363 Sales over the Objection of Junior Lienholders after Clear Channel
Written by: Eric W. Anderson
Parker Hudson Rainer & Dobbs LLP; Atlanta
Joshua J. Lewis
Parker Hudson Rainer & Dobbs LLP; Atlanta
Bankruptcy professionals
have become quite accustomed to the increasingly common phenomenon of a
troubled company filing a chapter 11 case and either simultaneously with the
petition or very soon thereafter filing a motion under §363 of the Bankruptcy
Code to sell all or substantially all of its assets. These liquidating chapter
11 cases have become so prevalent that some commentators have begun to predict
the imminent death of the “traditional” chapter 11 reorganization.[1]
The rise in the use of “363 sales” can be attributed to several factors,
including the speed with which such sales can be accomplished in a chapter 11
case (compared to the time necessary to propose and confirm a plan) and the
resulting reduction in expense. Just as important, investors and purchasers in the
merger-and-acquisition markets in many instances demand that a sale of
distressed assets be structured as a §363 sale so that a purchaser can take the
assets free and clear of all liens and claims in a relatively quick procedure,
and not have to entangle itself in the debtor’s chapter 11 plan process. The
certainty and finality of the §363 sale process are critical to these
purchasers.
Historically, bankruptcy courts have largely gone along with this trend and allowed debtors to sell all or substantially all of their assets pursuant to §363 on an expedited basis in emergency situations. Prospective asset purchasers frequently offer to buy all or part of a debtor’s business intending to operate the business as a going concern, but condition the offer on the ability to consummate the sale quickly, and free and clear of liens. The ability of a bankruptcy court to authorize a §363 sale in such a case is necessary to save the going concern value of the assets being sold. Moreover, such a sale serves bankruptcy objectives by preserving value for creditors, maintaining jobs for employees and ensuring the generation of future taxes for the community at large.
While most bankruptcy practitioners would agree that §363 sales often occur with positive results, an inherent tension exists in the Code between §363 sales and sales conducted pursuant to the procedural safeguards of the plan-confirmation process. As a result of that tension, some courts have concluded that §363 should be more narrowly construed than it has been in the past. This article will discuss the extremely narrow construction of §363 recently expounded by the Ninth Circuit Bankruptcy Appellate Panel (BAP) in Clear Channel.[2] This article will also discuss how the BAP changed the landscape with respect to whether courts may effectively alter a §363 sale order on appeal. Finally, this article will analyze the BAP decision and its potential impact on the distressed sale market, and will suggest alternative strategies to address the possible hurdles raised by this decision.
The Statutory Construct
Section 363(b)(1) of the Code provides that the “trustee, after notice and hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate….”[3] Further, a trustee may sell property under §363(b) “free and clear of any interest in such property of an entity other than the estate” if one or more of the conditions under §363(f) exists:
(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;
(2) such entity consents;
(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;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.[4]
Lastly, if a sale under §363(b) is authorized by a bankruptcy court, §363(m) states:
The reversal or modification on appeal of an authorization under subsection (b)...of this section...does not affect the validity of a sale or lease...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.[5]
Clear Channel: Factual Background
Prior to filing for bankruptcy relief, the debtor PW LLC in Clear Channel was attempting to assemble various parcels of real estate in order to build a mixed-use complex of condominiums and retail space. When PW’s development efforts encountered various problems, DB Burbank, LLC, which held a first-priority lien on substantially all of PW’s assets, attempted to foreclose on the real estate. On the eve of foreclosure, PW filed a chapter 11 petition. Shortly thereafter, DB moved for the appointment of a trustee, and the bankruptcy court granted the motion.
The trustee quickly realized that DB would likely be granted relief from the stay to foreclose upon its collateral if an agreement could not be reached. After some negotiation, the trustee and DB agreed to an auction and §363 sale of PW’s assets. Under their agreement, DB served as the stalking-horse bidder for the sale. When no qualified overbidders bid on the debtor’s assets, DB purchased the assets pursuant to a credit bid in the approximate amount of its claim, which exceeded $41 million. Notably, the next highest bid for the debtor’s assets was a nonconforming contingent bid of only $25.25 million.
