Judge Markell's Bombshell BAP Ruling That a Winning Credit Bid in a Bankruptcy 363 Sale Doesn't Strip Off Junior Liens Confirms Ominous Predictions That the End of Bankruptcy Is Near!
At the end of last May, Chicago's ten bankruptcy judges gathered at a day-long, TMA-sponsored event and shared their candid, sometimes off-the-cuff, non-binding views on various hot bankruptcy topics. One of the liveliest panel discussions focused on various issues arising in bankruptcy 363 sales. In it, former Bankruptcy—now District Court—Judge David H. Coar asked whether any of the bankruptcy judges on the panel (or in the room) would refuse to recognize as the high bidder in a 363 sale a secured creditor who credit bid the full amount of its secured claim. Everyone in attendance agreed, without fanfare, that if the credit bid reflected the highest bid for the assets, the secured creditor would be declared the winning bidder, even if the creditor was undersecured.
Judge Coar didn't ask whether the winning credit bidder would, just like any winning cash bidder, take the assets free and clear of all junior liens, claims, and encumbrances, but all in attendance likely would have conceded that point too. In the end, however, Chief Judge Carol Doyle emphatically cautioned, don't take anything for granted because Code Section 363 is a statutory provision, and it's VERY important to review the statute itself in every case, because a bankruptcy judge's job is to interpret and enforce the statute, not the will of the parties.
When it comes to statutory construction in bankruptcy, as noted in this post, Nevada's Judge Bruce Markell—probably the only judge in US history to have Wittgenstein's entire collected writings on a shelf in his chambers—is one of the best. So when Judge Markell says that Section 363 doesn't say what everyone thinks it says, now that's news! Surprisingly though, until today, nothing has yet been publicly reported on Judge Markell's decision (issued late May and released for publication last month), though rumor has it that Arizona's Bankruptcy Judge Randolph Haines, himself no philosophical slouch (having a Yale Ph.D in philosophy), is planning a spirited counter-assault on Judge Markell's reasoning in an upcoming Norton's Bankruptcy Law Advisor release.
So what is it that Judge Markell has said that has judicial colleagues calling him "just plain nuts," that has bankruptcy lawyers consulting Nostradamus seeking confirmation of Baird & Rasmussen's prediction of the End of Bankruptcy, and that has title companies refusing to insure cases of lien stripping in bankruptcy asset sales? It's found not in his 1992 scholarly article, The Case Against Breakup Fees in Bankruptcy, but in his judicial opinion in Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 2008 WL 2840659 (9th Cir. BAP 7/18/08) (pdf), where—joined by the Eastern District of Washington's Chief Bankruptcy Judge Frank Kurtz and Idaho's Chief Bankruptcy Judge Jim D. Pappas, themselves judicial heavyweights in their own right—he wrote as follows:
This appeal presents a simple issue: outside a plan of reorganization, does § 363(f) of the Bankruptcy Code permit a secured creditor to credit bid its debt and purchase estate property, taking title free and clear of valid, nonconsenting junior liens? We hold that it does not.
In reaching this conclusion, we reject the contention that once the sale is consummated, the appeal from the order stripping the junior creditor's liens is moot and immune from scrutiny, and we hold that, in the circumstances of this case, the junior lienholder's rights are preserved.
The debtor in this case, PW, LLC (“PW”), owned prime real estate in Burbank, California. DB Burbank, LLC (“DB”), an affiliate of a large public hedge fund, held a claim of more than $40 million secured by PW's property....
DB, working with the Trustee, organized a campaign to consolidate all of PW's property and development rights and to sell this package, free and clear of all claims and encumbrances, at a sale supervised by the bankruptcy court. At the sale, DB was the highest bidder, paying its consideration by credit-bidding the entire amount of its debt.
The only problem was the existence of a consensual lien securing a claim of approximately $2.5 million in favor of a junior creditor, Clear Channel Outdoor, Inc. (“Clear Channel”). Relying solely on § 363(f)(5), the bankruptcy court confirmed the sale to DB free and clear of Clear Channel's lien.
The first issue presented is whether the appeal is moot. We conclude that while any relief related to the transfer of title to DB is moot, stripping Clear Channel's lien and related state law rights present an issue that is discrete and separable from title transfer. That part of Clear Channel's appeal is not moot.
After reviewing applicable law, we conclude that § 363(f)(5) cannot support transfer of PW's property free and clear of Clear Channel's lien based on the existing record. We thus reverse that portion of the bankruptcy court's order authorizing the sale to DB free and clear of Clear Channel's lien, and we remand the matter to the bankruptcy court for further proceedings. 2008 WL 2840659 at *1.
