Objecting to 363 Sale Orders Free and Clear of Interests: Speak Promptly or You'll Never Hold Your Piece

Contributed by Ginger Ellison.
Earlier this month, the United States Bankruptcy Court for the District of New Jersey enjoined a party from pursuing claims in state court against its competitor, the successful bidder in a 363 asset sale.  The bankruptcy court found that, despite arising prepetition, the competitor’s economic tort claims qualified as “interests” under section 363(f) of the Bankruptcy Code.  Consequently, the court found that the debtor had sold its assets free and clear of those claims, and the purchaser of the assets (the defendant in the state court litigation) could not be sued on account of those claims.  The bankruptcy court also held that the competitor’s failure to object to the asset sale “free and clear” of its claims constituted consent to the auction sale “free and clear” of such interests pursuant to section 363(f)(2) of the Bankruptcy Code.  The bankruptcy court held that rather than bringing its claim in state court months after the 363 sale was approved, the competitor should have sought relief from the sale approval order by means of Fed. R. Civ. P. 60(b).  Because the state litigation attacked specific bankruptcy court orders that previously had precluded the claims asserted by the plaintiff, the bankruptcy court issued the motion for injunctive relief.
In In re Christ Hospital, Christ Hospital, the debtor, filed a voluntary petition for protection under chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of New Jersey.  That same month, the bankruptcy court entered an order approving bidding procedures for the sale of the debtor’s assets.  An auction was held over the course of several days a month later in March 2012.  Hudson, the owner and operator of three for-profit hospitals in New Jersey, was the successful bidder.  On March 27, 2012, the court issued an order approving the debtor’s “363 sale,” which provided, among other things, that the sale of the debtor’s assets was free and clear of liens and claims pursuant to section 363(f) and that non-objecting holders of liens and claims were deemed to have consented to the free and clear sale.  In addition, the order provided that, effective on the closing date, parties asserting claims against Christ Hospital and/or any of the assets that were sold would be permanently enjoined and precluded from commencing or continuing any action against Hudson with respect to such claims.
The 363 sale to Hudson closed in July 2012.  Eight months later, Prime Healthcare, a major operator of for-profit acute care hospitals, initiated litigation against Hudson in New Jersey state court, alleging conspiracy, monopoly, tortious interference in contractual relations, tortious interference with prospective economic gain, and unfair competition.  Prime’s claims against Hudson related to Prime’s prepetition efforts toward acquiring the debtor’s assets.  Prime alleged that a principal of, and alleged major stakeholder in, the Hudson entities took actions that destroyed Prime’s contractual opportunity to purchase the debtor’s assets pre-bankruptcy, which Prime argued eventually forced the debtor into bankruptcy.  In August 2013, the New Jersey Superior Court dismissed the majority of Prime’s claims; however, it upheld three counts as they related to Christ Hospital on the basis that (i) the previous orders from the bankruptcy court concerned the sale of Christ Hospital after filing for bankruptcy and (ii) Prime’s claims pertained to actions by Hudson that took place prior to the debtor’s 363 sale.
On September 30, 2013, Hudson filed a motion in the bankruptcy court seeking to enjoin Prime from pursuing the state court litigation.  It argued that the court’s order approving the 363 sale provided Hudson with the benefits of broad “free and clear” protections as an asset purchaser under section 363(f).  By pursuing the lawsuit in state court, Hudson alleged that Prime was collaterally attacking and violating the bankruptcy court’s order.  Relying on principles of res judicata and collateral estoppel, Hudson contended that Prime must be enjoined from pursuing its pending state court litigation against Hudson.  Prime countered that the claims at issue related solely to Hudson’s prepetition, pre-bidding conduct involving Christ Hospital.  Prime maintained that its claims were “wholly unrelated” and “separate and apart” from the bankruptcy case, and therefore, the bankruptcy court lacked subject matter jurisdiction over Prime’s state law claims.
Under section 363(f) of the Bankruptcy Code, a debtor may sell property of the estate under sections 363(b) or (c) free and clear of another entity’s interest in such property under particular circumstances – including that where the entity consents to such sale.  Therefore, the central issues were (i) whether Prime’s economic tort claims qualified as section 363(f) “interests” and (ii) whether Prime’s failure to object to the asset sale “free and clear” of interests constituted consent to the auction sale on that basis pursuant to section 363(f)(2).