Clear Channel Outdoor Inc. (CCO), which held a junior lien on the debtor’s assets securing a claim of approximately $2.5 million, opposed the sale free and clear of its lien and argued that the proposed §363 sale could not take place over its objection because none of the conditions listed in §363(f) was satisfied. The bankruptcy court disagreed and approved the sale free and clear of CCO’s liens. CCO appealed the decision of the bankruptcy court but did not obtain a stay pending appeal. While the case was pending appeal, DB paid more than $1.5 million in connection with the closing of the sale to pay agreed-upon fees and expenses, including payments to a senior lienholder and payments to tax authorities for outstanding real property taxes.
The Issues on Appeal
On appeal, CCO sought reversal of the bankruptcy court’s decision authorizing the §363 sale free and clear of CCO’s liens. CCO continued to maintain that a sale free and clear of its liens was not possible in this case because none of the conditions of §363(f) was satisfied. DB and the trustee countered that the conditions set forth in both §363(f)(3) and (f)(5) had indeed been met, and further that the appeal was now moot in light of inequities that would result if the bankruptcy court were reversed.
Mootness
Prior to reaching the merits of CCO’s appeal under §363(f), the BAP first evaluated whether the appeal was moot as DB and the trustee argued. As the BAP noted in Clear Channel, “[i]n bankruptcy, mootness comes in a variety of flavors: constitutional, equitable, and statutory.”[6]
Constitutional Mootness
Constitutional mootness requires the evaluation of whether there is still a live case or controversy and whether it is still possible for the appellate court to fashion some relief.[7] In Clear Channel, the BAP had little difficulty determining that the appeal was not constitutionally moot in light of the fact that it was still possible for the BAP to fashion some relief by reversing the bankruptcy court’s order approving the §363 sale.
Equitable Mootness
Equitable mootness, in contrast to constitutional mootness, “requires the court to look beyond impossibility of a remedy to ‘the consequences of the remedy and the number of third parties who have changed their position in reliance on the order that is being appealed.’”[8] As the BAP noted, courts will generally consider the complexities and difficulties associated with unwinding a transaction, as well as the appellant’s failure to obtain a stay, in applying the doctrine of equitable mootness.[9] The BAP considered that while the parties to the sale were parties to the appeal, the transactions that occurred in connection with the sale of the property nevertheless affected the rights of, and were relied upon by, third parties. Moreover, there were numerous complex transactions that would have to be unwound if the order approving the sale were reversed. Indeed, in connection with the sale: title to PW’s property was transferred to DB; the trustee relinquished control of the development to DB; DB had assumed executory contracts and unexpired leases; and DB had executed and recorded a number of documents necessary to effectuate the sale. Thus, the BAP held that the “complexities and the impact on third parties” made review of the sale equitably moot.[10]
The BAP then went on to hold that although CCO’s appeal of the sale was equitably moot, the same could not be said about reinstating CCO’s liens.[11] In segregating the inquiry of whether an appeal is moot with respect to a completed sale as a whole versus whether an appeal is moot with respect to the lienstripping aspects of the sale under §363(f), the BAP concluded that “reattaching [CCO’s] lien to PW’s former property is not theoretically or practically difficult.” Further, the BAP concluded that reattaching CCO’s liens would not negatively impact third parties (suggesting that the result may have been different had the §363 sale been to a third party rather than a secured creditor pursuant to a credit bid). Thus, the BAP ultimately held that “[a]n appeal is not equitably moot as to lien-stripping under §363(f) if reversing the lien-stripping raises neither the issue of complexity nor the issue of negative impact on third parties.”[12]
Statutory Mootness