In fact, Judge Markell's opinion analyzes whether the senior lender's credit bid for its collateralized assets free and clear works under either Section 363(f)(3) or Section 363(f)(5), concluding as follows regarding the inapplicability of Section 363(f)(3):
Paragraph (3) permits the sale free and clear only when “the price at which such property is to be sold is greater than the aggregate value of all liens....” 11 U.S.C. § 363(f)(3) (emphasis added). If, as DB and the Trustee assert, “aggregate value of all liens” means the aggregate amount of all allowed secured claims as used in § 506(a), then the paragraph 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.” See, e.g., In re Gen. Bearing Corp., 136 B.R. 361, 366 (Bankr. S.D.N.Y. 1992).
As a result, we join those courts cited above that hold that § 363(f)(3) does not authorize the sale free and clear of a lienholder's interest if the price of the estate property is equal to or less than the aggregate amount of all claims held by creditors who hold a lien or security interest in the property being sold. 2008 WL 2840659 at *11.
As regards the inapplicability of Section 363(f)(5), Judge Markell and his colleagues first parsed the three key terms of the subsection, starting "with an analysis of what Congress meant by an 'interest,' then mov[ing] to the proper construction of a money satisfaction, and conclud[ing] with an examination of appropriate legal and equitable proceedings" (2008 WL 2840659 at *11), and then concluded as follows:
- "Consistent with the plain reading of § 363(f) generally, and § 363(f)(5) in particular, we construe “interest” to include the type of lien at issue in this appeal." 2008 WL 2840659 at *12.
- "We assume 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. Other courts agree and hold that it is not the type of interest that matters, but whether monetary satisfaction may be compelled for less than full payment of the debt related to, or secured by, that interest. Under the view that full payment is not necessary, it is not the amount of the payment that is at issue, but whether a 'mechanism exists to address extinguishing the lien or interest without paying such interest in full.' Other courts have required a showing of the basis that could be used to compel acceptance of less than full monetary satisfaction. Although this view leads to a relatively small role for paragraph (5), we are not effectively writing it out of the Code. Paragraph (5) remains one of five different justifications for selling free and clear of interests, and its scope need not be expansive or all-encompassing. So long as its breadth complements the other four paragraphs consistent with congressional intent, without overlap, our narrow view is justified.... [We] hold that the bankruptcy court must make a finding of the existence of such a mechanism and the trustee must demonstrate how satisfaction of the lien 'could be compelled.'” 2008 WL 2840659 at *13-14 (citations omitted).
- "Paragraph (5) requires that there be, or that there be the possibility of, some proceeding, either at law or at equity, in which the nondebtor could be forced to accept money in satisfaction of its interest. The bankruptcy court reasoned that there was no need to prove the existence or possibility of a qualifying legal or equitable proceeding when the interest at issue was a lien because all liens, by definition, are capable of being satisfied by money. The language of § 363(f)(5) indicates that compelling a nondebtor to accept a monetary satisfaction cannot be the sole focus of the inquiry under that paragraph. The statute additionally requires that 'such entity could be compelled, in a legal or equitable proceeding, to accept' such a monetary satisfaction. 11 U.S.C. § 363(f)(5) (emphasis added). The question is thus whether there is an available type or form of legal or equitable proceeding in which a court could compel Clear Channel to release its lien for payment of an amount that was less than full value of Clear Channel's claim. Neither the Trustee nor DB has directed us to any such proceeding under nonbankruptcy law, and the bankruptcy court made no such finding." 2008 WL 2840659 at *15 (citations omitted).
The opinion is also notable for its conclusion that the issue had not been rendered equitably or statutorily moot by the change of circumstances or the absence of a stay pending appeal. In finding that the matter was not equitably moot, Judge Markell wrote:
Here, even though all parties to the sale are present before this panel, complexities that cannot be easily undone arise with respect to the sale. These complexities and the impact on third parties make review of the sale (but only the sale) to DB equitably moot. But the same cannot be said about reinstating Clear Channel's liens. An appeal is not equitably moot as to lien-stripping under § 363(f) if reversing the lien-stripping raises neither the issue of complexity nor the issue of negative impact on third parties. That is the case here, and we hold that the lien-stripping aspect of the Sale Order is not equitably moot.
As an initial matter, reattaching Clear Channel's lien to PW's former 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.
By similar reasoning, our motions panel segregated the sale portion of the Sale Order from the lien-stripping portion of the order. Given the relative ease with which Clear Channel can receive the relief it requests (if it is entitled to that relief), and the relative lack of prejudice to anyone other than the parties to this appeal, we hold that Clear Channel's appeal of the stripping of its lien is not equitably moot. 2008 WL 2840659 at *4-5 (citations omitted).
