In the ongoing and seemingly never ending low interest environment, some might argue that the Bankruptcy Code as it applies to commercial debtors has become more of a sale platform than a reorganization tool. Although that may change if rates ever do rise, for now, it remains critically important for practitioners to be mindful of the procedural hurdles that exist in a contested sale process. One group of litigants recently ran directly into those hurdles when the U.S. Court of Appeals for the Third Circuit denied their appeal of a sale order as being statutorily moot, largely because a stay had not been obtained, in Pursuit Capital Managment Fund 1 v. Burtch (In re Pursuit Capital Managment, 2017 U.S. App. LEXIS 20889 (3d Cir. Oct. 24, 2017).

Facing approximately $5 million in judgments with virtually no liquid assets, Pursuit Capital Management, (Pursuit) commenced a voluntary Chapter 7 bankruptcy proceeding in March 2014. Listed within its schedules filed with the court were potential avoidance claims it held against its owners and members. Since he lacked the resources to prosecute these claims, the trustee opted to sell them to a group of estate creditors for the sum of $125,000. Not surprisingly—the very owners and members against whom the avoidance claims would be brought—vigorously objected. Accordingly, the Delaware Bankruptcy Court directed the trustee to consider offers from the defendants as well.

As is often the case, the trustee determined that an auction process would best maximize value for the estate. Importantly, the auction procedures sought by the trustee and approved by the court, contained a fairly standard provision which permitted the trustee to modify the sale process “as he deemed] appropriate to comply with his fiduciary obligations” and to use his sole discretion to determine the highest and best bid. A contentious telephonic auction was commenced on July 7, 2015, but abruptly cut short when counsel for the defendants asserted a scheduling conflict. At the time, the defendants had submitted the highest bid at $170,000.

Following the adjournment, the trustee proposed eight alternative dates to resume the auction, but none were acceptable. Therefore, in the interest of reaching finality, he directed all parties to submit sealed bids by July 30. The creditor group submitted a sealed bid of $180,000, while the defendants not only failed to submit a new bid, but affirmatively withdrew the one previously lodged.

Receiving no other bids, the trustee declared the creditor group bid the winner and moved for a court order approving the sale. In response, the defendants filed a motion to adjourn and submitted a new bid for $200,000 by email, to which the creditor group objected. The bankruptcy court ordered the approval hearing to go forward, prior to which the defendants made a second email offer of $220,000, which was rejected by the Trustee.

At the sale hearing, the defendants unsuccessfully attempted to reopen the auction with an overbid in the amount of $205,750. Later, during cross examination of the trustee, the defendants tried yet again to present the trustee with a bid, increased this time to $250,000. The bankruptcy court, however, refused to allow “bidding from the podium.” Ultimately, the sale was approved, largely because the creditor group's bid, despite being numerically smaller than any of the defendant's 11th-hour offers, could lead to greater recovery for the estate—since the creditor group would pursue litigation against the defendants, whereas if the claims were sold to the same defendants, it would have the effect of extinguishing them. Indeed, following the court's entry of the sale order, the creditor group initiated an adversary proceeding against the defendants, which remains ongoing. Importantly, the sale order contained a finding of good faith under Section 363(m) of the Bankruptcy Code.

Following the sale hearing, the defendants did not request a stay and instead directly challenged the sale's legitimacy through appeal. The district court found the appeal statutorily moot under Section 363(m) because a stay had neither been sought or obtained and the validity of the sale itself would necessarily be affected by any modification or reversal of the sale order. The crux of the argument before the Third Circuit, therefore, was not the legality of the asset sale, but statutory mootness.

Section 363(m) provides that a challenge to a sale is mooted if “the underlying sale or lease was not stayed pending appeal, and the court, if reversing or modifying the authorization to sell or lease, would be affecting the validity of such a sale or lease,” as in Krebs Chrysler-Plymouth v. Valley Motors, 141 F.3d 490, 499 (3d Cir. 1998). Interestingly, the court mentioned in a footnote that its view is in the minority; as most other circuits have adopted per se rules automatically mooting such challenges absent the appellant obtaining a stay.

Before applying this test, however, it was important to examine whether the creditor group made the purchase in good faith and for value. If not, the Section 363(m) finding would, itself, be negated. Ultimately, the court found that both the trustee and the creditor group had acted in good faith, through a competitive auction process that increased the sale price of the assets sold, and that “appropriate value” was paid for those claims, despite being numerically less than the defendant's subsequent bids. Furthermore, the court rejected an argument of bad faith arising from the trustee's modification of the auction procedures following the adjournment based upon the wide-ranging authority provided to the trustee in the bid procedures and the defendant's own conduct which created the need for such modification.