The BAP similarly held that CCO’s appeal was not statutorily moot under §363(m), quoted supra, which limits the effect of a reversal or modification on appeal of the validity of a sale or lease under §363(b) or (c). The BAP reasoned that §363(m) by its terms applies only to sales or leases authorized under subsection (b) or (c) of §363, indicating that Congress intended §363(m) to address only changes of title or other attributes of a sale, and not terms of those sales such as the “free and clear” term at issue in Clear Channel. Thus, the court rejected DB’s argument that its agreement to purchase the property was conditioned on receiving a free-and-clear title and held that “§363(m) does not apply to lien-stripping under §363(f).”[13]
Sales Free and Clear under §363(f)
After determining that CCO’s appeal was not moot, the BAP went on to evaluate the merits of CCO’s claim that the sale could not be authorized free and clear under §363(f) because none of the five paragraphs that authorize such a sale applied in this case. Specifically, the BAP’s focus was on whether the sale of PW’s assets to DB satisfied either §363(f)(3) or (f)(5). Section 363(f)(1), (f)(2) and (f)(4) were not at issue in Clear Channel, as neither DB nor the trustee alleged that “applicable nonbankruptcy law” permitted the sale of property free and clear of CCO’s interest, CCO consented to the sale, or the junior creditor’s interest was subject to a bona fide dispute.[14] As discussed below, the BAP did not address—and perhaps the issue was not raised on appeal—whether §363(f)(1) might well have provided a basis to approve the sale free and clear assuming that a properly conducted foreclosure sale under California law extinguishes all junior liens.
BAP’s Discussion of §363(f)(3)
In seeking to have the BAP affirm the bankruptcy court’s decision authorizing the §363 sale free and clear of CCO’s liens, DB and the trustee argued that the sale was proper pursuant to §363(f)(3), which provides in pertinent part:
[T]he trustee may sell property under subsection (b)...free and clear of any interest in such property...if...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....
Specifically, the trustee argued that the “aggregate value of all liens” means the economic value rather than the face value of the liens such that there may be a sale free and clear of “out-of-the-money” liens.[15]
As the BAP recognized, a number of courts have held that a §363(f)(3) sale may take place “free and clear of the property rights of junior lienholders whose nonbankruptcy liens are not supported by the collateral’s value.”[16] The BAP, however, joined a separate group of courts in holding that the “value” of the liens under subsection (f)(3) refers to the liens’ face value.[17] Further, the BAP noted that “[p]aragraph (3) permits the sale free and clear only when ‘the price at which such property is to be sold is greater than the aggregate value of all liens....”[18] Thus, the BAP concluded, even if one accepted that the “aggregate value of all liens” means the economic value of the liens, “in any case in which the value of the property being sold is less than the total amount of claims held by secured creditors, the total of all allowed secured claims will equal, not exceed, the sales price, and the statute requires the price to be ‘greater than’ the ‘value of all liens.’”[19] As a result, the BAP held that paragraph (f)(3) “does not authorize the sale free and clear of a lienholder’s interest if the price of the estate property is equal to or less than the aggregate amount of all claims held by creditors who hold a lien or security interest in the property being sold.”[20]
BAP’s Discussion of §363(f)(5)
After disposing of the trustee’s §363(f)(3) argument, the BAP turned its attention to the “anything but plain” meaning of §363(f)(5) and the “conundrum” of its application.[21] Indeed, “[a]s with section 363(f)(3), the case law and leading treatises have had some difficulty construing section 363(f)(5),”[22] which states:
the trustee may sell property under subsection (b)...free and clear of any interest in such property...if...such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.[23]
The bankruptcy court had found that paragraph (f)(5) applies whenever a claim or interest can be paid with money, but the BAP found that “it does not necessarily follow that such liens can be satisfied by paying any sum, however large or small.”[24] Rather, the BAP found that “paragraph (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.”[25] Notably, the BAP rejected an argument that has been accepted by other courts—that a cramdown under §1129(b)(2) is such a qualifying legal or equitable proceeding.[26] The BAP reasoned that cramdown does not exist under nonankruptcy law, and to allow cramdown to be relied upon to sell assets free and clear of liens under paragraph (f)(5) would undermine the plan-confirmation process.
