Two recent district court decisions, each involving appeals of a bankruptcy sale order where the appellant(s) failed to obtain a stay pending appeal, provide insight into statutory mootness under section 363(m) of the Bankruptcy Code. In both In re HDR Holdings, Inc.,1 and Barnes v. 309 RTE 100 Dover LLC,2 the appellant(s) advanced arguments designed to avoid mootness by challenging the respective bankruptcy court’s finding that the buyer was a “good faith purchaser.” The appeals were dismissed as statutorily moot in each instance. The district courts’ analyses illustrate the challenges appellants face when seeking to avoid statutory mootness under section 363(m) and underscore the importance to purchasers of developing a solid factual record during a sale process. And we may soon get even more guidance on this important topic, as the Barnes decision was appealed to the Second Circuit Court of Appeals.
Section 363(m) of the Bankruptcy Code provides that a sale to a “good faith” purchaser authorized under section 363(b) or (c) of the Bankruptcy Code cannot be reversed or modified on appeal, unless such sale was stayed pending appeal.3 Challenges to bankruptcy sales after they close are generally held to be “statutorily moot.” These cases – one each from courts in the Second and Third Circuits – address when, if ever, can a successful challenge be brought against a purchaser of assets in bankruptcy after the sale closes (i.e., when the sale is not stayed pending appeal). The key lies whether the “good faith” finding itself was made in error. For buyers, the best protection is to make sure the record is robust and the bankruptcy court’s findings are strong in support of the good faith finding.
Executive Summary of HDR Holdings
Following the commencement of their chapter 11 cases, the Debtors filed a motion to sell substantially all of their assets to their DIP lender, Schramm II, Inc. (“Schramm II”), an entity wholly owned by the Debtors’ controlling majority shareholder GenNx360 Capital Partners, L.P. (“GenNx360”), pursuant to a Stalking Horse Purchase Agreement (the “APA”). The APA included “avoidance actions” in the assets to be sold, but did not specify or define what those were.
At the hearing on the Debtors’ proposed bidding procedures, the Debtors, Schramm II, GenNx360 (collectively, the “Appellees”), the official committee of unsecured creditors (the “Committee”), and unsecured creditor DNOW, L.P. (“DNOW”; together with the Committee, the “Appellants”) (collectively, the Appellants and the Appellees, the “Parties”) reached an agreement resulting in “significant modifications” to the sale process. The Appellants advised the bankruptcy court that they consented to the approval of the APA, its terms, and entry of a bidding procedures order. Accordingly, the bankruptcy court entered a bidding procedures order, which reflected the Parties’ agreed modifications to the sale process and approved the assets to be acquired under the APA. Approximately one month later, the Committee commenced an adversary proceeding against GenNx360, asserting certain avoidance actions (the “Avoidance Actions”) despite having agreed to the terms of the APA, which included the sale of “avoidance actions.”
After the sale process resulted in no other bids, the Debtors proceeded with the sale to Schramm II, which would effectively “capture and eliminate” the Committee’s adversary proceeding by transferring the Avoidance Actions pursuant to the APA. The Committee objected, arguing that applicable case law was unclear as to whether avoidance actions were transferrable property of the estate and that the APA did not specify that the Avoidance Actions were to be acquired thereunder. At the sale hearing, the bankruptcy court overruled the objections to the sale, determining that the “sale process was fair,” the “insider relationship” between Schramm II and GenNx360 “was not hidden,” that “all the parties were aware” that avoidance actions, which included the Avoidance Actions, were to be sold under the APA, and that applicable law did not “preclude the sale of avoidance actions.” Accordingly, the bankruptcy court entered a sale order (the “Sale Order”), but, upon the Appellants’ request, refused to waive the temporary fourteen (14) day stay imposed by Bankruptcy Rules 6004(h) and 6006(d). Both the Committee and DNOW appealed the approval of the sale transaction; however, neither sought a stay of the Sale Order pending appeal and the sale closed soon after.
