Daily Development for Friday, August 22, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri
Another wonderful Jack Murray contribution. The case often is referred to as the "Clear Channel" case.
BANKRUPTCY; “FREE AND CLEAR SALES;” FINALITY: Ninth circuit BAP restricts bankruptcy "mootness" doctrine for sales under Bankruptcy Code Section 363.
In re PW, LLC, 2008 WL 2840659 (9th Cir. BAP (Cal.), July 18, 2008)
The Ninth Circuit BAP held that, notwithstanding the junior lienholder's failure to obtain a stay pending appeal of the bankruptcy court's order approving a sale of the estate property free and clear of the junior lien, § 363(f) of the Bankruptcy Code did not permit the senior secured creditor to credit-bid its debt and purchase the estate property free and clear of the junior lien based on the "mootness" doctrine.
In this single asset real estate case, the bankruptcy trustee and DB Burbank, LLC ("DB"), which held a first-priority secured lien of more than $40 million on substantially all of the assets owned by the debtor, PW, LLC ("PW"), entered into a "Binding Term Sheet" that established specific procedures for an auction and sale of PW's assets. The Binding Term Sheet also provided that DB would serve as a "stalking horse" bidder for a sale of the property, and that if there were no qualified bidders for an amount greater than the "strike price" of $41,434,465, DB would buy PW's property for that amount. In addition, DB agreed to pay the Trustee a "Carve-Out Amount" of up to $800,000 for certain administrative fees and other costs and expenses. (DB also agreed not to seek relief from the automatic stay and to refrain from communicating with third parties regarding the sale of PW's assets.)
On March 20, 2007, the bankruptcy court entered an order establishing a procedure for the sale of PW's property, and the trustee moved to approve the sale free and clear of liens under § 363(f)(3) and (f)(5) of the Bankruptcy Code. The junior lien creditor, Clear Channel Outdoor, Inc. ("Clear Channel," whose consensual lien secured a claim for $2.5 million), opposed the motion, arguing that § 363(f) was not applicable. On April 26, 2007, over Clear Channel's objection, the bankruptcy court entered a separate order authorizing the sale free and clear of Clear Channel's lien under § 363(f)(5) ("Sale Order"). Only three bids for the property were timely received, and none qualified because they were not in excess of the strike price. (The highest was a nonconforming contingent bid of only $25.25 million.) Therefore, the trustee sold PW's property to DB at the strike price, and DB paid the trustee the Carve-Out Amount for the receiver's fees and certain other administrative fees and e xpenses.
On May 31, 2007, the bankruptcy court confirmed the sale to DB and found that DB was a purchaser in good faith. The court entered a "Confirmation Order" to this effect, and declined to stay that order pending appeal (as did a prior motions panel of the BAP). The sale closed on June 15, 2007. Clear Channel received no payment under the terms of the sale because DB's credit bid meant that there were no proceeds to which Clear Channel's lien could attach.
On Clear Channels appealed, attempting to reverse the sale order and confirmation order and to establish that its lien ought to extend to the Carve Out Amount.
According to the 9th Circuit BAP:
This appeal presents a simple issue: outside a plan of reorganization, does § 363(f) of the Bankruptcy Code permit a secured creditor to credit bid its debt and purchase estate property, taking title free and clear of valid, nonconsenting junior liens? We hold that it does not. In reaching this conclusion, we reject the contention that once the sale is consummated, the appeal from the order stripping the junior creditor's liens is moot and immune from scrutiny, and we hold that, in the circumstances of this case, the junior lienholder's rights are preserved. . . .
We conclude that while any relief related to the transfer of title to [the purchaser] is moot, stripping the [objecting lienholder's] lien and related state law rights present an issue that is discrete and separable from title transfer. That part of the [objecting lienholder's] appeal is not moot.”
The court evaluated the issue under various mootness tests in reaching its conclusion. The BAP excused the failure of Clear Channel to obtain a stay pending appeal by stating that in the particular circumstances of this case, "when a bond staying the consummation of the deal would have been far in excess of the lien that Clear Channel is trying to protect, we question whether that remedy is exclusive."
The BAP further concluded that neither § 363(f)(3) or (5) (the only two provisions of § 363(f) deemed applicable by the BAP in this particular case) permitted the "stripping" of liens. (Sec. 363(f) provides, in pertinent part, that the trustee may sell property free and clear of any interest in the property only if . . . (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; . . . (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest").
“The Trustee asserts that the "aggregate value of all liens" in this paragraph means the economic value of such liens, rather than their face value. This argument arises from § 363(f)(3)'s variance from general Code usage; that is, whether its reference to "value of all liens" is simply an unfortunate deviation from the Code's general preference to refer to claims, and not liens, or whether it has some other significance.”
