Interests and Good Faith Under 363: A New Decision Explores the Limits of Both

A recent decision from the U.S. Bankruptcy Court for the District of Montana highlights the limits of the term “interests” under § 363(f) of the Bankruptcy Code and the limits of “good faith” under § 363(m). In In re Mountain Divide LLC, Case No. 16-61015-11 (Bankr. D. Mont. 2016), the debtor filed a chapter 11 petition and, shortly thereafter, filed a motion to sell substantially all of its assets to Deep River Operating LLC and Future Acquisition North Dakota LLC (FAC). Deep River and FAC were considered a joint stalking-horse bidder. Deep River, however, failed to provide the debtor with the financial information necessary to demonstrate its ability to close the sale. As a result, FAC stepped into Deep River’s position in accordance with the bidding-procedures order, and was ultimately determined to be the successful bidder at the auction.

The bankruptcy court entered a sale order that, among other things, (1) found that the debtor and FAC negotiated and entered into the purchase and sale agreement at arm’s length without collusion or fraud, (2) that FAC was a good-faith purchaser in accordance with § 363(m), and (3) that the debtor’s assets would be sold to FAC free and clear of all liens, claims and interests under § 363(b) and (f). The sale order also enjoined essentially all persons and entities from asserting the interests against FAC. The sale to FAC closed on Jan. 20, 2017, and the debtor’s chapter 11 plan was confirmed on Nov. 30, 2017.

After closing, FAC filed a complaint against Deep River in the U.S. District Court for the Southern District of Texas, alleging that Deep River breached the provisions of the bid agreement executed between FAC and Deep River, which governed their own agreement to submit a joint bid to purchase the debtor’s assets. Under the bid agreement, FAC and Deep River agreed to, among other things, jointly purchase the debtor’s assets (30 percent to FAC and 70 percent to Deep River). Deep River asserted counterclaims against FAC, alleging that FAC breached the Bid Agreement and tortuously interfered with Deep River’s existing and prospective contracts. Interestingly, neither FAC nor Deep River had ever disclosed the bid agreement to the bankruptcy court during the sale proceedings.

Even though it sued Deep River in Texas District Court, FAC also brought proceedings before the Montana Bankruptcy Court alleging that Deep River’s counterclaims in the district court action constituted a collateral attack on the sale order. Specifically, FAC argued that the counterclaims were “interests” that had been sold free and clear under § 363(f), and that the sale order enjoined persons (presumably, including Deep River) from pursuing such interests against FAC.

The bankruptcy court, however, ruled that Deep River’s counterclaims arising under the bid agreement were not the type of interests that § 363 or the sale order sought to preclude after the sale, because the counterclaims were not attacking the validity of the sale, nor were they the type of successor-liability claims that are commonly thought of as “interests” under the Bankruptcy Code. In fact, Deep River’s counterclaims against FAC were not dependent on FAC’s ownership of the property sold and not dependent on the outcome of the sale itself. The counterclaims also did not allege that the sale was improper or the result of conspiracy; instead, they were based on the bid agreement and FAC’s alleged breach of the bid agreement. The bankruptcy court further concluded that Deep River’s counterclaims did not conflict with any provision of the sale order. Interestingly, the bankruptcy court noted that the tortious-interference claims could ultimately constitute a collateral attack on the sale order, but that it could not reach a conclusion on this issue based on the record before the court.[1]

Although FAC did not argue the point, the bankruptcy court analyzed whether the sale order’s good-faith finding under § 363(m) precluded Deep River’s counterclaims. The bankruptcy court found that the protections afforded by § 363(m) apply “only if the court, upon reversing or modifying the order authorizing the sale, would affect the validity of the sale.” Quoting the Ninth Circuit Bankruptcy Appellate Panel’s Clear Channel decision, the bankruptcy court concluded that § 363(m) addresses “only changes of title or other essential attributes of a sale ... [and that] the terms of those sales, including the free and clear term at issue here, are not protected.”[2] In short, § 363(m) does not apply when there is no risk of reversal or modification of the sale following an appeal. The bankruptcy court could not conclude that would happen based on the record before it. As such, the bankruptcy court held that Deep River’s counterclaims against FAC did not amount to an impermissible collateral attack on the sale order or its provisions, nor were they precluded by § 363(m).

Practice Pointer

This decision highlights that “interests” under § 363(f) has its limits. Here, “interests” did not include claims against a purchaser that were based on an undisclosed contract governing a joint bid for the debtor’s assets. Moreover, even though the bankruptcy court found that the purchaser was entitled to good-faith protections under § 363(m), those protections did not preclude certain claims against the purchaser related to the sale. It is unclear from the decision why FAC and Deep River did not disclose the bid agreement during the sale proceedings.

Practitioners often err on the side of disclosure to avoid allegations of collusion. While FAC’s and Deep River’s decision may have been a proper and justifiable at the time of the sale proceedings, query whether disclosure of the bid agreement during the sale proceedings or a reference to it in the sale order would have helped FAC’s post-sale proceedings against Deep River in the bankruptcy court.