The buyer in a bankruptcy sale is not a “good faith” purchaser entitled to moot an appeal under Section 363(m) if the buyer had a “detailed, long-standing knowledge” of adverse claims to ownership of the property being sold, according to District Judge Katherine Polk Failla of New York.
Even though Judge Failla did not dismiss the appeal as moot under Section 363(m), she examined the merits and upheld the sale. In her opinion filed on September 24, she also held that a transfer of ownership of a lawsuit is a “sale” covered by Section 363(m).
The facts were horribly complex. For the sake of the significant holdings, however, the facts were simple.
A nonbankrupt company and the trustee for a bankrupt company both claimed ownership of a lawsuit. The trustee for the bankrupt company negotiated a settlement with the defendants in the suit in which the trustee would transfer the claims in the lawsuit to the defendants, thus allowing them to extinguish the suit. In return, the defendants waived claims against the bankrupt estate.
The nonbankrupt company filed an objection to the sale but was overruled by Bankruptcy Judge Shelley C. Chapman. Among other things, she found that the lawsuit belonged to the bankrupt estate, giving power of sale to the trustee.
The nonbankrupt company appealed, but the trustee argued that the appeal was moot under Section 363(m). That section provides that the reversal or modification of an order approving a sale “does not affect the validity of a sale” to a purchaser “that purchased . . . such property in good faith, whether or not such [purchaser] knew of the pendency of the appeal, unless such authorization and such sale . . . were stayed pending appeal.”
First, Judge Failla ruled that the transfer of ownership of the lawsuit qualified as a “sale” to fall within Section 363(m). In part, she was persuaded by the settlement agreement, which, on occasion, referred to the transaction as a “sale.”
Section 101(43) of the Bankruptcy Code defines a “purchaser” as a “transferee of a voluntary transfer.” By equating a “purchaser” with a “transferee,” the Bankruptcy Code itself “all but disposes of the question at hand,” she said.
Judge Failla held that the transfer of the lawsuit qualified as a sale covered by Section 363(m). She saw “no meaningful distinction between a sale, on the one hand, and a transfer of property in exchange for valid consideration on the other.”
Nonetheless, the sale would not be moot unless the buyers were good faith purchasers. Judge Failla concluded that they were not, meaning that the appeal was not moot under Section 363(m).
The bankruptcy judge had found in the sale-approval order that the buyers were good faith purchasers entitled to the protections of Section 363(m). The bankruptcy judge also found no fraud, collusion or bad faith. However, that was not enough for Judge Failla.
The Second Circuit, she said, defined a good faith purchaser as someone who buys property without notice of adverse claims. Still, if mere knowledge of an objection to a sale were sufficient to negate Section 363(m), Judge Failla said “the provision’s reach would be dramatically circumscribed.”
Courts require more than mere knowledge of adverse claims, Judge Failla said. She was, however, unable to locate a “specific rule” sufficient to differentiate between mere knowledge of objections and knowledge “sufficient to preclude a finding of good faith.”
Judge Failla cited Mission Product Holdings Inc. v. Old Cold LLC (In re Old Cold LLC), 879 F.3d 376 (1st Cir. Jan. 12, 2018), cert. pending under Mission Product Holdings Inc. v. Tempnology LLC, 17-1657 (Sup. Ct.).
In Old Cold, the First Circuit ruled that knowledge of “a likely appellate challenge to the sale itself” is not an “adverse claim.” Citing the Fifth Circuit, the Boston-based appeals court said there is a difference between knowing there are objections to the sale and having knowledge of an adverse claim. To read ABI’s discussions of Old Cold, click here and here.
Judge Failla said the defendants did not qualify as good faith purchasers given “their detailed, long-standing knowledge of [the] adverse claims of which they themselves are the subjects.” She said the buyers, as defendants in the suit, had participated in discovery “and had doubtlessly analyzed the merits of the disputed causes of action.”
How could Judge Failla overturn the bankruptcy court’s finding of fact that the buyers were good faith purchasers without saying that the factual conclusions were clearly erroneous? Judge Failla evidently believed that the bankruptcy judge employed the wrong legal standard, giving rise to de novo review on appeal.
In any event, the opinion teaches that a bankruptcy judge’s finding regarding status as a good faith purchaser is not the final word on appeal.
Having ruled that the appeal was not statutorily moot under Section 363(m), Judge Failla went on to review the merits. She concluded that the bankruptcy judge was correct in approving the settlement and finding that the trustee owned the claims he was selling.