Posts Tagged ‘United States Court of Appeals for the Ninth Circuit’
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Avoidance and Recovery
A recently-issued Ninth Circuit decision creates potentially new avenues of recovery for creditors of an insolvent debtor.
Fitness Holdings International, Inc. (FHI), a home fitness corporation, had received significant funding between 2003 and 2006 from two entities: Hancock Park, its sole shareholder, and Pacific Western Bank. Â FHIâs unsecured obligations to Hancock Park, totaling $24 million, were subordinated to $12 million in secured financing by Pacific Western Bank in the form of a $5 million term loan and a $7 million line of credit (all guaranteed by Hancock Park).
One of the most effective vehicles for the rescue and revitalization of troubled business and real estate to emerge in recent years of Chapter 11 practice has been the “363 sale.”
Named for the Bankruptcy Code section where it is found, the “363 sale” essentially provides for the sale to a proposed purchaser, free and clear of any liens, claims, and other interests, of distressed assets and land.
The section has been used widely in bankruptcy courts in several jurisdictions to authorize property sales for “fair market value” . . . even when that value is below the “face value” of the liens encumbering the property.
In the Ninth Circuit, however, such sales are not permitted – unless (pursuant to Section 363(f)(5)) the lien holder “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”
A recent decision issued early this year by the Ninth Circuit Bankruptcy Panel and available here)Â provides a glimpse of how California bankruptcy court areÂ employing this statutory exception to approve “363 sales.”
East Airport Development (EAD) was a residential development project inÂ San Luis Obispo which, due to the downturn of the housing market, never came completely to fruition.
Originally financed with a $9.7 million construction and development loan in 2006, EAD’s obligation was refinanced at $10.6 million in mid-2009.Â By February 2010, the project found itself in Chapter 11 in order to stave off foreclosure.
A mereÂ two weeks after its Chapter 11 filing, EAD’s management requested court authorization to sell 2 of the 26 lots in the project free and clear of the bank’s lien, then to use the excess proceeds of the sale as cash collateral.
In support of this request, EAD claimed the parties had previously negotiatedÂ a pre-petition release price agreement.Â EAD argued the release price agreement was a âbinding agreement that may be enforced by non-bankruptcy law, which would compel [the bank] to accept a money satisfaction,â and also that the bank had consented to the sale of the lots.Â A spreadsheet setting forth the release prices was appended to the motion.Â The motion stated EAD’s intention to use the proceeds of sale to pay the bank the release prices and use any surplus funds to pay other costs of the case (including, inter alia, completion of a sewer system).
The bank objected strenuously to the sale.Â It argued there was no such agreement – and EAD’s attachment of spreadsheets and e-mails from bank personnel referencing such release prices ought to be excluded on various evidentiary grounds.
The bankruptcy court approved the sale and cash collateral use over these objections.Â The bank appealed.
On review, the Ninth Circuit Bankruptcy Appellant Panel found, first,Â that the bankruptcy court was within the purview of its discretion to find that, in fact, a release price agreement did exist – and second, that such agreement was fully enforceable in California:
It is true that most release price agreements are the subject of a detailed and formal writing, while this agreement appears rather informal and was evidenced, as far as we can tell, by only a few short writings. However, this relative informality is not fatal. The bankruptcy court is entitled to construe the agreement in the context of and in connection with the loan documents, as well as the facts and circumstances of the case. Courts seeking to construe release price agreements may give consideration to the construction placed upon the agreement by the actions of the parties. . . . Here, the parties acted as though the release price agreement was valid and enforceable and, in fact, had already completed one such transaction before EAD filed for bankruptcy. On these facts, [EAD] had the right to require [the bank] to release its lien on the two lots upon payment of the specified release prices, even though [the bank] would not realize the full amount of its claim. More importantly, [EAD] could enforce this right in a specific performance action on the contract. For these reasons, the sale was proper under Â§ 363(f)(5).
