Das Moot – Debtors’ Argument that 363(m) Moots Creditors’ Appeal of Sale Order Gets Sunk by Third Circuit

Contributed by Christopher Hopkins
As promised in our first post on the Third Circuit’s recent decision on In re ICL Holding Co., Inc., this post discusses issues regarding constitutional, statutory, and equitable mootness raised in connection with the U.S. government’s objection to the debtors’ sale of substantially all of their assets under section 363(b) of the Bankruptcy Code.  
In ICL Holdings, the debtors sought approval of the sale of substantially all estate assets to their secured creditors. Under the terms of the sale agreement, the secured creditors agreed to establish certain escrows to pay the debtors’ professionals’ fees and expenses. In addition, and to resolve the creditors’ committee’s objection to the proposed sale, the secured creditors entered into a settlement agreement with the committee and established a $3.5 million trust for the benefit of the unsecured creditors.
The U.S. government – which would incur a $24 million administrative claim as a result of the sale – objected to the proposed sale and the settlement agreement, arguing that the escrows and the settlement violated the Bankruptcy Code’s priority scheme. The government reasoned that the payment of the escrows to the debtors’ professionals and the settlement payments to the unsecured creditors violated the Bankruptcy Code’s priority scheme insofar as the government would not receive pro rata distributions from the escrows, and the unsecured creditors would receive distributions ahead of the government.
The United States Bankruptcy Court for the District of Delaware approved the sale and the settlement agreement over the government’s objection, ruling that neither the escrows nor the settlement payments constituted property of the estate. The government appealed both decisions and sought stays pending resolution of the appeals. Both the bankruptcy court and the district court denied the government’s request for stays pending appeal.
On appeal to the Third Circuit, and as a result of the government’s failure to obtain a stay pending appeal, both the debtors and the committee argued that the government’s appeal was constitutionally, statutorily, and equitably moot.
Constitutional Mootness
The debtors and the committee argued that the government’s objection was constitutionally moot because the secured creditors retained a $35 million first-priority lien on all property of the debtors’ estates following the sale. The debtors reasoned that, as a result of the secured creditors’ remaining liens, the government would not be entitled to any relief with respect to the escrows or settlement payments because the funds would go to the secured creditors. Accordingly, the government would not be entitled to any relief with respect to its administrative claim.
The Third Circuit disagreed, stating that a case “becomes [constitutionally] moot only when it is impossible for a court to grant any effectual relief whatever to the prevailing party.” The court explained that the government’s $24 million administrative claim would go unpaid if the distributional terms of the escrows and settlement payments were upheld and, therefore, the government had a “concrete interest” in the outcome of its objections. The remoteness of the government’s recovery was insufficient to render the objection constitutionally moot.
Statutory Mootness
The debtors and the committee also argued that the government’s objection was statutory moot by section 363(m) of the Bankruptcy Code because bankruptcy court and the district court had denied the government’s request for a stay of the sale and settlement agreement pending appeal.   Section 363(m) effectively “moots any challenge to a [section] 363 sale that affects the validity of the sale so long as the purchaser acted in good faith and the appellant failed to obtain a stay of the sale.”
The Third Circuit rejected this argument. After acknowledging that some courts interpret section 363(m) as limiting appellate review to the narrow issue of whether the property was sold to a good faith purchaser, the court stated that it interprets section 363(m) more broadly such that it would review “any sale-challenge that doesn’t affect the validity of the sale.” Thus, the court concluded that section 363(m) would not moot the government’s objections if the court could redistribute the escrows and the settlement payment “without disturbing the sale.”
Both the debtors and the committee argued that any redistribution of the escrows or settlement payment would disturb a “fundamental term of the transaction,” and therefore deprive key stakeholders of a bargained-for benefit of the sale. Further, the committee argued it would not have withdrawn its objection to the sale absent the settlement.
The court rejected both arguments reasoning that section 363(m) moots only those challenges that would claw back the sale from a good faith purchaser. The court refused to hold that section 363(m) protects every term in a sale agreement – even those that may be integral to the sale – especially when such provisions apply to non-purchasers.
Equitable Mootness
The committee argued that the government’s objection with respect to the settlement payments was equitably moot because over $2 million had already been distributed to unsecured creditors. The court rejected the committee’s argument, however, on the ground that the doctrine of equitable mootness did not apply prior to the confirmation of a chapter 11 plan. The court stated that “outside the plan context, we have yet to hold that equitable mootness would cut off our authority to hear an appeal, and do not do so here.” The court also noted that any unfairness to the committee was mitigated by the fact that, but for the settlement agreement, the unsecured creditors would have received nothing.
The Third Circuit’s holdings in ICL Holdings regarding the constitutional, statutory, and equitable mootness of the government’s appeal help clarify the circumstances in which such doctrines apply. Perhaps most importantly, the Third Circuit has clarified that section 363(m) only moots appeals of sale orders that seek to upset the sale itself. As a result, it seems that parties may continue to appeal particular provisions of sale orders, especially those that affect non-purchasers, without having such appeals rendered statutorily moot by section 363(m). Further, the court has clarified that, at least for now, the doctrine of equitable mootness has not been extended beyond the context of plan confirmation. This opinion should give pause to those who plan on mooting out appeals through quick consummations of sales.
Christopher Hopkins is an Associate at Weil Gotshal & Manges, LLP in New York.