16. See, e.g., In re Tri­bune Media Co., 799 F.3d 272, 280 (3d Cir. 2015); In re Sem­crude, L.P., 728 F.3d 321, 324 (3d Cir. 2013).

17. See, e.g., In re Tran­swest Resort Prop­er­ties, Inc., 801 F.3d 1161, 1172 (9th Cir. 2015).

18. See, e.g., In re Pac. Lum­ber Co., 584 F.3d 229, 241 (5th Cir. 2009).

19. See, e.g., In re Sem­crude, L.P., 728 F.3d 321 (3d Cir. 2013).

20. See, for exam­ple, the third fac­tor in the Sixth Cir­cuit test: “dis­pro­por­tion­ate­ly harm the reliance inter­ests of oth­er par­ties before the court,” In re City of Detroit, Michi­gan, 838 F.3d 792, 798 (6th Cir. 2016); or the third fac­tor in the Third Cir­cuit test “Whether relief would affect the rights of non-lit­i­gat­ing par­ties,” In re Philadel­phia News­pa­pers, LLC, 690 F.3d 161, 170 (3d Cir. 2012).

21. See In re Metro­me­dia Fiber Net­work, Inc., 416 F.3d 136, 142 (2d Cir. 2005).

22. See In re Diet Drugs, 582 F.3d 524, 552–53 (3d Cir. 2009).

23. See Enough Already, The Econ­o­mist (2004), http://www.economist.com/node/3196317 (Detail­ing the way the air­line com­pa­nies used Chap­ter 11 to sys­tem­at­i­cal­ly avoid­ed lia­bil­i­ties aris­ing from a change in the industry).

24. See Robert Kut­tner, The Age of Dou­ble Stan­dards, The Amer­i­can Prospect (2005), http://prospect.org/article/age-double-standards.