It doesn't take too much experience in the world of bankruptcy to learn that most of the time, when the proverbial train is leaving the station, it stops for no one. The bankruptcy court approves the transaction over objection and the objecting parties are unable to obtain a stay pending appeal. Because there is no stay pending appeal, the parties to the court-approved transaction head to closing table. The egg is scrambled and cannot be unscrambled. Any appeal is resisted, and often dismissed, on mootness grounds. This is especially true with fast-moving sales under §363, in part because of the protection from a reversal on appeal provided by 11 U.S.C. §363(m).[1] Such sales are increasingly common in chapter 11 cases, which can give creditors an exit strategy much faster than the usual time needed to confirm a plan of reorganization.
A recent decision from the 9th Circuit Bankruptcy Appellate Panel (BAP), Clear Channel Outdoor Inc. v Knupfer (In re PW LLC), 391 B.R. 25 (9th Cir. B.A.P. 2008), reviews the different kinds of mootness, and in the facts before it, demonstrates that there can be limits on what can be mooted. In Clear Channel, an appeal of the sale of real estate under §363 was moot, but an appeal of the lienstripping - a part of the sale that the buyer considered essential to the sale - was not moot, and was reversed and remanded.
The basic facts are likely ones that will be increasingly common in the current economic environment. The debtor, PW Inc. (PW), owned numerous parcels of real estate. The secured creditor, DB Burbank LLC (DB), held a claim of approximately $40 million secured by PW's real estate. Pursuant to an agreement with DB, the chapter 11 trustee sold this real estate "free and clear of all claims and encumbrances at a sale supervised by the bankruptcy court."[2] Only three "outside" bids were made, and DB, as the stalking-horse bidder, credit-bid the entire amount of its debt. The bankruptcy court (relying on §363(f)) confirmed the sale to DB "free and clear" of liens over the opposition of Clear ChannelOutdoor Inc., a creditor holding a lien junior to DB's lien. Clear Channel's claim was approximately $2.5 million. The bankruptcy court denied a stay pending appeal, as did the BAP. The sale closed shortly thereafter, and following the closing DB paid more than $1.5 million to third parties for various matters, including (1) by prior agreement, certain administrative fees, (2) a "carve-out" amount to the chapter 11 trustee, (3) amounts owed to a senior lienholder, (4) amounts owed for real estate taxes and (5) other costs and expenses associated with the closing. Nothing was paid to Clear Channel.
Clear Channel appealed. DB and the trustee moved to dismiss the appeal as moot, which was granted by a motions panel as to the sale, but the motions panel left to the merits panel to determine whether the appeal was moot as to the stripping of Clear Channel's lien.
Mootness
The BAP approached the mootness question in three parts: constitutional mootness, equitable mootness and statutory mootness.
Constitutional Mootness. The BAP stated that a case is constitutionally moot only if it is "impossible to grant relief." Since (among other possibilities) the lienstripping could be reversed-even if such relief might be "difficult or inequitable"-the appeal was not constitutionally moot.
Equitable Mootness. Equitable mootness has a lower standard-for instance, whether it is too complex and difficult to unwind the ensuing transactions in light of how third parties have changed their position in reliance on the order that is being appealed. The BAP conceded that the complexities of the sale and the impact on third parties made review of the sale equitably moot.[3] The court recognized that:
Title to [the] property has been transferred to DB, and the Trustee has relinquished control over the development of [the] property to DB. DB has assumed the executory contracts and unexpired leases. DB has also executed and recorded a number of documents necessary to effectuate the sale. All of these have required significant expenditures.[4]
But all of that was irrelevant to the narrow issue of lienstripping:
[R]eattaching Clear Channel's lien to [the] property is not theoretically or practically difficult. Both parties are before the court, and no third-party action is required to reestablish Clear Channel's position. Moreover, DB has not identified any third party who would be prejudiced because it relied on the bankruptcy court's orders... As a result, while the appeal related to the sale itself may be equitably moot, the panel could reverse the transfer of Clear Channel's lien to the nonexistent sale proceeds and hold that it remains attached to property transferred to DB.[5]
Statutory Mootness. The BAP finally turned to statutory mootness because of the provisions of §363(m). The BAP pointed out that the order of the bankruptcy court authorized two things-the sale under §363(b), and the lienstripping under §363(f). The court looked at the language of §363(m) and noted that it applies only to "an authorization under subsection (b) or (c) of [§363]."[6] The court also focused on §363(m)'s language that protects "the validity of a sale" from a reversal or modification on appeal, and stated:
This limitation leads us to conclude that Congress intended that §363(m) address only changes of title or other essential attributes of a sale... The terms of those sales, including the "free and clear" term at issue here, are not protected.[7]
DB contended, of course, that the "lienstripping" was an essential attribute of the sale. But DB's arguments that its agreement to purchase the property was conditioned on receiving a "free and clear" title and that "the sale language cannot be separated from the lien-stripping language because both sale and lien-stripping were integral to its decision to purchase the property,"[8] fell on deaf ears. First, Congress chose specific words for §363(m) that mean that lienstripping is not protected by §363(m), and second, DB knew or should have known all along that lienstripping might not work. So its assertion that the sale was inseparable from the lienstripping rings hollow, as does its argument that a stay was required to avoid mootness. See Suter, 504 F.3d at 990 (failure to obtain stay not always fatal to mootness defense).[9]
