The U.S. Court of Appeals for the Third Circuit recently affirmed approval of the sale of substantially all of the assets of acute-care hospital operator LifeCare Holdings, Inc. pursuant to §363 of the Bankruptcy Code.1 LifeCare’s assets were sold to its existing secured creditors, who “credit bid” their secured debt and funded both an escrow account for payment of professional fees and a $3.5 million trust for the benefit of general unsecured creditors. However, the sale was opposed by the U.S. Government, which stood to receive nothing on account of its $24 million administrative tax claim and argued that property was distributed through the escrow account and the trust in contravention of the Bankruptcy Code’s priority scheme (which generally requires payment of administrative expenses before distributions can be made on account of prepetition unsecured claims).

For the reasons discussed below, the Third Circuit affirmed the bankruptcy court’s finding that the property placed in trust and in escrow was not estate property and could be distributed to creditors at the purchaser’s discretion. Its decision is especially noteworthy in light of existing Third Circuit case law prohibiting secured creditors from “gifting” recoveries to junior creditors or equity holders under a plan of reorganization and further highlights the optionality created by §363 sales where confirmation of a chapter 11 plan is impossible or impractical.

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