South Edge: Who Can Appeal The Appointment Of A Trustee?

Is it procedurally correct, fair or even rational to appoint an outsider to run a company—over management's objections—and then permit that outsider, and only that outsider, the opportunity to challenge his or her own appointment? In South Edge, the U.S. District Court for the District of Nevada did just that. It dismissed a debtor's and its constituent equity-owners' appeals from the appointment of a chapter 11 trustee, holding that only the newly appointed trustee had authority to appeal her own appointment.1

At first blush, this appears to impair the appellate rights of the aggrieved party in interest, present significant due-process concerns for affected debtors and apply a "through-the-looking-glass" circular logic. After all, what trustee would challenge his or her own appointment? A closer examination of the South Edge decision, however, reveals that it is grounded in longstanding principles of corporate and bankruptcy law and preserves the right to a meaningful appeal of a trustee's appointment. Ultimately, the South Edge decision presents a new twist in a familiar tale—which corporate debtors, their managers and stakeholders should consider carefully when faced with the possible appointment of a bankruptcy trustee.

South Edge: The Appointment of an Involuntary Trustee

South Edge was a Nevada limited liability company created in 2004 by several of the nation's largest homebuilders (known as "members") for the sole purpose of acquiring land south of Las Vegas and developing a master-planned 2,000-acre, 14,000-residential unit, "new urbanism" project called Inspirada. To this end, the members caused South Edge to borrow more than $500 million pursuant to syndicated multi-tiered loans, which South Edge was obligated to repay as members purchased from the acquisition entity and developed their respective allocated parcels of land. Initial development of Inspirada seemed promising, but the collapse of the U.S.—and in particular the Nevada—housing market beginning in 2006, and the ensuing mortgage market crash of 2007, set in motion a domino effect that ultimately caused South Edge to default on its loans. Following more than a year of state court litigation, the default eventually precipitated an involuntary chapter 11 case against South Edge commenced by the lenders in the Nevada bankruptcy court. The petitioning creditors also moved to appoint a chapter 11 trustee.2

After a four-day trial, the bankruptcy court granted both the creditors' involuntary petition (the "involuntary order") and the creditors' motion to appoint a trustee (the "trustee order"), thereby divesting existing management—directed by a board consisting of representatives of the individual members—from operational control of the project and disposition of the property of the estate, setting the stage for the inevitable appeals from the bankruptcy court's orders.

Two events transpired, or rather did not transpire, during the bankruptcy court trial that dramatically affected the appeals that followed. First, the members did not oppose the creditors' motion to appoint an involuntary trustee (only South Edge opposed the motion through its own, separate counsel), and second, neither the members nor South Edge moved the court to stay the orders pending appeal.3

Appeals from Trustee's Appointment

South Edge and its members each appealed the trustee order and the involuntary order to the Nevada district court. Since they had not formally opposed the motion to appoint a trustee, the...