The Appellees filed a motion to dismiss both appeals as statutorily moot pursuant to section 363(m). Citing to Third Circuit precedent, the District Court for the District of Delaware recognized that section 363(m) creates a “mootness test” wherein an appeal of a sale to a “good faith” purchaser is not moot only if (i) the sale was stayed pending appeal or (ii) the validity of the sale will not be affected by a reversal or modification of the sale order.4 The district court reasoned that such mootness test furthers section 363(m)’s “dual policies—providing finality to bankruptcy sales and court orders, and encouraging bidding in bankruptcy asset sales,” which serve to “attract investors and rehabilitate debtors” by avoiding litigation.5 The district court determined, however, that because the Third Circuit has not interpreted section 363(m) to moot non-stayed appeals of sales automatically, it was required to review the bankruptcy court’s finding of “good faith” under the “clear error” standard, turning to “traditional equitable principles” of “one who purchases in ‘good faith’ and for ‘value.’”6
In the opposition to the motion, the Appellants first argued that Schramm II was not a “good faith purchaser for ‘value’” as to the Avoidance Actions because it was an insider of the Debtors and sought to acquire such actions for the purpose of “burying them.”7 However, the district court held that insider status alone is insufficient to establish “a lack of good faith” and the Appellants failed to identify “any ‘admissible evidence of bad faith’ sufficient to satisfy” the clear error standard.8 Noting that the bankruptcy court had correctly found that Schramm II’s insider status was disclosed from “day one” and that the process was not unfair or fraudulent, the district court rejected the Appellants’ first argument.9 Second, the Appellants argued that the sale process was unfair because they were unaware that the Avoidance Actions would be sold under the APA.10 The district court quickly rejected this argument based upon the record, noting that the sale motion disclosed that avoidance actions would be included in the sale.11 The district court further noted that the bankruptcy court had found the Appellants’ unfairness argument “less persuasive” because they had “agreed in advance to the process.”12 Accordingly, because the Appellants did not produce evidence of bad faith, fraud, or collusion, the district court found no clear error in the bankruptcy court’s good faith finding.13
With respect to the whether Schramm II purchased the assets “for value,” the Appellants argued that Schramm II did not do so because it failed to “itemize and separately value” the Avoidance Actions.14 The district court noted that the Appellants did not cite any authority in support of this assertion and that Schramm II had provided over $11 million in consideration for all assets, which included the Avoidance Actions.15 As a result, the district court found no clear error in the bankruptcy court’s finding that Schramm II provided value for the assets.16
Having concluded that the sale was in good faith, the district court turned to section 363(m)’s mootness test.17 Because it was undisputed that a stay pending appeal was not obtained, the district court considered “whether the relief requested on appeal will affect the sale’s validity.”18 To make this determination, the district court recognized that Third Circuit precedent required it to look to the “remedies requested,” and that any challenge to a “central element” of the sale, that could “affect the value of the purchased assets,” or that “would claw back the sale from a good-faith purchaser” would indeed affect the sale’s validity.19 After evaluating the specific relief requested by the Appellants, which included the return of cash, the district court concluded that that the appeals would affect the validity of the sale.20 Accordingly, because the Appellants did not demonstrate any “clear error” in the bankruptcy court’s “good faith” purchaser finding, failed to seek a stay pending appeal, and sought relief that would “undo central aspects of the sale,” the district court granted the Appellees’ motion to dismiss the appeals as statutorily moot.21
Executive Summary of Barnes
The Debtors owned and operated a private ski and golf resort (the “Club”). After the Debtors’ cases were converted to ones under chapter 7 of the Bankruptcy Code, the chapter 7 trustee (the “Trustee”) filed motions (the “Sale Motions”) seeking the approval of bidding procedures in connection with the proposed sale of the Club in two parts: (1) a certain chairlift (the “Chairlift”); and (2) real estate and all other assets (the “Real Estate”; together with the Chairlift, the “Assets”). After a hearing on the Sale Motions, the bankruptcy court entered an order establishing bidding procedures for the Assets and approving the respective stalking horse bids for the Chairlift and Real Estate. Hermitage Member Group, Inc. (the “Member Group”) submitted a qualified combined bid for the Assets.
