Bankruptcy: Section 363 Sales Must be Free & Clear of Liens in Bankruptcy
I can't tell you how many times our client has successfully collected its loan out of the proceeds from a sale of the borrower's assets in a bankruptcy case. When a sale of assets occurs in bankruptcy outside of a Plan of Reorganization, it must meet the five part test set forth under Bankruptcy Code Section 363(f). Often, these sales are called "363 Sales." In 2008, the Ninth Circuit Bankruptcy Appellate Panel issued a significant ruling that effects Section 363 Sales. The key take away from this ruling is that even if the Bank is fully secured by the assets being sold, the sale - outside of a Plan of Reorganization - will not be approved unless the junior secured creditors are also paid in full or consent to the sale. This ruling deals a stunning blow to liquidating assets in Bankruptcy in the current marketplace, where the Bank's collateral has dropped in value in a meaningful way and junior creditors are out of the money.
My colleague, Walter Gouldsbury, a member of the JMBM Special Assets Team™, puts the Clear Channel opinion in perspective and in doing so, gives workout professionals a quick and easy place to go to understand the rules that govern Section 363 Sales.
SECTION 363 SALES FREE AND CLEAR OF LIENS IN BANKRUPTCY
By: Walter W. Gouldsbury III, Esq.
The sale of the assets of a debtor often play a crucial role in the success of a bankruptcy case. This is true whether the bankruptcy involves a Chapter 11 case and the debtor is reorganizing or liquidating under a plan of reorganization, or a Chapter 7 case where liquidation is the only possibility. In either instance, the reorganization or liquidation efforts of the debtor and the ultimate return to creditors often hinge on the sale of the debtor's assets.
This is especially important now, given the tremendous increase in the number of bankruptcy filings where the estate assets are primarily comprised of real property. With bankruptcy being a last resort for many debtors, the reality is that these commercial real property assets are often encumbered by multiple liens that exceed the value of the real property. As the real estate market continues to deteriorate, debtors and trustees have been faced with the situation of selling the real property in a "short sale" leaving many lienholders "out of the money". More and more senior secured creditors are "credit bidding" less than the amount of their secured debt to the detriment of nonconsenting junior lienholders.
It critical important to understand the framework of Section 363(f) and the requirements for a sale of real property free and clear of liens to be authorized by a bankruptcy court. It is also important to have a general understanding of the case law interpreting said statutory provisions. This article will provide an overview of the statutory framework of Section 363(f) and analysis of an opinion issued by the United States Bankruptcy Appellate Panel ("BAP") for the Ninth Circuit in the case entitled Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP (Cal.) 2008) that is changing the landscape for sales free and clear in the Ninth Circuit.
Brief Overview of Section 363 (f)
Multiple liens on property of the debtor pose special problems for a debtor-in-possession, a Chapter 11 trustee or a Chapter 7 trustee who is presented with the need to sell property of the debtor free and clear of the liens. Section 363 (f) sets the ground rules as follows:
The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if -
(1) applicable non-bankruptcy 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 motion to sell free and clear of liens must be denied if any of the above stated requirements set forth in 11 U.S.C. Section 363 (f) cannot be satisfied.
Whether or not Section 363 (f)(1) can be satisfied is a matter of non-bankruptcy law and may controlled by state law or non-bankruptcy federal law and can vary depending on the type of asset being sold. For instance, California state law does not permit a sale of real property free and clear of liens. Nguyen v. Calhoun (2003) 105 Cal. App. 4th 432, 438. On the other hand, Uniform Commercial Code Section 9-611, et. seq. authorizes a foreclosure of personal property collateral free and clear of a security interest. U.C.C. § 9-611, et seq.
Sections 363 (f)(2) and (f)(4) are more straightforward. In order for Section 363 (f)(2) to be satisfied and a sale free and clear liens to be authorized thereunder, the affected lienholders must consent. 11 U.S.C. § 363(f)(2). In addition, if a lien is subject to a bona fide dispute, i.e. an objection to the lienholder's claim has been asserted in the bankruptcy case, a sale can be authorized free and clear of said lien under Section 363(f)(4). 11 U.S.C. § 363(f)(4).
With respect to Sections 363 (f)(3) and (f)(5), bankruptcy courts have applied differing interpretations to these statutory provisions. While the law may vary by circuit, the recent Clear Channel decision issued by the Ninth Circuit Bankruptcy Appellate Panel clarified the law in the Ninth Circuit with respect to Sections 363(f)(3) and (f)(5). Clear Channel is now the test for approval of sales free and clear of liens under Section 363(f) in the Ninth Circuit and may impact the right of secured creditors to bid the amount of their secured debt. The Clear Channel case involved an appeal of a bankruptcy court decision issued that confirmed a sale of real property pursuant to Section 363 (f). PW, LLC ("PW"), the bankrupt, owned real property parcels in Burbank, California. PW was attempting to develop the subject property pursuant to a development agreement with the City of Burbank when it started experiencing financial difficulties. DB Burbank, LLC ("DB"), a first priority lienholder in substantially all of PW's assets, held a secured claim in excess of $40 million and began foreclosure proceedings in July 2006. PW filed a Chapter 11 bankruptcy case and a Chapter 11 trustee was appointed. Clear Channel Outdoor Inc. ("Clear Channel") was a junior lienholder holding a secured claim of approximately $2.5 million.
