Debtors beware: The Sixth Circuit Court of Appeals has recently expanded the ability of parties to appeal a bankruptcy court's approval of a sale of assets notwithstanding the statutory mootness rule set forth in section 363(m) of the Bankruptcy Code. While a majority of courts have adopted a per se rule automatically mooting such appeals where there is no stay of the order approving the sale, the Sixth Circuit has now joined the Third and Tenth Circuits in requiring proof that the reviewing court is unable to "grant effective relief without impacting the validity of the sale." Brown v. Ellmann (In re Brown), 851 F.3d 619 (6th Cir. 2017). Although the Brown case involved a chapter 7 debtor and the extent of exemptions for an individual under section 522 of the Bankruptcy Code, the mootness test adopted by the Sixth Circuit has potentially important implications for corporate chapter 11 debtors pursuing a sale of assets in the Sixth Circuit.

A Review of Section 363(m) of the Bankruptcy Code

Under Article III of the U.S. Constitution, federal courts have jurisdiction to consider only actual cases or controversies. U.S. Const. Art. III, § 2, cl. 1. When it becomes impossible for a court to grant effective relief, such as after a change in circumstances during a pending appeal, a live controversy ceases to exist and the case becomes constitutionally moot. See Mills v. Green, 159 U.S. 651, 653 (1895).

Section 363(m) of the Bankruptcy Code provides for a further statutory mootness rule beyond the general mootness rule under Article III of the U.S. Constitution. Section 363(m) applies to the sale of a debtor's assets to a good-faith purchaser under section 363 of the Bankruptcy Code and provides that:

[t]he reversal or modification on appeal of an authorization under subsection (b) or (c) of [section 363 of the Bankruptcy Code] of a sale or lease of property 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.

Pursuant to section 363(m), if an appellant is unable to obtain a stay pending appeal of a section 363 sale to a good-faith purchaser, the appeal should be mooted. See Official Comm. of Unsecured Creditors v. Anderson Senior Living Prop., LLC (In re Nashville Senior Living, LLC), 620 F.3d 584, 591 (6th Cir. 2010). Section 363(m) is a powerful protection for good-faith purchasers because it limits the 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, 581 (6th Cir. 2005) (citing Licensing by Paolo v. Sinatra (In Re Gucci), 126 F.3d 380, 392 (2d Cir. 1997)).

Courts have noted that the statutory mootness provided by section 363(m) serves important public policy considerations. Maximization of value is a fundamental goal of the Bankruptcy Code. Toibb v. Radloff, 501 U.S. 157, 163 (1991). By protecting the finality of bankruptcy sales, section 363(m) maximizes the value of a debtor's estate by encouraging the participation of buyers who are assured that a deal consummated with a debtor or bankruptcy trustee will not be modified by an appellate court after a sale transaction closes. Weingarten Nostat, Inc. v. Serv. Merch. Co., 396 F.3d 737, 741 (6th Cir. 2005) (citing Anheuser-Busch, Inc. v. Miller (In re Stadium Mgmt. Corp.), 895 F.2d 845, 847 (1st Cir. 1990)).

The Existing Circuit Split

The majority of U.S. courts of appeal, including the First, Second, Fifth, Seventh, Eleventh, and D.C. Circuits, have generally adopted a per se rule that the appeal of a sale order is automatically mooted if the closing of the sale is not stayed pending appeal. See Ginther v. Ginther Trusts (In re Ginther Trusts), 238 F.3d 686, 689 (5th Cir. 2001); U.S. v. Salerno, 932 F.2d 117, 122–23 (2d Cir. 1991); In re Stadium Mgmt. Corp., 895 F.2d 845, 847 (1st Cir. 1990); In re Charter Co., 829 F.2d 1054, 1056 (11th Cir. 1987); In re Sax, 796 F.2d 994, 997–98 (7th Cir. 1986); In re Magwood, 785 F.2d 1077, 1080 (D.C. Cir. 1986).

These courts have based the per se rule on the language of section 363(m) and the associated public policy considerations discussed above—in particular, maximizing value by protecting the finality of bankruptcy sales. See U.S. v. Salerno, 932 F.2d at 123 (discussing the public policy behind the finality of bankruptcy sales in its discussion of the per se rule); In re Stadium Mgmt. Corp., 895 F.2d at 847 (same); In re Sax, 796 F.2d at 998 (same).

By contrast, the Third and Tenth Circuits have held that section 363(m) does not automatically moot an appeal so long as it is possible to grant effective relief without impacting the validity of the sale. See Krebs Chrysler-Plymouth, Inc. v. Valley Motors, 141 F.3d 490, 498–99 (3d Cir. 1997) (holding that the appeal was moot under section 363(m) only after examining each remedy requested by the appellant and determining that each would affect the validity of the sale); Osborn v. Durant Bank & Trust Co. (In re Osborn), 24 F.3d 1199, 1210 (10th Cir. 1994) (holding that the appeal of the sale was not mooted by section 363(m) when Texas state law provided potential for a constructive trust on sale proceeds notwithstanding the distribution and commingling of sale proceeds).

The Third Circuit stated that its conclusion in Krebs was based in large part on its desire to maintain consistency between its interpretation of section 363(m) and a "parallel provision" in section 364(e) of the Bankruptcy Code. Section 364(e) provides that the reversal or modification on appeal of an order approving a postpetition loan or extension of credit does not affect the validity of debts or liens granted to a good-faith lender, unless the order approving the loan or extension of credit was stayed pending appeal.

