Seventh Circuit Rules that Section 363(m) Doesn’t Render Appeals Moot

Writing for a three-judge panel, Circuit Judge Frank Easterbrook overruled two Seventh Circuit precedents, in the process narrowing the effect of Section 363(m) on appeals from orders approving sales.

Before the corporate debtor’s bankruptcy, the lender’s servicer mistakenly filed a satisfaction of mortgage. Also before bankruptcy (and evidently outside the preference period), the lender discovered the mistake and unilaterally cancelled the satisfaction.

Before bankruptcy, no intervening rights arose, and no one relied on the erroneous mortgage satisfaction.

In bankruptcy, the debtor challenged the validity of the mortgage in an adversary proceeding. Bankruptcy Judge Deborah Thorne of Chicago didn’t bite. She held that the mortgagee retained its lien rights. The debtor appealed but lost in district court.

The debtor appealed to the circuit, contending it was entitled to receive the sale proceeds and distribute the proceeds to other creditors.

The bankruptcy court approved a sale of the property before the appeal was heard, prompting the lender to argue that Section 363(m) made the appeal moot. The section provides that a “reversal or modification on appeal of an authorization . . . of sale or lease of property does not affect the validity of a sale or lease . . . to an entity that purchased or leased such property in good faith.”

In his March 1 opinion, Judge Easterbrook held that Section 363(m) did not moot the appeal, overruling two Seventh Circuit precedents in the process. Reaching the merits, he went on to agree with Judge Thorne and held that the lender had not lost its lien rights.

Judge Easterbrook said that mootness is a constitutional doctrine designed to avoid the issuance of advisory opinions. The fact that a statute may obviate the availability of certain relief does not render the appeal moot.

Judge Easterbrook cited the Norris-LaGuardia Act, which precludes injunctions in some labor disputes. When the act applies, he said the court dismisses the suit but does not declare it moot.

On an appeal from a bankruptcy sale, Judge Easterbrook said there is a “live controversy about who should get the money generated by the sale.” He went on, “That’s why we held long ago that Section 363(m) does not concern mootness.” He added, “A defense, even an ironclad defense, does not defeat jurisdiction.”

Judge Easterbrook said that Section 363(m) “does not say one word about the disposition of the proceeds of a sale or lease.” Other circuits, he said, “likewise hold that Section 363(m) does not specify what happens to the money.”

Judge Easterbrook issued two holdings: (1) “Section 363(m) does not make any dispute moot,” and (2) Section 363(m) does not “prevent a bankruptcy court from deciding what shall be done with the proceeds of a sale or lease.”

However, the holdings were at odds with two Seventh Circuit precedents. In In re River West Plaza-Chicago, LLC, 664 F.3d 668 (7th Cir. 2011), the appeals court had held that Section 363(m) not only precludes upsetting the sale but also prevents the court from redirecting sale proceeds to the debtor’s estate. Similarly, a portion of In re Sax, 796 F.2d 994 (7th Cir. 1986), said that all disputes within the scope of Section 363(m) are moot.

For a three-judge panel to overrule circuit authority, Judge Easterbrook relied on Circuit Rule 40(e). He therefore circulated the opinion on all active circuit judges, and none voted to hear the case en banc.

Turning to the merits, Judge Easterbrook upheld the enforceability of the mortgage lien. He distinguished In re Motors Liquidation Co., 777 F.3d 100 (2d Cir. 2015), where the Second Circuit held that a release of lien was binding because the mistake was not discovered until after bankruptcy when the debtor in possession gained the rights of a hypothetical lien creditor.