by Christopher Combest, Faye B. Feinstein
(TMA International Headquarters)
Before the opinion of the 9th U.S. Circuit Court of Appeals Bankruptcy Appellate Panel (BAP) in Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (B.A.P. 9th Cir. 2008), many practitioners would have said that a Bankruptcy Court’s sale order was virtually invulnerable, unless an appellant obtained a stay of the order pending appeal. Some commentators are concerned, however, that Clear Channel has put Bankruptcy Courts out of the asset-sale business.
The BAP held in Clear Channel that some aspects of a sale order may be appealed and undone, even absent a stay. Also potentially troubling was the BAP’s treatment of what has long been a significant advantage of sales under U.S. Bankruptcy Code Section 363: the ability to sell property free and clear of liens, claims, and other interests. In Clear Channel, the BAP reversed the Bankruptcy Court’s sale order to the extent that it permitted the debtor to transfer real estate to a senior creditor in exchange for that creditor’s credit bid, free and clear of a junior creditor’s lien.
The current economic environment may give rise to an increase in the use of the bankruptcy process to liquidate financially troubled companies or selected assets of such companies. Lehman Brothers provided a stark example. Chapter 11 also has figured prominently in the public debate over whether, and how, to restructure the U.S. auto industry.
Although the holdings in Clear Channel may have been unexpected and run counter to common belief, large companies, such as Lehman Brothers, Bally Total Fitness, Value City, and Mervyn’s department stores, have continued to file Chapter 11 cases for the purpose of selling their assets or have resorted to such sales after other options available in Chapter 11 evaporated.
It is worth examining what exactly the Clear Channel opinion did and did not do. The BAP did limit the protections of Bankruptcy Code Section 363(m) regarding the validity of a good-faith sale when a sale order is appealed. In response, asset purchasers may amend their purchase agreements in some respects and reconsider how quickly they are willing to close a transaction after entry of a sale order.
However, its reversal of the sale free and clear of a junior lien was not intended by the BAP to be the final word on the issue — the panel remanded that matter to the Bankruptcy Court, instructing it to apply to that issue an analysis more carefully rooted in the text of the Bankruptcy Code. The ironic importance of Clear Channel may be that, by insisting that parties and courts firmly ground their sale motions and orders in the language of the Bankruptcy Code and create an appropriate record, sale orders may actually become less open to attack on appeal.
The debtor that gave rise to the Clear Channel case was PW, LLC, a developer of a mixed-use project of luxury condominiums and retail space in Burbank, California. The project required PW to aggregate 18 parcels of real estate into a single lot. Its senior secured mortgage lender, DB Burbank, LLC, held a claim against PW of more than $40 million, secured by substantially all of the developer’s assets.
PW’s problems with the development project, including difficulties in assembling all the parcels of land, led DB Burbank to commence a foreclosure proceeding and obtain a state court receiver, with whom it worked to finance the acquisition of the remaining parcels. Its troubles continued, however, and on the eve of DB Burbank’s foreclosure sale, PW filed Chapter 11. DB Burbank quickly obtained appointment of a Chapter 11 trustee and eventually came to an agreement with the trustee providing for a marketing period and an auction sale of PW’s assets under Section 363. DB Burbank was to be the stalking horse bidder at the sale, with a credit bid of just over $40 million.
The assets were to be sold free and clear of all liens and interests, including a junior lien held by Clear Channel securing a claim of $2.5 million, with liens to attach to sale proceeds. Clear Channel objected to the sale of the assets free and clear of its lien, but the Bankruptcy Court overruled the objection and permitted the sale to go forward. DB Burbank ultimately won the property with its credit bid, and the Bankruptcy Court approved the sale free of Clear Channel’s lien. Moreover, because the credit bid did not result in any actual cash proceeds coming into the PW bankruptcy estate, Clear Channel received nothing on its $2.5 million claim.
Key Statutory Language
Bankruptcy Code Section 363(b) permits the sale of estate property free and clear of liens, claims, and other interests if at least one of five circumstances described in Sections 363(f)(1) through (f)(5) exists. In approving the sale to DB Burbank, the Bankruptcy Court relied solely on Section 363(f)(5), which allows sales of estate property free of the interests of another entity if:
such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. (Emphasis added.)
In addition, the sale order in the Clear Channel case afforded to DB Burbank, as purchaser, the protections of Section 363(m):
[t]he reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale…of property does not affect the validity of a sale…under such authorization to an entity that purchased… such property in good faith…unless such authorization and such sale…were stayed pending appeal. (Emphasis added.)
This provision is sometimes referred to as creating “statutory mootness.” That is, even if an appellate court could undo a sale transaction with minimal disruption to the parties involved, Section 363(m) makes such an appeal moot if the appellant has not obtained a stay of the closing of the transaction. Section 363(m) is Congress’s expression of how important the finality and reliability of asset sales are to debtors and their creditors and to the essential asset-maximizing purposes of the Bankruptcy Code.
Although Clear Channel had requested a stay pending appeal of the sale order, its request was denied. On appeal, it requested reversal of the sale order issued by the Bankruptcy Court.
Although Clear Channel’s request for a stay pending resolution of the appeal had been denied by both the Bankruptcy Court and the BAP, the appellate panel found a way to hear the appeal despite the Section 363(m) prohibition against invalidating a sale that has not been stayed. The panel distinguished between the Bankruptcy Court’s authorization of the sale and the terms under which the sale was to be made.
