Under section 363 of the Bankruptcy Code, a debtor is permitted to sell substantially all of its assets outside of a plan of reorganization. Over the past two decades, courts have increasingly liberalized the standards under which 363 sales are approved. A recent decision from the United States Court of Appeals for the Third Circuit,

In re ICL Holding Co., Inc., arguably continues this trend, but provides hope for general unsecured creditors. Because section 363 sales can often primarily benefit secured creditors, unsecured creditors frequently object to the process as a veiled foreclosure. As a means to prevent conflict, secured creditors are increasingly “gifting” funds to the unsecured creditor body. The ICL Holding Court held that cash payments made by secured lenders to unsecured creditors pursuant to a 363 sale did not upset the Bankruptcy Code’s rigid priority scheme, and were therefore permissible.

In ICL Holding, the debtor’s primary secured creditor credit-bid its $320 million secured claim pursuant to section 363(k) of the Bankruptcy Code. The Unsecured Creditors Committee and United States Government objected to the asset sale as a “veiled foreclosure” that would leave both of their constituencies with nothing. Notably, however, under the terms of the bid, the secured lender agreed to pay certain administrative claims (namely professional fees) of the estate, but not all of them (including tax claims). To resolve the Committee’s objection, the secured lender agreed to deposit $3.5 million in escrow to benefit the general unsecured creditors. The Government, however, continued to object, claiming that the sale and subsequent settlement with the Committee upset the Bankruptcy Code’s priority scheme since general unsecured creditors would be paid before administrative tax claims, and professional administrative claims would be paid while other administrative claims would not. The Bankruptcy Court approved the settlement and sale, which was sustained by the District Court.

On appeal, the Government argued that the professional and settlement escrows were property of the bankruptcy estate and that the Code’s priority of payment scheme applies to § 363 sales, even if that paradigm textually applies only in the context of a plan of reorganization. The Third Circuit disagreed with the first point, concluding that the settlement monies—which the secured lender paid directly to the unsecured creditor body—did not constitute “estate property”. The Court of Appeals was persuaded by the fact that the settlement proceeds never became a part of the estate since they were to flow directly from the lender to the unsecured creditors. In contrast to theArmstrong World, decision, 432 F.3d 507 (3d Cir. 2005), the Third Circuit distinguished between the gifting of estate property from a senior to a junior creditor (relevant in that case), to the secured lender’s provision of its own “new money” property to a junior creditor, as was anticipated in ICL Holding.

Continuing, the Third Circuit found the question of whether the escrowed funds for the benefit of estate professionals was permissible under the Bankruptcy Code to be “more difficult,” though it ultimately came to the same conclusion. Under the Asset Purchase Agreement in ICL Holding, the escrowed funds were listed as part of the purchase price for the debtor’s assets. The objectors thus argued that those funds were property of the estate under 11 U.S.C. § 541(a)(6), which includes “proceeds . . . of or from property of the estate.” In considering the issue, the Court it focused on the “economic reality of what actually occurred.” Under the Asset Purchase Agreement, which memorialized the § 363 sale’s terms, the secured lenders purchase all of the debtor’s assets, including its cash, in exchange for its $320 million credit bid. Thus, because the secured lender bought all of the debtor’s cash, it also bought all residual cash from the asset sale—including the escrowed funds it was already paying for the benefit of the estate professionals. Therefore, “as a matter of substance,” the Third Circuit found that the escrowed funds had belonged to the lender (as successful buyer) and were not estate property and therefore not subject to the Bankruptcy Code’s rigid priority analysis.

The implications of the ICL Holdings decision are potentially substantial in providing to purchasers of a debtor’s estate assets under a § 363 sale a means to resolve objections outside of the rigid priority scheme of the Bankruptcy Code so long as the purchaser uses its own funds to do so and the transactions are otherwise disclosed to and approved by the Court. The extent to which this case becomes a common paradigm for future transactions remains to be seen.