When Shakyamuni Buddha was at Mount Grdhrakuta, he held out a flower to his listeners. Everyone was silent. Only Mahakashyapa broke into a broad smile. The Buddha said, "I have the True Dharma Eye, the Marvelous Mind of Nirvana, the True Form of the Formless, and the Subtle Dharma Gate, independent of words and transmitted beyond doctrine. This I have entrusted to Mahakashyapa."
Golden-faced Gautama really disregarded his listeners. He made the good look bad and sold dog's meat labeled as mutton. He himself thought it was wonderful. If, however, everyone in the audience had laughed, how could he have transmitted his True Eye? And again, if Mahakashyapa had not smiled, how could the Buddha have transmitted it? If you say the True Dharma Eye can be transmitted, then the golden-faced old man would be a city slicker who cheats the country bumpkin. If you say it cannot be transmitted, then why did the Buddha approve of Mahakashyapa?
Holding out a flower,
The Buddha betrayed his curly tail.Heaven and earth were bewildered,
At Mahakashyapa's smile.
This is a well known Buddhist story, and one that means a lot of different things depending on where you're hearing it from. We're hearing it in the context of Zen; so what does that tell us? Like Gutei's Finger and Joshu's "Mu," in the Buddha's Flower, we have another example of something presented with no explanation, which defies our attempts to attach a meaning to it, and in doing so provoking a response. Again, try as you might to attach a meaning to it, you're forced to come to the conclusion that it is you attaching that meaning, not a meaning inherent in the gesture.
We're hearing it from Mumon, who tells you that this story presents the Buddha "selling dog meat labeled as mutton." What is he getting at with this? Let's take note that the focus of the story, the point where it reaches its climax, is in the Buddha's presenting the transmission of his teaching to Mahakashyapa. Considering that Zen holds no specific practice, or belief, or scripture to be holy, transmission of anything seems nonsensical. So what is being transmitted is this "True Dharma Eye, the Marvelous Mind of Nirvana, the True Form of the Formless, and the Subtle Dharma Gate, independent of words and transmitted beyond doctrine." That's an awfully big mouthful to describe what is essentially the lack of dualistic, conceptual, discriminating mind.
So let's take it piece by piece. The Buddha holds up a flower. There is no meaning behind this gesture, though nearly everyone in attendance (and every reader) tries to find a meaning to derive from it. In reality, it is an ordinary gesture, trying to provoke the audience to dismiss that part of their mind that craves to conceptualize. Mahakashyapa smiles, and the Buddha declares him the recipient of the transmission. However, nothing is transmitted. Mahakashyapa simply sees the lack of meaning in the gesture. It's not that something special was transmitted only to Mahakshyapa. In fact, the whole of the exchange is entirely lacking in anything special or conceptual.
However, the Buddha gives it a grand label, and makes it seem exclusive. This what Mumon means when he says that he's selling dog meat as mutton. He's taking something that isn't special, and making it seem special in order to turn heads. Why would he do this? To get others investigating of course. To make them think themselves in circles. He is setting the trap that will exhaust their thinking, and hopefully once that thinking is exhausted, they'll get it as well.
Mumon also asks, what would have happened if Mahakashyapa hadn't smiled? What would have happened if everyone had smiled? Wouldn't the Buddha's grand plan have been ruined? It's worth noting that this story is almost certainly not historical, so it is best not to look at it as a testimony of ancient fact. It is firmly in the realm of legend, and Mumon either knows this, or is at least using the story in that way. Asking questions about "what would have happened if this had happened differently?" are specifically designed to trip you up, in precisely the same way that the Buddha's grand description was designed to trip up his followers. In exactly the same way as Hyakujo's student's question about "what would have happened if the monk had given the correct answer" in case 2 is a trap to test his teacher.
Trying to break down the circumstances of the koan doesn't help you. That is the same as trying to derive an explanation from the Buddha's flower. The fictional nature of it doesn't matter; here it is in front of you, presented only as it is. Cast away your discriminating mind and see it, simple and ordinary. Don't be deceived by the convoluted "True Dharma" label, or by the mentality that this is exclusive or limited. Otherwise, Mumon has also sold you dog meat labeled as mutton.