According to the BAP, its application “leads to a relatively small role for paragraph (5),” and the court cited specific examples of the role paragraph (5) might play: “a buyout arrangement among partners, in which the controlling partnership agreement provides for a valuation procedure that yields something less than market value of the interest being bought out...or satisfaction of obligations related to a conveyance of real estate that normally would be specifically performed but for which the parties have agreed to a damage remedy.”[27] Surprisingly, however, in its recitation of the various possible proceedings in which a junior lienholder could be compelled to accept less than the full amount of its claim, the BAP ignored one of the most obvious such proceedings: a foreclosure sale. While a comprehensive survey of state foreclosure laws is well beyond the scope of this article, it seems fair to suggest that whether or not a particular state has a judicial foreclosure system, one of the most basic elements of most foreclosure schemes is the extinguishment of junior liens. The real property foreclosure sale would seem to be the epitome of the “legal or equitable proceeding” referred to in §363(f)(5), but it was not even mentioned by the BAP.[28]
Implications of Clear Channel
There can be little doubt that Clear Channel has made it more difficult to accomplish a §363 sale in the Ninth Circuit. First, Clear Channel will certainly motivate junior-lien creditors to object to §363 sales with the hope of securing some concession payment from senior secured creditors. Second, in the face of such an objection, a bankruptcy court may be less likely to authorize a sale free and clear of liens under §363(f). Third, a buyer will have less confidence in the finality of bankruptcy court orders in light of the BAP’s decision as it relates to mootness.
What can practitioners take away from Clear Channel, and how can they overcome these difficulties? One obvious approach would be to make the argument that seems to have been ignored not only by the Clear Channel court, but also seems to have largely been ignored or untested in the reported cases, which is to argue that a sale may be authorized free and clear of junior creditor liens under either §363(f)(1) or (f)(5) because of the ability of a senior creditor to foreclose its interests under state law and thereby extinguish junior liens. Using that argument under §363(f)(1), a secured creditor ought to be able to argue that a state foreclosure law constitutes an “applicable nonbankruptcy law” that would permit the sale of property free and clear of a junior creditor lien or interest. For example, Georgia employs a nonjudicial foreclosure scheme pursuant to which, in a properly drafted deed to secure debt, the secured creditor is appointed as attorney-in-fact to sell the borrower’s real property at foreclosure and extinguish any junior liens or interests in the property. Georgia’s foreclosure statute (and others like it in other states) would therefore seem to be an appropriate nonbankruptcy law that permits the sale free and clear of interests.
Similarly, the foreclosure argument should also be applicable with respect to §363(f)(5). Under a properly-conducted foreclosure sale in most states, a junior creditor can be forced either to accept nothing on its liens or be forced to accept less than all of its claim, depending on the price obtained at the foreclosure. The Clear Channel court specifically recognized that a §363(f)(5) “proceeding” could result in the junior creditor receiving less than the amount of its claim.[29] The BAP noted that in the §363(f)(5) analysis, the issue is not how much a junior lienholder can be compelled to accept, but rather whether some legal mechanism exists to permit the extinguishment of the junior lien without fully satisfying the lienholder’s debt.[30]
Another possible effect of the Clear Channel case may be that companies in distress that are planning to use chapter 11 to effect the sale of all or substantially all of their assets may simply avoid the §363(f) objection fight by filing pre-packaged or pre-arranged plans of liquidation at the commencement of the case. Depending on the severity of the debtor’s financial distress and liquidity crisis, some debtors—in conjunction with their secured lenders—may choose this route to attempt to blunt the potential leverage that Clear Channel might have provided to a junior lienholder. Under the right circumstances, a debtor might achieve confirmation of a plan of liquidation very quickly. Even the fastest plan process, though, will typically take longer than a §363 sale process and thus may result in increased administrative costs and the loss of going-concern value to the estate.