Finally, in concluding that a ruling was not rendered moot by Section 363(m), which will not permit an appellate review court to invalidate a sale to a good faith purchaser unless the objecting party obtained a stay pending appeal, Judge Markell wrote:
We conclude that § 363(m) does not apply to lien-stripping under § 363(f). First, § 363(m) by its terms applies only to “an authorization under subsection (b) or (c) of this section....” Here, the remaining challenge is to the authorization under subsection (f) to sell the property free of Clear Channel's lien.... Second, the subsection limits only the ability to “affect the validity of a sale or lease under such authorization....” Here, the telling locution is the limitation of § 363(m) to “sale[s] or lease[s]” authorized under § 363(b) or (c). Omitted is the “use” prong of authorization. As a result, a plain-language reading of the section would not give § 363(m) protection to an out-of-the-ordinary-course use approved by a bankruptcy court. This limitation leads us to conclude that Congress intended that § 363(m) address only changes of title or other essential attributes of a sale, together with the changes of authorized possession that occur with leases. The terms of those sales, including the “free and clear” term at issue here, are not protected. Indeed, Congress could easily have broadened the protection of § 363(m) to include lien-stripping. 2008 WL 2840659 at *6 (citations omitted).
In reaching these conclusions, Judge Markell and his BAP colleagues relied heavily upon important canons of statutory construction, several of which are cited in these 60 pages of handouts (reprinted with permission) of now-retired Chief Bankruptcy Judge Thomas F. Waldron. They, too, deserve your close attention.
Personally, I found the Court's rejection of the equitable mootness arguments the most questionable aspect of the decision. After all, absent the Court-approved sale, the lender could have had the automatic stay lifted and foreclosed out the junior lienholders' interests in a state court proceeding. Instead, it was left holding the bag with no way to foreclose out the junior liens because its senior lien interests were extinguished in the sale. But, equitable mootness is a complex doctrine whose resolution is very fact-specific and requires a thorough understanding of the complete record and the knowledge and motivations of the affected parties. Thus, one can't be too critical of the Court's ruling on this point. And with the parties having "buried the hatchet" (as the old saying goes) and settled their differences, nothing more will be decided in this case.
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Back in 2004, the pathbreaking decision of the Seventh Circuit's Chief Judge Frank Easterbrook invalidating "critical vendor" payments was at first widely criticized, and later widely adopted. The opinion of Judge Markell and his BAP colleagues invalidating lien stripping of junior liens in 363 credit bid sales will surely be widely criticized, but may well follow the same course. If it does, then the end of bankruptcy may truly be near (though exiting distress situations will be far more complex)! Then again, economic practicalities and institutional inertia may relegate this decision to the "just plain nuts" dustbin (and there join then-Professor Markell's 1992 recommendations against the use of breakup fees in bankruptcy 363 sales). Stay tuned, as this battle has just begun!
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8/18/08 Update: Be sure to read Bob Eisenbach's analysis of some implications of the decisions for Section 363 sales at his In the (Red) Business Bankruptcy Blog. Most people pay a lot of money to Bob and his firm for that kind of advice. Be thankful.
© Steve Jakubowski 2008
Judge Markell's ruling makes a lot of sense.
You are absolutely right about the dubiousness of the equitable mootness argument. And, on the merits, it is equally dubious that a credit bid in a bankruptcy results in a dramatically worse result for the senior lender than a state law foreclosure.
The decision is poorly reasoned and very problematic. The rationale -- particularly the rejection of application Section 363(m) to sales free and clear under Section 363(f) -- is not limited to situations where a first lien lender is credit bidding. The opinion raises real questions for bidders in bankruptcy sales -- particularly in circumstances where bidding procedures are structured to allocate risk of appeals to the buyer or to require buyers to close prior to the expiration of the appeal period.
I'm puzzled how Markell came to the conclusion that "accepting a money satisfaction for such interest" means accepting _less_ than the full value of the interest. The opinion never addresses what "money satisfaction" means, but looking at the plain language, I think it is just as reasonable to interpret to mean "accepting cash payment for such interest"--that the phrase has nothing to do with the value of the satisfaction and everything to do with the form of the satisfaction. In other words, it could be a parallel to 502(c)(2).
If that's the case, then 363(f)(5), should read as permitting a free and clear sale if the entity holding the interest could be compelled to accept monetary satisfaction for its interest rather than say, specific performance. That would mean that the existence of junior lien holders are no obstacle to free and clear sales, only holders of various injunctive rights, etc.
Also, fwiw, the equitable mootness decision looks a lot like the 11th Circuit's reasoning in the Saybrook Manufacturing cross-collateralization case on 364(e)--the attack on the DIP lender's liens wasn't barred by 364(e) because the DIP facility wasn't properly authorized. Even if one likes the policy results in these cases, it's hard to know what 363(m) and 364(f) do if they do not prevent authorization to be reexamined after the fact.