“The Trustee and DB assert that, under conventional bankruptcy wisdom, supported by § 506(a), the amount of an allowed secured claim can never exceed the value of the property securing the claim. Since a secured claim is a form of "lien," see 11 U.S.C. § 101(37), some courts have found that an estate representative may use § 363(f)(3) to sell free and clear of the property rights of junior lienholders whose nonbankruptcy liens are not supported by the collateral's value. That is, there may be a sale free and clear of "out-of-the-money" liens (citations omitted).”
“We disagree. This reading expands § 363(f)(3) too far. It would essentially mean that an estate representative could sell estate property free and clear of any lien, regardless of whether the lienholder held an allowed secured claim. We think the context of paragraph (3) is inconsistent with this reading. If Congress had intended such a broad construction, it would have worded the paragraph very differently.”
The BAP did affirm that portion of the bankruptcy court's decision holding that certain "carveout" payments by the purchaser (to pay trustee's fees, administrative fees and certain other costs and expenses) were not "proceeds" of the sale and that they did not constitute part of the objecting lienholder's lien.
With respect to § 363(f)(5), the BAP determined that: (1) "interest'" includes a lien; (2) sec. 363(f)(5) refers to a legal or equitable proceeding in which the nondebtor could be compelled to take less than the value of the claim secured by the interest (not simply by paying the money owed under a lien obligation); and (3) the bankruptcy court must make a finding of the existence of such a mechanism and the trustee must demonstrate how satisfaction of the lien "could be compelled." The BAP rejected the trustee's argument that "cramdown" under § 1129(b)(2) is a qualifying legal or equitable proceeding (disagreeing with other courts that have so held). The BAP held that because of the bankruptcy court's "incorrect interpretation" of § 363(f)(5), it would remand the case for the purpose of allowing the parties "to attempt to identify a qualifying proceeding under nonbankruptcy law (if one exists) that would enable them to strip Clear Channel's lien and make the sale of PW's property to DB free and clear under § 363(f)(5)."
Reporter’s Comment 1: The BAP's specific holding on the “mootness” issue appears to be one of first impression in the Ninth Circuit (or elsewhere), and could have severe consequences for bankruptcy debtors hoping to sell estate assets to prospective purchasers, as such prospective purchasers will not actually know if they are receiving title to the property "free and clear" of all other liens and interests, even if the sale order states that it is free and clear of such interests and no stay of the sale order is obtained by the objecting party. It will also give title insurers pause when deciding if (or under what conditions) they will insure such sales.
Reporter’s Comment 2: The BAP's narrow reading of § 363(f) in the PW case could have disastrous consequences -- at least with respect to cases with similar fact situations within the jurisdiction of the Ninth Circuit that involve sales "free and clear" of existing liens -- even where no stay of the bankruptcy court's sale order was obtained and the purchaser was determined by the court to have made a good-faith offer. The PW decision could make it far more difficult to extinguish junior liens through a § 363 sale, impairing the ability of debtors to orderly liquidate estate property and significantly reducing the number of interested purchasers.
The BAP's analysis of § 363(m) of the Bankruptcy Code also
is troubling. Section 363(m) states as follows:
The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.
In the PW case, DB clearly was a good-faith purchaser that purchased the estate property pursuant to a valid bankruptcy court order (which was not stayed pending an appeal), after long and difficult negotiations regarding the terms of the sale. Because DB was in fact the buyer at the sale, the BAP's decision may have effectively discharged DB's first mortgage lien (by merger as it was now the owner of the property) and elevated Clear Channel's $2.5 million lien to a first-priority position. See Thomas L. Kent and Cynthia M. Cohen, Buyer Beware: Bankruptcy Sales Under Section 363 of the Bankruptcy Code May be Subject to Attack (Paul Hastings - Staying Current, June 23, 2008), p.1, https://e2k.exchange.umkc.edu/exchweb/bin/redir.asp?URL=http://www.paulhastings.com/publicationDetail.aspx?PublicationId=935; written before the PW decision was formally published and while a motion for reconsideration was pending):
“Unless the [PW] decision is changed on reconsideration, it will likely reduce interest in buying at section 363(f) sales. Its impact will be strongest when the amount of the claims secured by the property to be sold exceeds the value of the property and one or more of the lienors does not consent to a sale free and clear. Buyers participate in section 363 sales in substantial part because the sale process is relatively quick, less expensive than the plan confirmation process, and - until now - thought to be final and binding on all parties. If, as a result of the BAP's decision, buyers' interest in section 363 sales wanes, Chapter 11 debtors may be impelled to conduct sales pursuant to a plan of reorganization, which will take substantially more time and, with the additional confirmation risks, be much more expensive. (The authors also note that "The BAP opinion used the terms free and clear and lien-stripping as if they were interchangeable. Lien-stripping is a different concept from selling free and clear." Id. at p.4, n. 3)”.
See also Bankruptcy Service, Lawyers Edition (Database updated July 2008), 2c BANKR. SERVICE. L. ED. § 20-419 (stating that "Under 11 USCA § 363(m), appeal of sale of debtor's assets to good faith purchaser is moot where appealing party has failed to obtain stay of sale," and collecting and summarizing cases from federal circuit courts of appeal (including the Ninth Circuit).
