United States: Ninth Circuit: Standard For Constitutional Standing Applies To Bankruptcy Appeals

Federal appellate courts have traditionally applied a "person aggrieved" standard to determine whether a party has standing to appeal a bankruptcy court order or judgment. However, this standard, which requires a direct, adverse, and financial impact on a potential appellant, is derived from a precursor to the Bankruptcy Code and does not appear in the existing statute. It also arguably conflicts with the general constitutional standing rule that governs litigation in federal courts, which, among other things, requires a litigant to demonstrate "a concrete and particularized injury in fact."

The U.S. Court of Appeals for the Ninth Circuit addressed the interplay between these standards in Clifton Capital Group LLC v. Sharp (In re East Coast Foods Inc.), 66 F.4th 1214 (9th Cir. 2023), as amended and rehearing denied, 2023 WL 5965812 (9th Cir. Sept. 14, 2023). The Ninth Circuit reversed a district court ruling affirming a bankruptcy court order approving an award of enhanced fees to a chapter 11 trustee, concluding that the appellant lacked constitutional standing to appeal the fee order because any injury to the appellant was "too conjectural and hypothetical." In so ruling, the Ninth Circuit held that an appellant must satisfy the requirements for constitutional standing in the first instance rather than the more exacting "person aggrieved" standard.

Standing

"Standing" is the legal capacity to commence litigation in a court of law. It is a threshold issue—a court must determine whether a litigant has the legal capacity to pursue claims before the court can adjudicate the dispute.

In order to establish "constitutional" or "Article III" standing, a plaintiff must have a personal stake in litigation sufficient to make out a concrete "case" or "controversy" to which the federal judicial power may extend under Article III, section 2, of the U.S. Constitution. See Pershing Park Villas Homeowners Ass'n v. United Pac. Ins. Co., 219 F.3d 895, 899 (9th Cir. 2000).

In bankruptcy cases, various provisions of the Bankruptcy Code confer another type of standing on various entities (e.g., the debtor, the debtor-in-possession, a bankruptcy trustee, creditors, equity interest holders, official committees, or indenture trustees), among other things, to participate generally in a bankruptcy case or commence litigation involving causes of action or claims that either belonged to the debtor prior to filing for bankruptcy or are created by the Bankruptcy Code. For example, in a chapter 11 case, section 1109 of the Bankruptcy Code provides that any "party in interest," including the debtor, the trustee, a committee of creditors or equity interest holders, a creditor, an equity security holder, or an indenture trustee "may raise and may appear and be heard on any issue" in a chapter 11 case.

This "bankruptcy" or "statutory" standing is distinct from constitutional standing, which is jurisdictional—if a potential litigant lacks constitutional standing, the court lacks jurisdiction to adjudicate the dispute. The distinction between constitutional and bankruptcy standing was examined by the U.S. Court of Appeals for the Third Circuit in In re Wilton Armetale, Inc., 968 F.3d 273 (3d Cir. 2020), in which the court of appeals held that the ability of a creditor to sue in bankruptcy is not a question of constitutional standing (because the risk of loss creates standing) but, rather, an issue of statutory authority because creditors may lose authority to pursue claims under the Bankruptcy Code.

The Third Circuit explained that, in accordance with the U.S. Supreme Court's decision in Lexmark Int'l, Inc. v. Static Control Components, Inc., 572 U.S. 118, 125 (2014), constitutional standing has only three elements: (i) there must be "a concrete and particularized injury in fact"; (ii) the injury must be "fairly traceable" to the defendant's conduct; and (iii) "a favorable judicial decision" would likely redress the injury. 572 U.S. at 125. Once a plaintiff satisfies those elements, the action "presents a case or controversy that is properly within federal courts' Article III jurisdiction." Id. The party invoking the jurisdiction of a federal court bears the burden of establishing the elements of Article III standing. Lujan v. Defs. of Wildlife, 504 U.S. 555, 561 (1992).