The BAP interpreted Section 363(m) to proscribe only appeals that challenge the “essential attributes of a sale” — e.g., changes of title or assignments of possessory interests in leased property. However, because the free-and-clear nature of the sale was deemed by the BAP to be merely a “term” of the sale and therefore unprotected by Section 363(m), Clear Channel’s appeal could proceed.
The BAP’s holding on the scope of Section 363(m) may be the least persuasive part of its opinion. One could argue that the entire sale order entered by a Bankruptcy Court constitutes the “authorization” contemplated by Section 363(m). Beyond merely declaring that assets are to move from the estate to the purchaser, such orders typically contain many provisions that are negotiated and likely to be considered by the buyer to be part and parcel of its deal. The BAP did not convincingly explain why a “sale” whose validity may not be affected on appeal does not encompass the entire sale transaction and all of its terms described in and authorized by the sale order.
Moreover, the language of Section 363(f) specifically states that property may be sold “under subsection (b) or (c) [of Section 363] free and clear of any interest in such property,” subject to the conditions set out in Section 363(f). This language suggests that the free-and-clear aspect of an asset sale is, in fact, an inherent part of the transfer authorized by a sale order under Section 363(b) or (c), and not a piece of unrelated relief.
The BAP’s analysis of Section 363(m) did not distinguish between situations in which a secured creditor takes a debtor’s assets by credit-bid and those in which an unrelated third party buys the assets for cash and goes on to conduct its business in reliance on the sale order. One might wonder if the BAP would have sliced Section 363(m) quite so finely had the case involved the rights of such a disinterested third-party purchaser, as opposed to a holder of a mortgage. But in light of the ruling, such purchasers may be warier now of relying solely on Section 363(m) for protection.
The Bankruptcy Court determined that Section 363(f)(5) permitted the sale of PW’s assets free and clear of Clear Channel’s junior lien. On appeal, the BAP explained that a free-and-clear sale under Section 363(f)(5) requires an actual showing that the nonconsenting lien holder could be required, via a court proceeding, to accept a monetary payment in exchange for its lien, even if that payment is less than the full amount owed.
However, the BAP viewed the Bankruptcy Court as having reduced the complex language of Section 363(f)(5) to almost nothing by holding that the subsection permits free-and-clear sales any time the interest at stake is one “that could be satisfied with money,” regardless of how much money was being tendered and whether a particular procedure existed outside of bankruptcy for compelling the lien holder to accept such a payment. In effect, the BAP held that the Bankruptcy Court let PW and DB Burbank obtain the relief they wanted without showing compliance with the statute.
The BAP did not write Section 363(f)(5) out of the Bankruptcy Code. It told the Bankruptcy Court and the parties to go back on remand and specifically identify, if they could, the type of court proceeding that the BAP had described. They also were to demonstrate how and why that proceeding satisfied the requirements of Section 363(f)(5) and how it could function to deprive Clear Channel of its lien without full (or, in this case, any) payment.
Although the BAP did not specifically suggest it, one qualifying proceeding under Section 363(f)(5) might well have been a state law mortgage foreclosure proceeding. After all, the entire purpose of such a proceeding is to allow a secured creditor to sell its collateral and extinguish all other interests, whether or not the collateral is sold at a price sufficient to pay those interests in full, so long as senior liens are covered.
Because the parties in the Clear Channel case have resolved their dispute, it is unclear how the Bankruptcy Court might have addressed the BAP’s concerns or how a revised ruling on remand might have been viewed by the appellate panel.
Lessons Learned
Before Clear Channel, many practitioners would have assumed that, absent a stay, no aspect of a sale could be undone by an appellate court, including, for example, the recording of deeds, the payment of sale proceeds, and the migration of liens from the assets to the sale proceeds. Purchasers eager to close a transaction before the appeal period has run often rely on Section 363(m) to protect the sale from being unraveled if the sale order is reversed or modified. They may be better advised now to refrain from closing until the appeal period has elapsed.
Purchasers now also might seek new protections in asset purchase agreements against the possibility that the purchased assets may be deemed encumbered. For example, they may seek a right to return encumbered assets to the estate for a refund of the purchase price or an “appeal escrow” of some or all of the sale proceeds. Such an escrow would be released to the estate if no timely appeal were filed but would be returned to the purchaser if an appeal were filed and not resolved in a manner favorable to the purchaser’s interests within a reasonable period of time.
The Clear Channel decision is not binding on any Bankruptcy Court outside the 9th Circuit (and may not be binding on Bankruptcy Courts within that circuit, as that issue has not been resolved). However, there now have been at least two instances of an appellate court for the same underlying reason throwing cold water on what had become a regular bankruptcy practice. In its 2004 decision in the Kmart Corporation Chapter 11, the 7th Circuit refused to allow debtors to make millions of dollars of critical-vendor payments with little or no evidentiary record and based on legal argument that often amounted to “other courts have done it.”
The 9th Circuit BAP appears to have similarly intended to caution parties and courts against relying on nonconsensual sales free and clear of liens and other interests when the “record” consists of the recitation of Section 363(f) in the sale motion and unexamined arguments or conclusory statements that the sale meets one or more of that section’s criteria.
Contrary to what some believe, Clear Channel is not a death knell for Section 363 sales. The clear message of Clear Channel is that attorneys, financial advisors, debtors, and prospective purchasers are well-advised to think through sale motions, sale orders, and particularly the evidence to be presented at sale hearings in an effort to insure that the sale proceeding and resulting orders by the court can withstand attack.