Finally, if faced with a jurisdiction in which courts are likely to follow the Clear Channel lead and refuse to approve sales free and clear of liens where a junior creditor might object, senior lienholders may simply resort to foreclosures, whether before bankruptcy or after bankruptcy, by seeking immediate relief from the automatic stay.[31]
Even if the court is willing to approve a sale free and clear of liens over a junior-lien creditor objection based on the §363(f) factors, the Clear Channel decision casts doubt upon whether a purchaser can ever feel comfortable closing the transaction until any appeal has been concluded. In the past, so long as the bankruptcy court made a finding in the order approving a sale that a buyer was purchasing the property in good faith, most buyers comfortably relied on the doctrine of equitable mootness and §363(m) to protect them from the effect of a possible reversal of the sale order on appeal, and proceeded to closing of the sale immediately so long as no stay of the order had been entered.
After Clear Channel, buyers may now be well advised to wait until all appeal periods have passed without any appeals pending before actually closing the transaction. This is true despite the fact that the Clear Channel opinion is arguably vulnerable to attack on a number of grounds. First, the opinion contains no authority for the ultimate conclusion that the finality of the lienstripping assets of a §363 sale can be segregated from the finality of the sale as a whole. The BAP gave short shrift to the buyer’s position that the “free and clear” aspect of the sale was an integral part of the purchase agreement, and left the secured creditor/purchaser in worse shape than if the sale had never occurred. By keeping the conveyance of title intact, but rewriting the terms of the deal between the debtor and DB, the BAP significantly harmed DB by forcing it to accept a purchase of property on terms to which it never agreed. DB was then left in a position where its state law right to foreclose on the property and extinguish junior liens was now taken away by the BAP, and it was involuntarily forced to accept its collateral subject to the junior liens. This wholesale alteration of the parties’ bargained-for rights is inappropriate and should provide a clear angle to attack the Clear Channel decision.
Moreover, in reaching this conclusion, the BAP questioned the fairness of the Bankruptcy Code and Rules with respect to the requirement that creditors obtain a stay pending appeal to avoid mootness concerns. But in doing so, the court simply ignored the plain language of the Code and Rules relating to the requirement that an appellant obtain a stay of the sale order pending appeal (and post a bond as a prerequisite to obtaining the stay) and, without any precedent to support it, essentially rewrote those provisions to reach the desired result.[32] This is certainly contrary to established Supreme Court precedent directing courts to follow the plain meaning of statutes as written.[33]
Conclusion
Although Clear Channel is an unwelcome opinion to senior secured creditors, the case does not present insurmountable problems for senior secured creditors. Indeed, senior secured creditors remain free to enter intercreditor agreements with junior secured creditors pursuant to which the junior creditor agrees in advance not to object to a §363 sale in bankruptcy. Senior secured creditors likewise remain free to file liquidating plans in lieu of motions to approve §363 sales when a junior creditor is likely to object to a sale.
Footnotes
1 See, e.g., Douglas G. Baird and Robert K. Rasmussen, The End of Bankruptcy, 55 Stan. L. Rev. 751 (2002); Douglas G. Baird and Robert K. Rasmussen, Chapter 11 at Twilight, 56 Stan. L. Rev. 673 (2003).
2 Clear Channel Outdoor Inc. v. Knupfer (In re PW LLC), Case No. 07-1176, 2008 Bankr. LEXIS 1934 (9th Cir. B.A.P. May 30, 2008).
3 11 U.S.C. §363(b)(1).
4 11 U.S.C. §363(f).
5 11 U.S.C. §363(m).
6 Clear Channel, 2008 Bankr. LEXIS 1934 at *11.
7 Id. at *11-12.
8 Id. at *12.
9 Id. at *12-13.
10 Id. at *15.
11 Id. at *16-17.
12 Id. at *15-16.
13 Id. at *18.
14 Notably, there is a dearth of case law on the subject of whether state foreclosure proceedings can constitute “applicable nonbankruptcy law” pursuant to which a senior secured creditor could sell assets free and clear of a junior secured creditor’s liens.