Time-Out: Defining “Interests” Under Section 363(f)
The first issue to decide was whether Prime’s economic tort claims qualified as section 363(f) “interests.”  Whereas Prime argued that the timing upon which its claims arose – i.e., the fact that Prime’s interests were developed prepetition – should determine whether the claims qualify as section 363(f) “interests,” the bankruptcy court adamantly disagreed.  The court found that “interests” arising prepetition are regularly affected by 363 sales. As such, it is not the timeline that controls whether a claim qualifies as an “interest” under section 363(f) but, instead, the nature of the interest at issue.
The bankruptcy court noted that courts have struggled to define “interests” for section 363(f) purposes, but also found that they have been trending toward a broader definition that encompasses obligations flowing from property ownership beyond in rem interests.  Ultimately, it adopted the Third Circuit precedent of the scope of section 363(f) interests as being “connected to, or aris[ing] from, the property being sold.”  The court found that Prime’s allegation that the lost benefit of its asset purchase agreement subsequently “forced” the hospital into bankruptcy rendered its claims “obviously intertwined” with the chapter 11 case.  As a result, the court held that Hudson’s obligations, as alleged in the claims, were connected to, or arose from the 363 sale of assets and their use by Hudson as the successful bidder.  Thus, the claims qualified as interests under section 363(f), and the debtor’s assets could be sold free and clear of them.
Time-In: Defining “Consent” Under Section 363(f)(2)
Upon finding that the claims qualified as interests under section 363(f), the next issue was whether Hudson had consented to the sale “free and clear” of such interests under section 363(f)(2).  Under section 363(f)(2), a trustee may sell property of the estate under sections 363(b) or 363(c) free and clear of another entity’s interest in such property if such entity consents.  To begin, the court noted that the order approving the asset sale expressly provided for consent and, therefore, was not subject to collateral attack.  Relying primarily on FutureSource, the court found that where adequate notice of the sale was provided, failure to object to a 363 sale may constitute consent to a “free and clear” sale under section 363(f)(2).
Most notably, the court held that only Prime was aware of its position as a potential tort claimant against Hudson at the time of the bankruptcy sale.  As Prime had complete notice and knowledge of the terms of the section 363(b) sale and Prime’s interests were exclusively within its own control, the court found that Prime’s failure to object to the asset sale “free and clear” of its interests was properly considered consent to the auction sale pursuant to section 363(f)(2).  For added emphasis, the court held that Prime’s prolonged inaction resulted in its loss of any rights to protection of its interests pursuant to section 363(e).  It also noted that a party seeking relief from consent-based bankruptcy sale orders should instead turn to Fed. R. Civ. P. 60(b), which provide parties with an opportunity to seek relief from an order in very limited circumstances.
Finding that the debtor’s assets were sold free and clear of any interests, the bankruptcy court held that the state litigation improperly attacked the sale order.  It granted Hudson’s injunction, thereby forbidding Prime from pursuing its pending lawsuit against Hudson in the New Jersey Superior Court.
This case has two major implications for parties who wish to assert claims against property being transferred by means of a 363 sale.  First, as it pertains to the classification of the claim as an “interest” for section 363(f) purposes, the moment that the claim arises is irrelevant.  Whether arising prepetition or postpetition, bankruptcy courts in the Third Circuit will assess whether a claim qualifies as an “interest” under section 363(f) based on whether the claim is connected to, or arises from, the property being sold.  Second, a party that is put on notice of a 363 sale and later seeks relief from the approval order must seek relief from the bankruptcy court issuing the order, rather than by collaterally attacking the order in state court.  In short, parties who have claims relating to assets sold through a 363 sale would be wise to make their interests known as soon as possible.  As evidenced here, a claimant who is put on notice of the sale in the bankruptcy court and sits quietly for a prolonged period may be deemed to have consented to a sale free and clear of its interests, and a state court will not be able to resuscitate that party’s claim.