The article notes that Third Circuit has rejected a per se rule mooting appeals absent a stay of the sale of estate property at issue. On the other hand, the majority of the federal courts of appeals follow a per se rule, automatically mooting appeals absent a stay of the sale or lease at issue. Weingarten Nostat, Inc. v. Service Merchandise Co., Inc., 396 F.3d 737, 741 (6th Cir. 2005) ("'Bankruptcy' [or "statutory"] mootness [under § 363(m)] is predicated on the particular need to encourage participation in bankruptcy asset sales and increase the value of the property of the estate by protecting good faith purchasers from modification by an appeals court of the bargain struck with the debtor").
Reporter’s Comment 3: As a result of the BAP's holding in the PW case, a purchaser of a bankruptcy estate's real property assets pursuant to § 363 may be unable to obtain title insurance prior to expiration of the applicable appeal period and confirmation that no appeal of the bankruptcy court's sale order was timely filed, without a specific exception for any subsequent reversal or modification of all or part of the bankruptcy court's sale order, even if the sale order has not been stayed.
Reporter’s Comment 4: The BAP, in the PW case, argued that it was not setting aside the sale of the debtor's assets, which it acknowledged was valid and final, but that it was instead reversing only so much of the bankruptcy court's order as "stripped" the junior creditor's lien. The BAP stated that "Such relief might be difficult or inequitable, but it is not impossible." In re PW, LLC, 2008 WL 2840659 at *4. But, as noted above, many otherwise interested prospective purchasers likely will not be willing to take the risk of purchasing the debtor's real property or other assets when they unsure if and when the sale will be final or if the property can truly be purchased "free and clear" of existing liens and other interests (and whether and other what circumstances they will be able to obtain title insurance for the transaction). The BAP stated in its opinion that DB "was aware of the risks of going forward with the sale," Id., but it is difficult to believe that DB truly believe d (after all the planning and negotiations preceding the sale and its willingness to act as a "stalking horse") that the sale might be set aside under any conceivable set of circumstances. The BAP reasoned that in this particular case, "[b]oth parties are before the court and no third-party action is required to reestablish Clear Channel's position," Id. at *5, and therefore found that no third party would be prejudiced because it relied on the bankruptcy court's sale order. The BAP ruled that it was possible to "reverse the transfer of Clear Channel's lien to the nonexistent sales proceeds and hold that it remains attached to the property transferred." Id. But certainly this is not what DB expected (or had reason to expect) would happen when it purchased the estate assets "free and clear" of all claims and interests. It will be interesting to see if the bankruptcy courts (and federal appellate courts) in other jurisdictions: (1) follow the holding in the PW case; (2) limit the ho lding to virtually identical fact situations, or; (3) reject it altogether.
Editor’s Comment: Jack Murray, the above commentator, has a point, of course, and a sharp one. But the “mootness” doctrine can also be a blunt instrument bludgeoning victims of overzealous Bankruptcy rulings and leaving them with effectively no appeal of a single judge’s mistake. This doctrine, for instance, was implicated in the now infamous Qualitech case, which permitted a sale free and clear of leases. Even if the court’s determination that leases should not be sacrificed in a free and clear sale was wrong as a matter of law, tenants protesting such ruling would be unable to challenge it if the same judge also refused to stay the sale on appeal of his or her ruling. Here is what the editor said about that problem in connection with another DD discussion of this issue, Weingarten Nostate v. Service Merchandise, 396 F. 3d 7347 (6th Cir. 2005) (Under the "mootness" doctrine contained in Bankruptcy Code Section 363, the courts' decision to deny a stay pending landlord's appe
al of a bankruptcy judge's order authorizing an assumption and assignment of a lease concludes the landlord's ability to appeal whether such authorization provided "adequate protection" to the landlord as required by Code Section 365.):
“Precision Industries, Inc. v. Qualitech, 327 F. 3d 537 (7th Cir. April 23, 2003) (the DIRT DD for 4//29/03) [held] that a "free and clear" sale of landlord's property under Section 363 wiped out the protections that a tenant had pursuant to Section 365 to preserve its possessory rights notwithstanding the landlord's rejection of the lease. Some Pollyanna commentators have dismissed Qualitech as based entirely on the notion that the tenant did not properly object to the sale in the bankruptcy court, but the editor has pointed out that even if the tenant had objected, the bankruptcy court might have denied the objection, and then refused to stay the sale. Now we see what would happen to that tenant if it was unable to stay the sale, which might be a problem for the tenant if all the landlord's property is being "jobbed out" in one sale. A court would be loathe to hold up such an advantageous event for one little tenant. Once the sale had occurred, as we see here, even purchasers wi th knowledge of the tenant's objections would buy free of them. .
Yes, Children, the Armageddon clock has moved a few notches along its fateful path for leasaehold rights on bankruptcy.”
The Reporter for this item was Jack Murray of First American Title Insurance, Chicago office.
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