15 Clear Channel, 2008 Bankr. LEXIS 1934 at *30-31 (citing In re Beker Industries Corp., 63 Bankr. 474, 477 (Bankr. S.D.N.Y. 1986); In re Terrace Gardens Park Partnership, 96 Bankr. 707, 712-13 (Bankr. W.D. Tex. 1989); In re Oneida Lake Dev. Inc., 114 Bankr. 352, 356 (Bankr. N.D.N.Y. 1990); In re WPRV-TV Inc., 143 Bankr. 315, 320 (D. P.R. 1991), judgment aff’d on other grounds, 983 F.2d 336 (1st Cir. 1993); In re Milford Group Inc., 150 Bankr. 904, 906 (Bankr. M.D. Pa. 1992)). Cf. 11 U.S.C. §1129(b)(2)(A)(i)(II), which provides that in evaluating whether or not a chapter 11 plan meets the “fair and equitable” test such that it may be confirmed over a secured creditor’s objection, the relevant test is whether the plan provides that the holder of the secured claim will receive cash payments with a present value “of at least the value of such holder’s interest in the estate’s interest in such property,” thus valuing the lien based on the value of the underlying collateral.
16 Clear Channel, 2008 Bankr. LEXIS 1934 at *31.
17 Id. at *32-33 (citing In re Stroud Wholesale Inc., 47 Bankr. 999, 1002 (E.D.N.C. 1985); In re Heine, 141 Bankr. 185, 189 (Bankr. D. S.D. 1992)).
18 Clear Channel, 2008 Bankr. LEXIS 1934 at *33-34 (emphasis added).
19 Id. at *34 (emphasis in original).
20 Id.
21 Id. at *35.
22 In re Canonigo, 276 B.R. 257 (Bankr. N.D. Cal. 2002).
23 11 U.S.C. §363(f)(5).
24 Clear Channel, 2008 Bankr. LEXIS 1934 at *39 (emphasis in original).
25 Id.
26 Id. at *50. But see In re Gulf States Steel Inc. of Ala., 285 B.R. 497, 507 (Bankr. N.D. Ala. 2002) (“Even if an actual payment were required, the lienholder would only be entitled to receive what it would receive in the event of a cram-down.”).
27 Id. at *41-43.
28 This omission is particularly curious because one of the cases relied upon by the BAP to support its holding concerning §363(f)(5) is Gulf States, 285 B.R. 497, but that case itself specifically discusses judicial and nonjudicial foreclosures as a means by which a junior lienholder can be compelled to release its liens. Id. at 508-509.
29 Clear Channel, 2008 Bankr. LEXIS 1934 at *40-41.
30 Id. at *39-41, citing In re Terrace Chalet Apts., 159 B.R. 821, 829 (N.D. Ill. 1993).
31 In a situation where a junior creditor will receive little or nothing on its claim and the debtor has already decided that a sale of its assets would be appropriate, the secured creditor should have little problem establishing the elements necessary for relief from the automatic stay under §362(d)(2). Almost by definition, the debtor has no equity in the property, and because the debtor has already determined that a sale of assets is appropriate, it should be obvious that the property is not necessary for an effective reorganization. Of course, the foreclosure alternative is fraught with other difficulties, most conspicuously the substantial variation in state law foreclosure schemes, some of which can take many months to achieve.
32 Clear Channel, 2008 Bankr. LEXIS 1934, at *22-23.
33 See, e.g., U.S. v. Ron Pair Enterprises Inc., 489 U.S. 235, 109 S.Ct. 1026, 1030, 103 L.Ed. 2d 290 (1989) (“where, as as here, the statute’s language is plain, ‘the sole function of the courts is to enforce it according to its terms’” (quoting Caminetti v. United States, 242 U.S. 470, 485 (1917)).