Lien Stripping
Because the "lienstripping" portion of the order below was not moot, the BAP turned to that issue of whether §363(f) permitted the stripping of Clear Channel's junior lien. The court easily disposed of three of the five numbered clauses of §363(f). The first clause permits a "sale free and clear of any interest in such property of an entity other than the estate, only if (1) applicable nonbankruptcy law permits sale of such property free and clear of such interest...." Since California law, applicable to this case, does not permit sales free and clear, that clause was inapplicable.[10]The second clause ("if...(2) such entity consents") was not applicable since Clear Channel did not consent. The fourth clause ("if...(4) such interest is in bona fide dispute") was not applicable as there was no dispute regarding the validity of Clear Channel's lien. That left only clauses (3) and (5) for any detailed discussion. In pertinent part, §363(f) provides:
The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if...(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;...or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.[11]
The BAP acknowledged that both "present legitimate and difficult questions of statutory interpretation."[12]
Section 363(f)(3): Not a Basis for Lien Stripping
After a review of various principles of statutory construction, the court turned to §363(f)(3). The key words are "the aggregate value of all liens" on the property. The trustee asserted that phrase means the "economic value" of such liens, rather than their face value, and that "under conventional bankruptcy wisdom" and §506(a), the amount of an allowed secured claim can never exceed the value of the property securing the claim. The court considered a number of cases where courts have used this approach to authorize sales free and clear of "out of the money" liens, but rejected this approach (and collected a number of decisions by other like-minded courts). The BAP stated that "this reading expands §363(f)(3) too far"[13] and would allow a sale free and clear "regardless of whether or not the lienholder held an allowed secured claim."[14] The BAP added one more textual reason for rejecting this broad interpretation:
If..."aggregate value of all liens" means the aggregate amount of all allowed secured claims as used in §506(a), then the paragraph [§363(f)(3)] could never be used to authorize a sale free and clear in circumstances like those present here; that is, when the claims exceed the value of the collateral that secures them. 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."[15]
Section 363(f)(5): Not Shown to Be a Basis for Lien Stripping
The BAP then turned to the parties' opposite contentions about the "plain meaning" of §363(f)(5), first noting that "the meaning of paragraph (5) is anything but plain...." The BAP parsed this paragraph to contain "at least three elements: that (1) a proceeding exists or could be brought in which (2) the nondebtor could be compelled to accept a money satisfaction of (3) its interest."[16]
Meaning of "Interest." The court rejected Clear Channel's argument that "interest" should be read to exclude liens (making it unavailable to strip Clear Channel's lien) because Congress intended "interest" to have an expansive scope. The court also relied on the text of §363(f), which broadly refers to "any interest" and another subsection, §363(f)(3), which "explicitly states that it applies only if 'such interest is a lien,' [thus] making it apparent that Congress intended a lien to be a type of interest."[17]
Compelling a Money Satisfaction. As an initial matter, the BAP determined that paragraph (5) refers to a legal and equitable proceeding in which the nondebtor could be compelled to take less than the value of the claim secured by the interest, even as it acknowledged that "this view leads to a relatively small role for paragraph (5)."[18] The court set out a couple of such examples, such as a buy-out arrangement among partners or certain liquidated damages provisions, in a effort to demonstrate that this construction did not render the paragraph meaningless. And in contrast, the court noted that if it followed the interpretation relied on by the bankruptcy court ("is it the kind of interest that could be satisfied with money, and if so, then, you can sell free and clear"[19]), then:
paragraph (5) would swallow and render superfluous paragraph (3), a provision directed specifically at liens. The specific provisions of paragraph (3) would never need to be used, since all liens would be covered, regardless of any negative or positive relationship between the value of a creditor's collateral and the amount of its claim. A result that makes one of five paragraphs redundant should be avoided.[20]
The court compared the much broader power to sell property in a chapter 12 case given by §1206, a section that specifically states that it is "in addition to" the authorization given by §363. That section provides:
After notice and a hearing, in addition to the authorization contained in section 363(f), the trustee in a case under this chapter may sell property under section 363(b) and (c) free and clear of any interest in such property of an entity other than the estate if the property is farmland, farm equipment, or property used to carry out a commercial fishing operation (including a commercial fishing vessel), except that the proceeds of such sale shall be subject to such interest (emphasis added).
The court determined that Congress would not have needed to add §1206 to the Bankruptcy Code in 1986 if §365(f)(5) already permitted sales free and clear of all liens, regardless of values. Thus, in order to rely on §363(f)(5), the court must make a finding "of the existence of such a [legal or equitable proceeding] and the trustee must demonstrate how satisfaction of the lien 'could be compelled.'"