In In re Swedeland Dev. Group, Inc., 16 F.3d 552, 559 (3d Cir. 1994) (en banc), the Third Circuit reasoned that "inasmuch as section 364(e) provides for the consequences of the reversal or modification of an order under 364(d) when the order has not been stayed pending appeal, it is impossible to conclude that section 364(e) in itself requires that an appeal be dismissed if a stay is not obtained." Instead, where "it was possible to fashion some meaningful, if only partial, relief," the Third Circuit concluded, an appeal would not automatically be moot under section 364(e). Id. at 560–61.

Similarly, in Krebs, the Third Circuit reasoned that section 363(m) would not automatically moot an appeal of an unstayed sale order where reversal or modification would not affect the validity of the sale. Krebs, 141 F.3d at 499. As a result, the Third Circuit evaluated each form of relief requested by the appellant and its potential impact on the validity of the sale in question. After concluding that each requested remedy would affect the validity of the underlying sale, the Third Circuit dismissed the appeal as moot.

Under the Tenth Circuit's interpretation of section 363(m), the appellee has the burden to "affirmatively demonstrate" that there is no relief available to the appellant. See C.O.P. Coal Dev. Co. v. C.W. Mining Co. (In re C.W. Mining Co.), 641 F.3d 1235, 1239 (10th Cir. 2011) (quoting Suter v. Goedert, 504 F.3d 982, 986 (9th Cir. 2007)). Thus, in Osborn, even though the sale proceeds had already been distributed pursuant to various orders of the bankruptcy court, the Tenth Circuit concluded that the mere possibility of equitable relief which might be provided by a flexible constructive trust remedy under Texas state law was sufficient to allow the appeal to proceed.

As a result, under Osborn, notwithstanding section 363(m), an appeal of a sale order will be allowed to proceed unless the bankruptcy court or other trial court has previously determined that no remedy is available which will not impact the validity of the sale itself. See Osborn, 24 F.3d at 1210 (declining to decide whether the appellants had a "definite entitlement to a particular equitable or other relief" and suggesting that the bankruptcy court or another trial court in a collateral action was the better forum to make such a determination). Therefore, in the Tenth Circuit, it appears that an appeal of a sale will be mooted pursuant to section 363(m) only when it is clear from the undisputed facts that an equitable remedy is unavailable. See Rushton v. ANR Co. (In re C.W. Mining Co.), 740 F.3d 548, 561 (10th Cir. 2014) (holding that an appeal was moot under section 363(m) where it was "clear from the undisputed facts" that the appellant could not prevail on its constructive trust theory).

The Sixth Circuit's Decision in Brown

In Brown, an individual debtor voluntarily commenced a chapter 7 case in the Eastern District of Michigan. In her petition, the debtor stated her intent to surrender her residence to the bankruptcy estate and did not claim any exemptions for the value of her redemption rights under Michigan law. The chapter 7 trustee sought permission during the case to sell the residence and distribute the proceeds. The debtor objected to the sale and sought to amend her initial disclosures to claim exemptions for the value of her redemption rights under sections 522(d)(1) and 522(d)(5) of the Bankruptcy Code. The bankruptcy court entered orders approving the sale and denying the debtor's requested exemptions. The sale subsequently closed while the appeal was pending because the sale approval order had not been stayed. After the district court affirmed the orders on appeal, the debtor appealed to the Sixth Circuit.

The trustee argued that the appeal was moot under section 363(m) because the debtor had not sought a stay pending appeal and the sale had closed. The Sixth Circuit, after recognizing the circuit split, adopted the minority approach of the Third and Tenth Circuits, declaring that "parties alleging statutory mootness under § 363(m) [must] prove that the reviewing court is unable to grant effective relief." The Sixth Circuit considered this to be the "superior interpretation" of section 363(m) because it "accommodates the provision's clear preference in favor of upholding the validity of bankruptcy sales without unduly restricting the appellant's right to contest errors of law made by the bankruptcy court." The Sixth Circuit also stated that its interpretation was "in line with the plain language of § 363(m)" because the statute "prohibits reviewing courts from modifying or setting aside a sale of property purchased in good faith" but does not explicitly "prevent a reviewing court from redistributing the proceeds from such a sale."

The court explained that, because the party seeking to have an appeal declared moot under section 363(m) bears the burden of proof, it was up to the bankruptcy trustee to inform the court whether any sale proceeds remained accessible and to address whether there was any equitable relief available to the debtor under Michigan state law. As the bankruptcy trustee did not address either issue in its briefing, the Sixth Circuit held that the trustee had "not carried his burden to demonstrate mootness under § 363(m)." Accordingly, the Sixth Circuit went on to address the merits of the appeal and upheld the bankruptcy court's approval of the sale and denial of the debtor's requested exemptions.

Implications and Considerations for Debtors in the Sixth Circuit

In bankruptcy cases within the Sixth Circuit, debtors will no longer be able to rely on the closing of a section 363 sale transaction to definitively moot all possible appeals. Instead, careful attention should be paid to the potential remedies that may be available to the appellant under nonbankruptcy law. If a remedy can be fashioned without impacting the purchaser of the assets, an appeal is likely to proceed. Moreover, because the Sixth Circuit requires the appellee to demonstrate the lack of any available remedy, those arguing mootness of the appeal of a sale order under section 363(m) must carefully address the lack of available remedies in their briefing to meet their burden of proof.