Finally, the judicially created concept of "prudential" or "zone of interests" standing examines whether: (i) the plaintiff's grievance falls within the zone of interests protected by a statute; (ii) the complaint raises abstract questions or a generalized grievance more properly addressed by the legislature; and (iii) the plaintiff is asserting his legal rights and interests or those of third parties. However, Congress can modify or even abrogate prudential standing requirements by statute. St. Paul Fire & Marine Ins. Co. v. Labuzan, 579 F.3d 533, 539 (5th Cir. 2009) (considering whether lawmakers intended to abrogate prudential standing requirements in section 362(k) of the Bankruptcy Code, which authorizes the recovery of damages for a willful violation of the automatic stay). In Susan B. Anthony List v. Driehaus, 573 U.S. 149 (2014), the U.S. Supreme Court questioned the concept of prudential standing, finding tension with the "virtually unflagging" obligation of federal courts to hear cases within their jurisdiction. Id. at 167 (citing Lexmark, 572 U.S. at 126; Sprint Communications, Inc. v. Jacobs, 571 U.S. 69, 77 (2013)).

Standing to Appeal Bankruptcy Court Orders or Judgments

In determining whether a party has standing to appeal a bankruptcy court order or judgment, courts have generally applied a "person aggrieved" standard instead of examining whether the potential appellant has Article III standing. The "person aggrieved" standard is more exacting than traditional constitutional standing because it requires that an appellant demonstrate that it was "directly, adversely, and financially impacted by a bankruptcy order." See Matter of Highland Cap. Mgmt., L.P., 57 F.4th 494, 501 (5th Cir. 2023) (citations and internal quotation marks omitted); accord Brown v. Ellmann (In re Brown), 851 F.3d 619, 623 (6th Cir. 2017); In re Ernie Haire Ford, Inc., 764 F.3d 1321, 1325 (11th Cir. 2014).

A party does not have standing to appeal a bankruptcy court's order or judgment merely by participating in a bankruptcy case as a party-in-interest or if the order or judgment causes only indirect harm to the party's asserted interest. See In re Bay Circle Prop., LLC, 2022 WL 16002916, *2–3 (11th Cir. Oct. 28, 2022). Furthermore, "for a person to be aggrieved, the interest they seek to vindicate on appeal must be one that is protected or regulated by the Bankruptcy Code." See Ernie Haire Ford, 764 F.3d at 1325–26.

The "person aggrieved" standard is a "prudential" requirement initially found within the Bankruptcy Act of 1898, which permitted an appeal by any "person aggrieved by an order of a referee." 11 U.S.C. § 67(c) (1976) (repealed 1978). It was designed to limit appeals in bankruptcy cases because bankruptcies invariably implicate the interests of various stakeholders, including those that may qualify as parties-in-interest in the bankruptcy case, but are not formally litigants in a particular contested matter or adversary proceeding. See Matter of Fondiller, 707 F.2d 441, 443 (9th Cir. 1983); accord In re Imerys Talc Am., Inc., 38 F.4th 361, 370–71 (3d Cir. 2022); Kane v. Johns-Manville Corp., 843 F.2d 636, 642 (2d Cir. 1988).

Even though lawmakers did not include the "person aggrieved" standard for appellate standing in the Bankruptcy Code in 1978 (or afterward), courts continue to apply the standard to this day. See generally Collier on Bankruptcy ¶ 5.07 (16th ed. 2023) (citing and discussing cases).

The Ninth Circuit addressed the "person aggrieved" standard and constitutional standing in East Coast Foods.

East Coast Foods

On March 25, 2012, East Coast Foods, Inc., manager of four locations of the landmark Los Angeles restaurant chain Roscoe's House of Chicken & Waffles (the "debtor"), filed for chapter 11 protection in the Central District of California. Shortly afterward, the bankruptcy court supplanted the debtor-in-possession with a chapter 11 trustee.

In July 2018, the court confirmed a chapter 11 plan of reorganization proposed for the debtor by its unsecured creditors' committee and principal. The plan provided that the allowed claims of all unsecured creditors, including subordinated creditors, were to be paid in full with interest over no more than four years from funds generated by the debtor's ongoing operations and non-estate sources. Under the plan, subordinated claims, including the consensually subordinated claim of Clifton Capital Group, LLC ("Clifton") in the amount of approximately $4.2 million, would be paid in full with interest after payment of all other unsecured claims and certain other claims.