After an auction on the Assets, the Member Group was declared the winning bidder and the bankruptcy court subsequently entered an order approving the sale (the “Sale Order”). In the Sale Order, the bankruptcy court made the following findings, among others: (i) the Member Group constituted a “purchaser in good faith” and was therefore “entitled to the protections of section 363(m) of the Bankruptcy Code”; and (ii) the Member Group was “not an ‘insider’ or ‘affiliate’ of the Debtors.”22
The founder of and a former equity holder in the Club (the “Founder”), who held an unsecured claim against the Debtors, appealed the Sale Order, but did not seek a stay pending appeal.23 The sale of the Club to the Member Group closed shortly thereafter.24 The Member Group, joined by the Trustee and secured creditor Barnstormer Summit Lift, LLC (“Barnstormer”; collectively, with the Member Group and the Trustee, the “Appellees”), moved to dismiss the Founder’s appeal of the Sale Order on the basis of statutory mootness pursuant to section 363(m) because the bankruptcy court-authorized sale had closed.
Noting that the Second Circuit has recognized section 363(m)’s rule of statutory mootness, the U.S. District Court for the District of Vermont reasoned that it had jurisdiction over the appeal only if it concluded that the bankruptcy court “clearly erred in finding the Member Group was a good faith purchaser.”25 Based on applicable case law, the district court determined that its inquiry into whether the Member Group was a good faith purchaser was required to focus on the Member Group’s conduct during the sale process and bankruptcy proceedings.26 Further, the district court concluded that instances of fraud, collusion, or attempts “to take grossly unfair advantage of other bidders” would overturn the bankruptcy court’s “good faith” finding.27
The Founder argued that the Member Group was not a “good faith purchaser and that the bankruptcy court clearly erred in finding the Member Group was not an ‘insider.’”28 In support, the Founder alleged that several individuals involved with the Member Group and Barnstormer “were actively and continuously involved with the financial and operational affairs of the Debtors, pre-petition, as members of the board of managers or ad hoc committees appointed by [the Founder] to provide a layer of additional oversight for the Club members.”29 According to the Founder, these individuals “circumvented” their fiduciary duties through their involvement in the sale of the Club.30
First, after examining the bankruptcy court’s specific “good faith” findings in the Sale Order, the district court quickly dismissed the Founder’s arguments as to the purchaser’s lack of good faith, concluding that such findings were both uncontested and supported.31 Second, in addressing the Founder’s arguments pertaining to “insider” status, the district court conducted both a statutory and non-statutory analysis of whether the Member Group and the specific individuals involved therewith constituted “insiders.”32 Because neither the Member Group nor those individuals had a relationship with the Debtors (i) enumerated in section 101(31) of the Bankruptcy Code or (ii) “close enough to gain an advantage attributable simply to affinity rather than to the course of business dealings between the parties,” the district court further concluded that there was no evidence of “insider” status.33 Moreover, the district court reasoned that even if the Founder had established that the specific individuals had “circumvented” their fiduciary duties, he failed to allege fraud, collusion, or an attempt to take grossly unfair advantage of other bidders.34 Accordingly, the district court held that it lacked jurisdiction to review the Sale Order and granted the Appellees’ motion to dismiss the appeal as statutorily moot pursuant to section 363(m).
Both HDR Holdings and Barnes illustrate the uphill battle appellants face when seeking to avoid statutory mootness under section 363(m). In each case, the district court focused the bulk of its analysis on the bankruptcy court’s factual findings regarding the conduct of the purchasers during the sale process, and underscored that such findings of good faith are difficult to upset under the “clear error” standard. As the cases demonstrate, while statutory mootness under section 363(m) may be difficult to overcome given the provision’s “dual policies” identified in HDR Holdings, it is not impossible. To help ensure that section 363(m)’s protections will not be overturned, potential purchasers should encourage the implementation of a fair and transparent sale process rooted in comprehensive bidding procedures to help build a solid record supported by specific factual findings in case a sale order is later appealed. Additionally, potential purchasers should themselves be transparent in disclosing any potential or actual “insider” relationships with debtors. On the other hand, parties that anticipate challenging a sale order would be wise to raise any perceived issues with the sale process, including the conduct of the purchaser, prior to entry of a sale order. Moreover, they should consider seeking to stay the closing of the sale pending appeal. Although this would likely result in upfront litigation, it may help such parties avoid the precarious circumstance of having to litigate statutory mootness later in the case. As noted, on December 8, 2020, the district court’s decision in Barnes was appealed to the U.S. Court of Appeals for the Second Circuit. We will be watching to see the outcome of the appeal and will report back on any interesting developments in this area of law.