On April 17, 2023, the Fifth Circuit issued a decision that demonstrated considerable deference to the bankruptcy court’s determination that a senior lender affiliated with the debtor remained a “good faith purchaser” when submitting a credit bid to purchase the debtor’s real property. [2]
Factual Background
In November 2016, Palm Springs, LLC (the developer), a commercial real estate developer and the original owner of real property at issue in Palm Springs, Calif. (the property), contracted with SR Construction (the contractor) to develop and build a hotel. [3] Approximately one year later, Hall Palm Springs LLC (the secured lender) provided additional financing. [4] In connection with this additional financing, the developer and the secured lender executed a subordination agreement that provided the secured lender with priority over the contractor. [5]
On Oct. 22, 2019, the developer terminated its relationship with the contractor, owing in excess of $14 million for the work completed. [6] Several days later, the developer defaulted on its loan with the Secured Lender, who immediately provided a notice of acceleration. In November 2019, the contractor filed a mechanic’s lien on the property. In January 2020, the contractor filed a foreclosure against the developer and secured lender, asserting that its mechanic lien had priority over the secured lender’s mortgage. Soon thereafter, the developer conveyed the property to an affiliate (the debtor) of the secured lender “as an alternative to foreclosure.” [7] By its terms, the developer would be released from its loan obligations, but would retain a 50% net profit interest in the property. The debtor intended to finish construction of the hotel, but the impact of the “novel coronavirus COVID-19 on the hospitality industry, coupled with the filing of numerous lawsuits,” prompted the debtor to pursue a sale of the property to a strategic buyer. [8]
A few months later, the debtor filed for bankruptcy in the Northern District of Texas and moved for approval of debtor-in-possession financing provided by the secured lender. Further, in connection with a court-approved sale process, the bankruptcy court permitted the secured lender to submit a credit bid over the objection of the contractor. After the debtor received no other bids other than the secured lender’s credit bid, the court held an evidentiary hearing and approved the sale and credit bid, and denied a motion by the contractor seeking to stay the sale order pending appeal. Following an appeal of the bankruptcy court’s orders, the district court held that the secured lender was a good-faith purchaser and dismissed the appeal as statutorily moot under § 363(m).
Analysis
The Fifth Circuit began its analysis by noting that the standard of review “for a good faith determination by the bankruptcy court that renders the appeal moot is a matter of some confusion in our circuit.” [9] Despite this confusion, the court declined to identify whether rulings are reviewed de novo or by clear error, noting that the secured lender prevails under either review.
The court then turned to the contractor’s argument that the secured lender is not acting as a good-faith purchaser because there were live “adverse claims” of which the secured lender was aware. Specifically, the contractor argued that the secured lender was aware of the various adversary proceedings and state court actions filed by the contractor that, if the contractor succeeded on, would provide for priority of the contractor’s liens over the secured lender. The court concluded by noting that “neither a mechanic’s lien nor an adversary proceeding to find that a transfer may be voidable (not that it is void) constitute an adverse claim affecting a purchaser’s good faith status in bankruptcy proceedings.” [10]
Conclusion
In sum, the Fifth Circuit’s opinion in Hall Palm Springs LLC demonstrates a great deference given to the lower court’s rulings with respect to challenges to a sale order. Importantly, a lender exercising its rights in a bankruptcy case does not equate misconduct or fraud and does not prevent the lender from being found a good-faith purchaser.
[1] Grayson is an attorney at the Dallas office of McDermott Will & Emery, focusing on restructuring and insolvency, emphasizing bankruptcy, corporate restructuring, workouts, creditors’ rights and commercial litigation. Grayson also teaches Bankruptcy Law in the Paralegal Studies Department at Collin College.
[2] SR Construction, Incorporated v. Hall Palm Springs L.L.C. (In re Palm Springs II L.L.C.), 65 F.4th 752 (5th Cir April 17, 2023).
[3] Id. at 756.
[4] Id.
[5] Id.
[6] Id.
[7] Id. at 757.
[8] Id.
[9] Id. at 759 (citing In re TMT Procurement Corp.¸764 F.3d 512, 520 (5th Cir. 2014)).
[10] Id. at 762.