The plan's commitment to pay all unsecured claims in full was to be funded by: (i) the reorganized debtor's commitment to pay $110,000 per month plus any excess monthly free cash flow from operations; (ii) an up to $10 million backstop commitment by the debtor's principal; and (iii) $130,000 per month to be contributed by nondebtor affiliates. In addition, the plan payments were secured by a lien on substantially all of the debtor's assets, which were valued at more than $39 million, leaving the reorganized debtor with $23.4 million in "net equity."

The plan provided that the debtor's principal would retain his equity interests in the debtor in exchange for his backstop commitment. All but two secured classes were identified as "impaired" by the plan.

Two impaired classes (class 1, a secured class, and class 9, the general unsecured trade claims class) voted to accept the plan. Clifton agreed to the treatment of its claim under the plan, which provided that Clifton's consensually subordinated claim and the claims of other class 11 creditors were impaired, but it is not clear whether Clifton voted to accept the plan. All other classes either rejected the plan or were deemed to reject it. In confirming the plan, the bankruptcy court held that the plan satisfied that Bankruptcy Code's cram-down confirmation requirements with respect to all dissenting impaired classes.

After the effective date of the plan, the reorganized debtor fell behind in making certain plan payments to unsecured creditors, due in part to liquidity problems resulting from the pandemic.

In his October 2018 final fee application, the trustee requested approximately $1.2 million, consisting of a "lodestar" amount of approximately $760,000 based on the hours worked, plus a 65% enhancement ($400,000) for exceptional services. Clifton objected to the application, arguing that the amount was unreasonable. The bankruptcy court approved the application, and Clifton appealed to the district court.

The trustee argued before the district court that Clifton lacked standing to appeal the fee order because it was not a "person aggrieved." The district court disagreed, ruling that Clifton satisfied that standard "[b]ecause the increased compensation to the Trustee will further subordinate [Clifton's] claim" and Clifton was therefore "directly and adversely affected" by the fee order. See In re East Coast Foods, Inc., 2019 WL 6893015, *3 (C.D. Cal. Dec. 18, 2019). The district court then vacated the bankruptcy court's fee order and remanded the case below with instructions either to apply the lodestar amount or to make detailed findings justifying a higher amount.

On remand, the bankruptcy court found that the full amount of the fee request was warranted due to the exceptional results in the case. After the district court affirmed on appeal, Clifton appealed to the Ninth Circuit.

The Ninth Circuit's Ruling

A three-judge panel of the Ninth Circuit reversed the ruling and remanded the case with instructions to the court below to dismiss the appeal.

Writing for the panel, Circuit Judge Ryan D. Nelson explained that it is unclear why courts continue to apply the pre-Bankruptcy Code "person aggrieved" rule "with little attention to Article III standing" in the absence of any statute providing authority to do so. Courts in the Ninth Circuit, he noted, "appear to have recast the pre-1978 statutory standard and applied it as a principle of prudential standing," which the Supreme Court questioned in Driehaus. East Coast Foods, 66 F.4th at 1218. After Driehaus, Judge Nelson wrote, "we have returned emphasis to Article III standing," which must be satisfied before examining whether an appellant has prudential standing under the "person aggrieved" standard. Id.

According to the Ninth Circuit panel, the rulings below had to be reversed because Clifton lacked Article III standing to appeal the bankruptcy court's fee order. First, Judge Nelson explained, Clifton could not demonstrate that it had suffered an "injury in fact." He rejected Clifton's argument that it was harmed because it had not yet received any payment of its subordinated claim under the plan and the bankruptcy court's approval of a $400,000 fee enhancement to the trustee impaired "both the likelihood and timing of any payment by further subordinating it." Id. at 1219.

The Ninth Circuit panel held that Clifton's alleged injury was "too conjectural and hypothetical to establish an injury in fact for Article III standing" and that the district court erred when it concluded that the fee award would further subordinate Clifton's claim. Id. In particular, Judge Nelson explained, the district court erroneously determined that the debtor's chapter 11 plan created a "limited fund" for the payment of creditor claims.

According to Judge Nelson, under Ninth Circuit precedent, the existence of a finite pool of assets to pay claims under a chapter 11 plan has been held to confer appellate standing on a party whose share of the asset pool is under threat. However, he emphasized, the debtor's chapter 11 plan did not establish such a limited fund but provided for the payment in full of all unsecured claims, including Clifton's claim, with interest, from the reorganized debtor's future income and outside sources of funding. Id. at 1219–20. In addition, Judge Nelson noted, the debtor's obligation to make plan distributions was secured by collateral of sufficient value to create a 35% "equity cushion." "[E]ven if [the trustee] receives the contested $400,000 bonus," he wrote, "this will not impact Clifton's ability to be paid because there are other sources from which to make Clifton's payment at the appropriate time." Id. at 1221.