The bankruptcy court established a sales procedure order under which DB would be the "stalking horse" bidder with an overbid amount set. The Chapter 11 trustee then moved to approve the sale free and clear of liens pursuant to Sections 363 (f)(3) and (f)(5). The proposed sale price was insufficient to pay off Clear Channel, which objected to the sale. Despite Clear Channel's objection, the bankruptcy court approved the sale of the assets to DB free and clear of Clear Channel's lien under Section 363 (f)(5) based on DB's $41,434,465 credit bid of its secured claim. Clear Channel, receiving nothing, appealed to the BAP. The BAP, among other things, reversed the order authorizing the sale to DB free and clear of Clear Channel's lien pursuant to Section 363(f)(5). In doing so, the BAP analyzed the applicability of Sections 363 (f)(3) and (f)(5).
With respect to Section 363 (f)(3), there is a disagreement among the bankruptcy courts regarding the application of the aggregate value standard under Section 363(f)(3) when considering whether or not to authorize a sale free and clear of liens. Certain courts have held that the proposed sale price must be greater than the aggregate amount of the debts encumbering the property ("Aggregate Lien View"). In re Canonigo, 276 B.R. 257 (Bktcy. N.D. Cal. 2002). Other courts have found that a sale can be authorized under Section 363(f)(3) if the sale price is equal to or exceeds the value of the collateral securing the liens. Under the latter interpretation, the value of the collateral is the determining factor, whereas, under the Aggregate Lien View, the "face amount" of the liens encumbering the property is determinative in whether a sale meets the requirements of Section 363 (f)(3).
The BAP in Clear Channel held that the Aggregate Lien View is the standard to be applied in the Ninth Circuit in determining whether a sale free and clear under Section 363 (f)(3) could occur. Clear Channel, 391 B.R. at 41. The Clear Channel opinion next addressed the ability of the bankruptcy court to approve a sale free and clear under Section 363(f)(5) over the objection of a non-consenting junior lienholder outside of a plan of reorganization.
As noted above, Section 363 (f) (5) allows the debtor to sell property free and clear of liens when "a legal or equitable proceeding" exists that will force the lien holder to accept less than the full money satisfaction of their interest. 11 U.S.C. Section 363(f)(5). While some courts have found in cases involving the reorganization of the debtor "if the holder of a lien could be compelled in a cram down to accept less than full satisfaction, . . . . the holder may be compelled to accept such satisfaction under Section 365 (f)(5)." [Matter of Stroud Wholesale, Inc., 47 B.R. 999, 1003 (E.D.N.C. 1985)], the BAP in Clear Channel disagreed and held that "the availability of cramdown under § 1129 (b)(2) is not a legal or equitable proceeding to which § 363(f)(5) is applicable." Clear Channel, 291 B.R. at 37. The BAP noted that "[u]nder the view that full payment is not necessary, it is not the amount of the payment that is at issue, but whether a 'mechanism exists to address extinguishing the lien or interest without paying such interest in full' ". Clear Channel, 291 B.R. at 43 (citing In re Gulf States Steel, 285 B.R. 497, 508 (Bktcy. N.D. Ala. 2002) ). Because the bankruptcy court did not apply the correct legal standard under 365(f)(5), the BAP reversed the bankruptcy court's order and remanded the case for further proceedings to allow the parties to "identify a qualifying proceeding under nonbankruptcy law (if one exists) that would enable them to strip Clear Channel's lien . . . under § 365(f)(5). Id. at 47. The ultimate holding of the Clear Channel appellate opinion is that Section 363 (f) does not permit a secured creditor to credit bid its debt and purchase estate property free and clear of valid nonconsenting junior lienholders outside of a plan of reorganization.
The impact that Clear Channel will have on sales free and clear under Section 363(f) in the Ninth Circuit remains to be seen. As the economic downturn in the real estate market continues, we will witness more and more properties that are encumbered by liens that far exceed the sales prices. By not allowing a senior secured creditor to credit bid the amount of its secured debt, without satisfying the junior lienholder, sales under Section 363(f) may not be approved, and any realization of the benefit of a bankruptcy case for any creditors in these cases is greatly diminished.
This is Dick Rogan, bank lawyer and author of www.SpecialAssetsLawyer.com, signing off for now. Join us again soon to check out what's new in the World of Workouts.
Year after year, day after day, workout professionals in the know rely on JMBM's Special Assets Team™ to handle problem commercial and real estate loans. Whatever problem loans you have, chances are, we've seen it. Give us a call.
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Our Perspective. JMBM represents commercial banks, special servicers, private lenders, asset-based lenders, hard money lenders and factors. We help lender clients throughout the United States craft business and legal solutions to their commercial and real estate troubled loans. For more information, please contact Dick Rogan at RRogan@JMBM.com, or (415) 398-8080.
Richard A. Rogan is Chair of the JMBM Special Assets Team™. He also serves as the co-managing partner of JMBM's San Francisco office and co-chair of its Bankruptcy Practice Group.
JMBM's Special Assets Team™ has represented hundreds of lenders in California and throughout the United States. We regularly appear in bankruptcy courts, district courts and superior courts. We are proud to serve as trusted counsel and advisors who look for a business solution and try to help lenders find the best possible resolution for each troubled loan. Whether a loan is being newly documented, restructured or litigated, JMBM's Special Assets Team™ has the skill, know-how and experience to solve your problem in a practical no-nonsense way.
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