Assets May Be Sold In Bankruptcy Free And Clear Of Successor Liability

• Published date: 28 October 2020
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Mr Timothy Hoffmann and Mark Douglas

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to sell assets of the bankruptcy estate "free and clear" of "any interest" in the property asserted by a non-debtor is an important tool designed to maximize the value of the estate for the benefit of all stakeholders. The U.S. Bankruptcy Court for the Central District of California recently examined whether such interests include "successor liability" claims that might otherwise be asserted against the purchaser of a debtor's assets. In In re Catalina Sea Ranch, LLC, 2020 WL 1900308 (Bankr. C.D. Cal. Apr. 13, 2020), the court joined the majority of courts in holding that assets can be sold to an insider of a debtor free and clear of successor liability claims within the plain meaning of section 363(f) of the Bankruptcy Code.

Free and Clear Bankruptcy Sales

Section 363(b)(1) of the Bankruptcy Code provides in relevant part that "[t]he trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate." Courts generally apply some form of a business judgment test in determining whether to approve a proposed use, sale, or lease of estate property under section 363(b)(1). See ASARCO, Inc. v. Elliott Mgmt. (In re ASARCO, L.L.C.), 650 F.3d 593, 601 (5th Cir. 2011); In re Stearns Holdings, LLC, 607 B.R. 781, 792 (Bankr. S.D.N.Y. 2019); In re Friedman's, Inc., 336 B.R. 891, 895 (Bankr. S.D. Ga. 2005); see generally Collier on Bankruptcy ("Collier") ' 363.02 (16th ed. 2020).

Under this deferential standard, a bankruptcy court will generally approve a reasoned decision by a trustee or DIP to use, sell, or lease estate property outside the ordinary course of business. See In re Alpha Nat. Res., Inc., 546 B.R. 348, 356 (Bankr. E.D. Va.), aff'd, 553 B.R. 556 (E.D. Va. 2016). However, when a transaction involves an "insider," courts apply heightened scrutiny to ensure that the transaction does not improperly benefit the insider at the expense of other stakeholders. See In re Alaska Fishing Adventure, LLC, 594 B.R. 883, 887 (Bankr. D. Alaska 2018); In re Family Christian, LLC, 533 B.R. 600, 622, 627 (Bankr. W.D. Mich. 2015).

Section 363(f) of the Bankruptcy Code authorizes a trustee or DIP to sell property "free and clear of any interest in such property of an entity other than the estate," but only if:

1. applicable nonbankruptcy law permits sale of such property free and clear of such interest;
2. such entity consents;
3. such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
4. such interest is in bona fide dispute; or
5. such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

11 U.S.C. ' 363(f). A bankruptcy court's power to order sales free and clear of a competing interest without the consent of the party asserting the interest has been recognized for more than a century. See Ray v. Norseworthy, 90 U.S. 128, 131-32 (1875). It promotes the expeditious liquidation of estate assets by avoiding delay caused by sorting out disputes concerning the validity and extent of competing interests, which can later be resolved in a centralized forum. It also facilitates the estate's realization of the maximum value possible from an asset. A prospective buyer would discount its offer significantly if it faced the prospect of protracted litigation to obtain clear title to an asset. See In re WBQ P'ship, 189 B.R. 97, 108 (Bankr. E.D. Va. 1995); accord In re Realia, Inc., 2012 WL 833372, at *10 (B.A.P. 9th Cir. Mar. 13, 2012) (noting that that "the purpose of the 'free and clear' language is to allow the debtor to obtain a maximum recovery on its assets in the marketplace"), aff'd, 569 F. App'x 544 (9th Cir. 2014).

Holders of such competing "interests" are provided with protections by the Bankruptcy Code. Pending the bankruptcy court's resolution of any disputes, the interest holder is entitled to "adequate protection" of its interest. This most commonly takes the form of a replacement lien on the proceeds of the sale. See generally Collier at ' 363.06[9].

Courts have sometimes struggled to identify the outer limits of the term "interest," which is not defined in the Bankruptcy Code or its accompanying legislative history. Most courts reject the narrow approach under which the reach of section 363(f) is limited to in rem property interests (such as liens or security interests) or only those claims that have...