The Ninth Circuit Bankruptcy Appellate Panel‘s East Airport decision provides an example of how bankruptcy courts in the Ninth Circuit are creatively finding ways aroundÂ legal hurdles to getting “363 sales” approved in a very difficult California real estate market.Â It likewise demonstrates the level of care which lenders’ counsel must exercise in negotiating the work-out of troubled real estate projects.
Nortonâs recently-published 2010 Annual Survey of Bankruptcy Law offers an intriguing article focusing on an often-overlooked difference between âSection 363 salesâ and Chapter 11 Plans â and suggesting that, for certain liabilities, Section 363 may actually afford broader relief than a Chapter 11 discharge.
InÂ Classic Chapter 11 Reorganizations Versus Section 363 Sales And The Effects On Environmental Cleanup Obligations: The Choice After Apex Oil Co.Â And General Motors, authors Joel Gross and Christopher Anderson contend:
â[U]nless the law [surrounding Section 363 sales] changes, any debtor seeking to provide maximum protection to its surviving business from broad cleanup liabilities for divested properties would be best advised to utilize a Section 363 sale. Â The protection from successor liability that can be achieved through such a sale will very likely exceed the more narrow discharge from monetary claims that can be obtained if the property is transferred under a plan of reorganization.â
In support of their argument, Gross and Anderson compare the results of two recent decisions â In re Apex Oil and the 2009 In re General Motors Corp. decision.
In Apex Oil, the 7th Circuit held that, despite its prior discharge in Chapter 11, the reorganized debtor remained liable for environmental liabilities incurred years earlier on the grounds that such liabilities were not âclaimsâ subject to discharge under Chapter 11âs provisions.Â A prior post regarding Apex is available here.
In General Motors â by contrast â the the US Government supported, and the Bankruptcy Court accepted, the transfer of GMâs business assets to a newly-formed entity (âNew GMâ) under a sale âfree and clear of all . . . interests,â including successor liability claims.Â In reaching this decision, the Bankruptcy Court relied on the reasoning set forth in In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir.2003) – i.e., that Section 363 provides a basis for selling assets free and clear of successor liability claims.
Not every circuit permits an extension of Section 363âs âfree and clearâ language to successor liability claims.Â See Michael H. Reed, Successor Liability and Bankruptcy Sales RevisitedâA New Paradigm, 61 Bus. Law. 179, 208â211 (2005) (surveying the lower courts’ application of TWA).Â Though at least one District Court and the Ninth Circuit Bankruptcy Appellate Panel have followed the TWA decision, the Ninth Circuit has not explicitly ruled.
Consequently, â[i]n light of the split in circuit authority, it remains to be seen whether the view that successor liability claims can ultimately be cut off via a Section 363 sale will prevail. Â For the time being, however, the majority of appellate courts (including the Second and Third Circuits where so many major Chapter 11 cases are fled) have held that they can, and there seems to be a similar trend in the lower courts.â
That said, the use of Section 363 to avoid environmental liabilities isnât without its problems: âOne potentially important limitation, which appears not to have been addressed by any court to date, is Section 363(e)’s requirement that all sales approved under Section 363 provide adequate protection for the interest of any entity in the property sold.â
Other issues present themselves as well.Â For example:
– Is it possible to provide for liens against the sale proceeds for successor interests?Â Gross and Anderson donât think so â as they see it, doing so would provide otherwise-unsecured creditors with preferential treatment.
– How much are contingent successor claims truly worth?Â Even if it were possible to provide âadequate protectionâ for successor claims, doing so raises the question of what such claims are truly worth.
– Finally, the ability to shield assets from successor liability claims frequently implicates the Courtâs equitable power under Section 105, and the extent of its scope.
Problematic or not, these considerations likely wonât stop debtors from taking a shot at a sale: â[G]iven the certainty following Apex Oil that at least some injunctive claims will survive a traditional chapter 11 reorganization, it can be expected that debtors with significant environmental exposure will prefer to follow the roadmap laid out in GM.â