The Ninth Circuit panel also rejected Clifton's argument that it was harmed because the fee award would prolong payment of its subordinated claim. According to Judge Nelson, the plan expressly provided, and Clifton clearly understood, that the payout term could be longer or shorter based on the amount of allowed claims and estimated that distributions on subordinated claims would be completed sometime between 2022 and 2024. "Ultimately," he wrote, "the Plan's guarantee that Clifton will be paid with interest precludes a finding of an injury in fact now even though these estimates thus far have proven inaccurate." Id. at 1222. The Ninth Circuit panel concluded that, given the possibility that the debtor might yet complete all distributions within the estimated timeframe, "Clifton has failed to establish the negative impact of any delayed payment not already addressed by the Plan." Id.

Finally, the Ninth Circuit panel emphasized that Clifton was not left without a remedy—it could sue to enforce the terms of the plan if the debtor defaulted. At that juncture, Judge Nelson noted, "there may be an actual injury that is both fairly traceable and would be easily redressable by ordering additional money deposited into the estate to pay Clifton's claims." Id.

Because the Ninth Circuit panel concluded that Clifton lacked Article III standing to appeal the fee order, it declined to address whether Clifton satisfied the prudential "person aggrieved" standard. Id. at 1222 n.11.

The Ninth Circuit panel accordingly reversed the district court's order and remanded the case to the court below with instructions to dismiss Clifton's appeal for lack of Article III standing.

Outlook

On September 14, 2023, the Ninth Circuit issued an amended opinion and denied Clifton's motion for rehearing en banc. A key takeaway from East Coast Foods is that, in the Ninth Circuit, Article III standing, as distinguished from prudential standing under the "person aggrieved" standard, is the gatekeeper (at least in the first instance) to appellate review of bankruptcy court orders or judgments. This means that in cases where a potential appellant lacks such standing, the appellate court does not have jurisdiction to hear the appeal.

The Ninth Circuit's ruling leaves certain important questions unanswered. For example, because the panel declined to address whether the appellant satisfied the more exacting "person aggrieved" standard, it is unclear whether an appellant that (unlike Clifton) satisfies the requirements for Article III standing must then also satisfy the "person aggrieved" standard to have standing to appeal. On the facts of East Coast Foods, Clifton likely would not have satisfied either standard, but other cases might be different.

Shortly after the Ninth Circuit handed down its ruling in East Coast Foods, the Fifth Circuit reaffirmed its commitment to the "person aggrieved" standard for bankruptcy appellant standing in bankruptcy in two separate decisions in the same chapter 11 case. See Dugaboy Investment Trust v. Highland Capital Management LP (In re Highland Capital Management LP), 2023 WL 4861770 (5th Cir. July 31, 2023) (dismissing for lack of standing an appeal of an order approving a settlement filed by a family trust controlled by the debtor's former chief executive holding an approximately 0.2% limited partnership interest in the debtor because the trust was not "directly affected" by the settlement and was therefore not a "person aggrieved," and rejecting the trust's argument that it had standing to appeal as an equity security holder pursuant to section 1109(b) and based on withdrawn claims filed in the case); NexPoint Advisors, L.P. v. Pachulski Sting Ziehl & Jones, L.L.P. (In re Highland Capital Management, L.P.), 74 F.4th 361 (5th Cir. 2023) (affirming a district court order dismissing for lack of standing an appeal filed by an administrative claimant and adversary proceeding defendant of bankruptcy court orders awarding professional fees and expenses because any harm to the appellant was too speculative). In so ruling, the Fifth Circuit held that the more exacting "person aggrieved" standard—as distinguished from Article III standing—is the more appropriate standard, and that the Supreme Court's decision in Lexmark did not invalidate the "person aggrieved" standard for bankruptcy appeals.

Given the disagreement among courts on the appropriate standard for bankruptcy appellate standing, knowledge of the approach applied by the appellate courts in any particular jurisdiction is important.

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