Objections To Bankruptcy Asset Sale Did Not Rise To Level Of "Adverse Interest" Defeating Buyer's Good-Faith Status

• Published date: 27 July 2023
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Mr Paul Green and Mark Douglas

The finality of asset sales and other transactions in bankruptcy is an indispensable feature of U.S. bankruptcy law designed to maximize the value of a bankruptcy estate as expeditiously as possible for the benefit of all stakeholders. To promote such finality, section 363(m) of the Bankruptcy Code prohibits reversal or modification on appeal of an order authorizing a sale or lease to a "good-faith" purchaser or lessee unless the party challenging the sale obtains a stay pending appeal. What constitutes "good faith" has sometimes been disputed by the courts.

The U.S. Court of Appeals for the Fifth Circuit recently revisited this issue in SR Construction Inc. v. Hall Palm Springs LLC (In re RE Palm Springs II LLC), 65 F.4th 752 (5th Cir. 2023). The court reaffirmed its earlier decisions that a buyer's or lessee's good faith under section 363(m) is not defeated merely because it is aware of objections to the proposed sale or lease. Instead, the claims of the party challenging the sale or lease must rise to the level of an "adverse interest" in the ownership of the property. The Fifth Circuit also held that transparency in the sale or lease process is of paramount importance in establishing good faith.

Mootness of Appeals Under Section 363(m)

"Mootness" is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. An appeal can be either constitutionally, equitably, or statutorily moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.

The court-fashioned remedy of "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan that has been "substantially consummated."

An appeal can also be rendered moot (or otherwise foreclosed) by statute. For example, section 363(m) of the Bankruptcy Code provides as follows:

The reversal or modification on appeal of an authorization [of a sale or lease of property in bankruptcy] does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

11 U.S.C. ' 363(m). Section 363(m) of the Bankruptcy Code is a powerful protection for good-faith purchasers because it limits appellate review of a consummated sale irrespective of the legal merits of the appeal. See Made in Detroit, Inc. v. Official Comm. of Unsecured Creditors of Made in Detroit, Inc. (In re Made in Detroit, Inc.), 414 F.3d 576 (6th Cir. 2005); see also In re Palmer Equip., LLC, 623 B.R. 804, 808 (Bankr. D. Utah 2020) (section 363(m)'s protection is vital to encouraging buyers to purchase the debtor's property and thus insuring that adequate sources of financing are available).

Statutory mootness under section 363(m) can preclude appellate review not only of an unstayed sale order, but also orders approving transactions that are an integral part of the sale. See, e.g., In re Pursuit Holdings (NY), LLC, 845 Fed. App'x 60, 62-63 (2d Cir. 2021) (the statutory mootness rule indisputably applies to challenges to any integral provision of an order approving a sale, such as a settlement); In re Trism, Inc., 328 F.3d 1003, 1007 (8th Cir. 2003) (mooting under section 363(m) "a challenge to a related provision of an order authorizing the sale of the debtor's assets" because the related provision was integral to the sale of the assets and reversing the provision would alter the parties' bargained-for exchange); see also Matter of Alabama-Mississippi Farm, Inc., 791 F. App'x 466, 470 (5th Cir. 2019) (section 363(m) does not preclude an appeal seeking a security interest in sale proceeds because "nothing in the record suggests that the sale . was dependent on how the proceeds of that sale were to be distributed").

Section 363(m) has also been read to go further than simply limiting appellate review and to protect broadly the interests of any good-faith purchaser by subjecting any collateral attack made against a section 363 sale to a good-faith purchaser to the requirements of Rule 60(b) of the Federal Rules of Civil Procedure, which governs motions for reconsideration of or relief from prior court judgments or orders. See In re Edwards, 962 F.2d 641 (7th Cir. 1992) (holding that a collateral attack on sale to a good-faith...