Bankruptcy cases can provide valuable opportunities for bargain shopping. Because the Bankruptcy Code includes an array of tools designed to encourage and facilitate distressed asset sales, vigilant buyers may be able to obtain property more quickly – and at lower prices – than in the general marketplace. However, deals that appear too good to be true often are, and parties seeking to purchase assets in bankruptcy sales need to be as careful to identify pitfalls as they are to identify opportunities.
One of the most powerful tools in the bankruptcy arsenal, and among the most beneficial for potential asset purchasers, is Section 363 of the Bankruptcy Code. Section 363 enables a debtor to sell estate assets “free and clear” of the liens and interests of secured creditors and other parties.
Such sales, at least in theory, benefit all constituencies in a bankruptcy case. Buyers take title to assets free and clear of all the liens, encumbrances, and claims that might otherwise have attached to those assets, and receive the extra comfort of a bankruptcy court order blessing the sale. Unsecured creditors benefit because a public sale may encourage active bidding, and hopefully will result in sufficient funds to make a distribution to unsecured creditors after payment of secured claims. Secured creditors similarly benefit from a robust bidding process while at the same time their risk is mitigated by their ability to credit the bid if cash bids are not sufficient to pay secured claims in full.
Despite the benefits of free and clear sales, secured creditors and others can suffer substantial harm if their collateral is sold out from under them without recourse. For that reason, Section 363 allows sales free and clear to take place only if one or more statutory conditions are first met – most commonly when 1) the entity holding an interest in the property consents, (2) the property is being sold at a price greater than the aggregate value of all liens on the property, or (3) the entity holding an interest in the property could be compelled in a legal or equitable proceeding to accept a money satisfaction of such interest.
Bankruptcy courts have often taken a liberal approach to finding the above conditions met. For example, many courts have found that a secured creditor “consents” to a free and clear sale based on its failure to file a formal objection and have approved the sale based on that “consent.” Other courts have allowed property to be sold for less than the aggregate value of all liens on the property when junior lienholders could have been forced to accept unsecured or undersecured status in a Chapter 11 plan of reorganization.
Recently, the pendulum has swung in the other direction, at least in Oregon. In “In re Smith,” an unpublished opinion recently issued by the Oregon bankruptcy court, the court explicitly held that a lienholder’s failure to object to a proposed sale is insufficient to satisfy the “consent” condition, and that the lienholder’s actual assent is required.
Invoking Clear Channel Outdoor, Inc. v. Knupfer, a controversial 2008 decision by the Ninth Circuit Bankruptcy Appellate Panel, the court further reiterated that in the absence of consent, the sale price of a free and clear sale must be higher than the amount of all liens – including junior liens that could be stripped off or down in a Chapter 11 plan of reorganization – against the property, or else there must be an actual (not hypothetical) legal or equitable ground to compel a non-consenting lienholder to accept a money satisfaction of its interest.
Although these are highly technical concepts, they can have real-world consequences to a purchaser of assets at a Section 363 sale. If a lienholder does not consent to the sale, or if one of the other sale conditions is not met, the purchaser may devote significant resources to a potential sale transaction and take steps in reliance on the closing of such sale, only to find that the bankruptcy court refuses to approve it. Even worse, if a bankruptcy court improvidently approves a sale and the transaction closes, the purchaser may find itself in limbo in the event of an appeal by a non-consenting creditor, as happened in the Clear Channel case.
A party interested in purchasing assets from a bankruptcy estate should not be afraid to do so. The speed, value, and other benefits of such a purchase can be considerable.
However, a party buying assets in a Section 363 sale should carefully monitor the bankruptcy case, and should confirm that any parties holding liens in the assets to be purchased have received notice of the proposed sale and, preferably, have participated in the case. Experienced bankruptcy counsel can help a prospective purchaser determine whether all the statutory requirements for a free and clear sale have been met and take all necessary steps to ensure a successful transaction.
Timothy Solomon is an attorney in Sussman Shank LLP’s bankruptcy and creditors’ rights practice group. Contact him at 503-227-1111 or firstname.lastname@example.org.