Legal or Equitable Proceeding. Forced to identify such a "legal or equitable proceeding," the trustee relied on decisions by several courts that have found that a cramdown under §1129(b)(2) can qualify as such. The BAP disagreed with the reasoning of those courts, dismissing it as "circular reasoning-it sanctions the effect of cramdown without requiring any of §1129(b)'s substantive and procedural protections."[21] The BAP noted that this would "undermine the entire confirmation process" and that courts had been "leery" of using §363(b) to "gut plan confirmation or render it superfluous."[22]
Because the bankruptcy court did not apply the correct legal interpretation of §363(f)(5), the case was remanded for further proceedings in order to "allow the parties to attempt to identify a qualifying proceeding under nonbankruptcy law (if one exists) that would enable them to strip Clear Channel's lien and make the sale of PW's property to DB free and clear under §363(f)(5)."[23] One would think that if PW or the trustee thought that such a law existed, it would have been brought to the attention of the BAP.
Impact on Chapter 11 Practice and Transactions in the Shadow of Bankruptcy
If you've ever wondered why the holder of a secured claim is almost always opposed to allowing any junior secured claim to exist on its collateral, this case is a sufficient answer. This case also validates the wisdom-if not the absolute necessity-of covering this situation in an intercreditor agreement in those cases where a subordinate lien is permitted. Not every case has an intercreditor agreement in place (or one that each and every secured party is a party to), of course, and some intercreditor agreements might fail, for whatever reason, to cover this situation.
Looking at such a situation from a purely economic perspective, a rule that gives the bankruptcy court the ability to sell an asset "free and clear" of all liens, with all liens to attach to the proceeds-even if the proceeds didn't cover all of the claims "secured" by the asset-certainly makes sense. Likewise, it makes no sense to give an "out of the money" lienholder the right to prevent such a sale; the resulting power to oppose, delay and exercise leverage is disconnected to any real economic interest.[24] But those are judgments reserved to Congress, and other than intimating that Congress made that judgment-but only in the context of chapter 12 when it added §1206-the BAP doesn't speculate about what is or is not "good" policy. Instead, the court stays focused on the words of the Code and principles of statutory construction, just as the Supreme Court has instructed.
There is obviously case law that goes in a different direction; the PW court cites to some of it. But the careful analysis offered by the Ninth Circuit BAP will demand attention whenever this issue arises in the future-as it often will. In bankruptcy courts where lienstripping has been permitted, this decision will provide ammunition to junior lienholders that wish to reargue the point. If there is no controlling Circuit-level authority permitting lienstripping in this context, future orders of a bankruptcy court permitting lienstripping will be crippled, given the "no mootness" determination made by this decision and the ability of any objecting junior lienholder to appeal (and argue for a similar result), even in the absence of a stay pending appeal. Where lienstripping is not permitted (or an appeal of a lienstripping order can be expected), debtors and their primary secured creditors that hope to use a quick §363 sale will face a number of practical difficulties. Whatever the "risk tolerance" of a senior secured lender might be vis-a-vis an objecting junior lienholder, in order to have a truly "safe" sale under §363 to a third party, the parties will need the advance consent of all lienholders. Certainly, no outside buyer can be expected to wade into the uncertain waters of a case like this, where what looked like "clean" title turned out to be illusory. Delaying the closing until all appeals are resolved will rarely be an attractive option. The consent of the junior lienholder will likely cost something, whether money or a more intensive sales process that has some chance of finding a buyer at a price that might reach down to the junior lienholder's "value." As a result, the senior lienholder may not be able to dominate every aspect of the sales process. At a certain "price" however, the senior lienholder will be forced to consider other alternatives, such as seeking relief from the automatic stay (although state court foreclosures can present complications all their own, especially when the collateral is, collectively, the assets of a business rather than a parcel of real estate) or getting the collateral free and clear of all liens under a confirmed plan of reorganization.
Footnotes
1 11 U.S.C. §363(m) provides that "the reversal or modification on appeal of an authorization under subsection (b) or (c) of [§363] of a sale...of property does not affect the validity of a sale...to an entity that purchased...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."
2 391 B.R. 30.
3 The BAP later noted that §363(m) would also make the sale statutorily moot. 391 B.R. at 35.
4 391 B.R. at 33-34.
5 391 B.R. at 34 (emphasis added).
6 391 B.R. at 35.
7 391 B.R. at 35-36. References to the protection given to the lease of property under §363(b) are omitted in this article.
8 391 B.R. at 36.
9 391 B.R. at 37.
10 391 B.R. at 37.
11 11 U.S.C. §363(f).
12 391 B.R. at 38.
13 391 B.R. at 40.
14 391 B.R. at 40.
15 391 B.R. at 40. The court also noted that Congress could have worded §363(f)(3) just like it worded §1206, discussed at greater length later in the opinion.
16 391 B.R. at 41.
17 391 B.R. at 42.
18 391 B.R. at 43.
19 391 B.R. at 42.
20 391 B.R. at 44.
21 391 B.R. at 46.
22 391 B.R. at 46.
23 391 B.R. at 47.
24 In this case, it would appear that the difference in values wasn't even close: Notwithstanding the services of a broker that was hired to market the "prime" real estate, only three bids were received, and the highest bid was a contingent bid for $25.25 million. DB's claim (and its credit bid) was $41.4 million.