Now, turning to the two-part test under Section 363(m), the court found to be indisputable that no stay had been sought; thus, the only question was whether a reversal or modification of the sale order would affect its validity. Acknowledging the strong presumption that validity would be affected by reversal and reflecting the general judicial preference that sale orders be upheld, the court noted that “the validity prong of our test provides 'a narrow exception that may lie for challenges to the sale order that are so divorced from the overall transaction that the challenged provision would have affected none of the considerations on which the purchaser relied,'” 2017 U.S. App. LEXIS 20889, at *31-32 (quoting In re Westpoint Stevens, Inc., 600 F.3d 231 249 (2d Cir. 2010))

This case did not fit into that “narrow exception.” The defendants argued that since they sought a declaration of the legality of the sale, its validity would not be affected because the creditors would still own what they had purchased even if they could not prosecute an action. The Third Circuit rejected this argument, because “to hold otherwise would allow a 'claw back' of the sale itself because the value of the claims, without the ability to prosecute them, would be completely eliminated and a central feature of the transaction would thus be frustrated, through no apparent fault of the creditor group.” Thus, because no stay was sought and because the remedy sought could not be granted without affecting the validity of the sale, the defendant's claims were deemed moot.

Challenging a Bankruptcy Court sale is never an easy task. It starts before the sale order is entered by disputing the right to a Section363(m) finding. After entry, a stay is always preferable, but often not economically possible. This ruling from the Third Circuit offers a refresher to practitioners in connection with sale cases. Following the letter of the Bankruptcy Code can be vital to securing or preserving rights and remedies, which otherwise may be lost through mootness. This decision also highlights the Third Circuit's two part analysis which differs from other jurisdictions. Here, even if a stay is not obtained, there still remains a small chance that a sale order which contains a Section 363(m) finding could be overturned if reversal or modification of the sale order would not affect its validity.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice on national bankruptcy matters and workouts, including the representation of major energy and health care companies in bankruptcy proceedings and general litigation throughout the United States. Kate Mahoney is an associate in the firm's Philadelphia office, where she concentrates her practice on commercial litigation matters.

In the ongoing and seemingly never ending low interest environment, some might argue that the Bankruptcy Code as it applies to commercial debtors has become more of a sale platform than a reorganization tool. Although that may change if rates ever do rise, for now, it remains critically important for practitioners to be mindful of the procedural hurdles that exist in a contested sale process. One group of litigants recently ran directly into those hurdles when the U.S. Court of Appeals for the Third Circuit denied their appeal of a sale order as being statutorily moot, largely because a stay had not been obtained, in Pursuit Capital Managment Fund 1 v. Burtch (In re Pursuit Capital Managment, 2017 U.S. App. LEXIS 20889 (3d Cir. Oct. 24, 2017).

Facing approximately $5 million in judgments with virtually no liquid assets, Pursuit Capital Management, (Pursuit) commenced a voluntary Chapter 7 bankruptcy proceeding in March 2014. Listed within its schedules filed with the court were potential avoidance claims it held against its owners and members. Since he lacked the resources to prosecute these claims, the trustee opted to sell them to a group of estate creditors for the sum of $125,000. Not surprisingly—the very owners and members against whom the avoidance claims would be brought—vigorously objected. Accordingly, the Delaware Bankruptcy Court directed the trustee to consider offers from the defendants as well.

As is often the case, the trustee determined that an auction process would best maximize value for the estate. Importantly, the auction procedures sought by the trustee and approved by the court, contained a fairly standard provision which permitted the trustee to modify the sale process “as he deemed] appropriate to comply with his fiduciary obligations” and to use his sole discretion to determine the highest and best bid. A contentious telephonic auction was commenced on July 7, 2015, but abruptly cut short when counsel for the defendants asserted a scheduling conflict. At the time, the defendants had submitted the highest bid at $170,000.

Following the adjournment, the trustee proposed eight alternative dates to resume the auction, but none were acceptable. Therefore, in the interest of reaching finality, he directed all parties to submit sealed bids by July 30. The creditor group submitted a sealed bid of $180,000, while the defendants not only failed to submit a new bid, but affirmatively withdrew the one previously lodged.

Receiving no other bids, the trustee declared the creditor group bid the winner and moved for a court order approving the sale. In response, the defendants filed a motion to adjourn and submitted a new bid for $200,000 by email, to which the creditor group objected. The bankruptcy court ordered the approval hearing to go forward, prior to which the defendants made a second email offer of $220,000, which was rejected by the Trustee.

