Challenges to Finality of Sale Orders

Federal policy weighs heavily in favor of protecting the finality of sale orders in bankruptcy.[1] “It has been held that 11 U.S.C. § 363(m) ‘reflects the salutary policy of affording finality to judgments approving sales in bankruptcy by protecting good faith purchasers, the innocent third parties who rely on the finality of bankruptcy judgments…. The finality and reliability of the judicial sales enhance the value of the assets sold in bankruptcy.’”[2] Additionally, finality is important because it removes the chance that purchasers will be dragged into endless litigation.[3]

The First and Third Circuits were recently faced with appeals from sale orders that challenged the finality principle. Two critical facts of the cases were similar: (1) The appellants did not seek a stay of sale order; and (2) the purchasers were designated good-faith purchasers entitled to the protection of § 363(m). Notwithstanding these circumstances, appeals lodged after the closings proceeded in direct contrast to precedent regarding the finality and reliability of bankruptcy court sale orders. Ultimately, both the First and Third Circuits affirmed the sale orders, finding the appeals statutorily moot. But in doing so, a weakness may have been revealed in the bankruptcy court sale-approval process and the finality afforded sale orders that could impact the certainty of and value obtained in future § 363 sales.

In Mission Prod. Holdings Inc. v. Old Cold LLC[4] a former contract party and aggrieved bidder argued that § 363(m) should not insulate a sale order from appeal, even absent obtaining (or even seeking) a stay in cases where either (1) the “good faith” finding itself is challenged, or (2) the aggrieved party is deprived adequate time to seek a stay; or (3) the absolute priority rule was allegedly violated.

Over two years after the sale closed, the First Circuit rejected the appellant’s arguments and recognized the importance of the protections provided by § 363(m). Because the purchaser was a good-faith purchaser and the sale closed without a stay, the First Circuit dismissed all remaining challenges to the appeal. The First Circuit concluded that § 363(m) applies even if the bankruptcy court’s approval of the sale was not proper, as long as the bankruptcy court was acting under § 363(b).[5]

A few months before the First Circuit’s decision in Old Cold, the Third Circuit analyzed the issue of statutory mootness in Pursuit Capital Management Fund 1 v. Burtch (In re Pursuit Capital Management LLC).[6] As in Old Cold, in Pursuit Capital an aggrieved bidder appealed a sale order arguing that the § 363(m) finding was improper, but the bidder failed to seek or obtain a stay of the sale itself. In affirming the bankruptcy court’s sale order, the Third Circuit focused its attention on mootness: “This case seems at first blush to be about the validity of the sale of legal claims … but, at this point, it is really about whether such merits issues have been preserved for present review.”[7]

The Third Circuit concluded that § 363(m) moots a challenge to a sale if two conditions are satisfied: “(1) the underlying sale or lease was not stayed pending the appeal, and (2) the court, if reversing or modifying the authorization to sell or lease, would be affecting the validity of such a sale or lease.”[8] The court noted that the two-part test really has “an additional step because we are first required to ask whether the purchaser at the sale ‘purchased ... [the] property in good faith.’”[9]

The Third Circuit ruled that the sale was conducted in good faith and then turned to the two-part test under § 363(m). Since no stay had been obtained, the only question was whether the reversal or modification of the sale order would affect its validity. The additional validity prong departs significantly from the “per se” rule, but less so from the rule followed in Old Cold. As explained by the Third Circuit, the “validity prong of our test provides ‘[a] narrow exception [that] may lie for challenges to the Sale Order that are so divorced from the overall transaction that the challenged provision would have affected none of the considerations on which the purchaser relied.’”[10] In Pursuit Capital, this narrow exception did not apply. The Third Circuit ruled that the remedy sought by the Pursuit parties (i.e., declaration of the legality of the sale) would undermine and affect the validity of the sale. As a result, the Pursuit parties’ appeal was deemed moot and the sale order was affirmed.

The outcomes in Old Cold and Pursuit Capital reaffirm the federal policy of finality in sale orders, and parties that seek to challenge a bankruptcy court sale should seek to stay the sale order to preserve appellate rights. However, the issuance of two circuit-level opinions on the subject suggests that the policy will continue to be tested and that buyers are never fully insulated from extensive litigation until the appeal period expires. In both cases, the bankruptcy court determined that the buyers were good-faith purchasers and approved the sales. The appealing parties did not obtain or even seek a stay of the sale orders. Instead, after the sales closed, appeals were filed challenging, among other things, the “good faith” findings. In each case, the appeals proceeded for more than two years. In the end, both courts ruled that the appeals were statutorily moot because the good-faith determinations were affirmed — but only after the prevailing parties had spent time, money and effort to confirm longstanding precedent or overcome conclusory or unpersuasive attacks on the good-faith purchaser’s determinations.

Absent finality, in a § 363 sale the price of the debtor’s assets may be reduced if the purchaser is not guaranteed ownership of those assets upon the closing of the sale. Specifically, the risk of subsequent and protracted litigation will be factored into the purchase price that bidders are willing to pay for the subject assets. This “chilling” effect on buyers may result in a loss of what is currently the primary reason why potential new buyers are attracted to § 363 auctions in the first place.[11]