At the sale hearing, the defendants unsuccessfully attempted to reopen the auction with an overbid in the amount of $205,750. Later, during cross examination of the trustee, the defendants tried yet again to present the trustee with a bid, increased this time to $250,000. The bankruptcy court, however, refused to allow “bidding from the podium.” Ultimately, the sale was approved, largely because the creditor group's bid, despite being numerically smaller than any of the defendant's 11th-hour offers, could lead to greater recovery for the estate—since the creditor group would pursue litigation against the defendants, whereas if the claims were sold to the same defendants, it would have the effect of extinguishing them. Indeed, following the court's entry of the sale order, the creditor group initiated an adversary proceeding against the defendants, which remains ongoing. Importantly, the sale order contained a finding of good faith under Section 363(m) of the Bankruptcy Code.

Following the sale hearing, the defendants did not request a stay and instead directly challenged the sale's legitimacy through appeal. The district court found the appeal statutorily moot under Section 363(m) because a stay had neither been sought or obtained and the validity of the sale itself would necessarily be affected by any modification or reversal of the sale order. The crux of the argument before the Third Circuit, therefore, was not the legality of the asset sale, but statutory mootness.

Section 363(m) provides that a challenge to a sale is mooted if “the underlying sale or lease was not stayed pending appeal, and the court, if reversing or modifying the authorization to sell or lease, would be affecting the validity of such a sale or lease,” as in Krebs Chrysler-Plymouth v. Valley Motors , 141 F.3d 490, 499 (3d Cir. 1998). Interestingly, the court mentioned in a footnote that its view is in the minority; as most other circuits have adopted per se rules automatically mooting such challenges absent the appellant obtaining a stay.

Before applying this test, however, it was important to examine whether the creditor group made the purchase in good faith and for value. If not, the Section 363(m) finding would, itself, be negated. Ultimately, the court found that both the trustee and the creditor group had acted in good faith, through a competitive auction process that increased the sale price of the assets sold, and that “appropriate value” was paid for those claims, despite being numerically less than the defendant's subsequent bids. Furthermore, the court rejected an argument of bad faith arising from the trustee's modification of the auction procedures following the adjournment based upon the wide-ranging authority provided to the trustee in the bid procedures and the defendant's own conduct which created the need for such modification.

Now, turning to the two-part test under Section 363(m), the court found to be indisputable that no stay had been sought; thus, the only question was whether a reversal or modification of the sale order would affect its validity. Acknowledging the strong presumption that validity would be affected by reversal and reflecting the general judicial preference that sale orders be upheld, the court noted that “the validity prong of our test provides 'a narrow exception that may lie for challenges to the sale order that are so divorced from the overall transaction that the challenged provision would have affected none of the considerations on which the purchaser relied,'” 2017 U.S. App. LEXIS 20889, at *31-32 (quoting In re Westpoint Stevens, Inc., 600 F.3d 231 249 (2d Cir. 2010))

This case did not fit into that “narrow exception.” The defendants argued that since they sought a declaration of the legality of the sale, its validity would not be affected because the creditors would still own what they had purchased even if they could not prosecute an action. The Third Circuit rejected this argument, because “to hold otherwise would allow a 'claw back' of the sale itself because the value of the claims, without the ability to prosecute them, would be completely eliminated and a central feature of the transaction would thus be frustrated, through no apparent fault of the creditor group.” Thus, because no stay was sought and because the remedy sought could not be granted without affecting the validity of the sale, the defendant's claims were deemed moot.

Challenging a Bankruptcy Court sale is never an easy task. It starts before the sale order is entered by disputing the right to a Section363(m) finding. After entry, a stay is always preferable, but often not economically possible. This ruling from the Third Circuit offers a refresher to practitioners in connection with sale cases. Following the letter of the Bankruptcy Code can be vital to securing or preserving rights and remedies, which otherwise may be lost through mootness. This decision also highlights the Third Circuit's two part analysis which differs from other jurisdictions. Here, even if a stay is not obtained, there still remains a small chance that a sale order which contains a Section 363(m) finding could be overturned if reversal or modification of the sale order would not affect its validity.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice on national bankruptcy matters and workouts, including the representation of major energy and health care companies in bankruptcy proceedings and general litigation throughout the United States. Kate Mahoney is an associate in the firm's Philadelphia office, where she concentrates her practice on commercial litigation matters.