State and federal laws provide numerous protections to secured parties to preserve their interests in collateral. As secured parties well know, however, these protections become more and more limited when the collateral is pledged to multiple secured parties. Issues, like priority of interests and liens, become more prevalent when the collateral at issue falls in value and multiple secured parties are fighting to enforce their interests in order to satisfy their debts.
One forum where this dispute commonly arises is in the context of bankruptcy sales outside of the ordinary course of business. Section 363 of the Bankruptcy Code authorizes such sales with bankruptcy court approval. 11 U.S.C. § 363(b).
But, section 363 also provides that generally “on request of an entity that has an interest in property used, sold or leased, or proposed to be used sold or leased, by the trustee [or debtor], the [bankruptcy] court, with or without a hearing, shall prohibit or condition such use, sale, or lease as is necessary to provide adequate protection of such interests.” 11 U.S.C. § 363(e).
What happens then when a secured party may not want its collateral sold in a bankruptcy sale? Recognizing that this could be a common occurrence, section 363(f) of the Code provides that a trustee or debtor may sell property “free and clear of any interest in such property of an entity other than the [bankruptcy] estate.” 11 U.S.C. § 363(f). However, one of five of the following conditions must be met in order for such a sale to proceed:
- applicable nonbankruptcy law permits the sale;
- such entity [i.e., the secured party] consents;
- 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;
- such interest is in bona fide dispute; or
- 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) (emphasis added).
The third condition was primarily in dispute in the case of In re Bay Circle Properties, LLC, et al., Case No. 15-58440-WLH (Bankr. N.D. Ga. Feb. 14, 2017), where the debtor attempted to sell its property free and clear of junior liens. The case is worthy of discussion because it exemplifies the precarious condition that junior lienholders can find themselves in a bankruptcy setting.
Debtor Bay Circle Properties, LLC (“Bay Circle“) and several affiliates filed bankruptcy under chapter 11 on May 4, 2015. Bay Circle owned two properties with large office warehouse buildings in Georgia, and its affiliated debtors owned several other properties in the Atlanta metropolitan area. The debtors valued all of these properties to be in excess of $40 million.
Wells Fargo was the primary secured lender of Bay Circle and the other debtors, with a secured claims in excess of $22 million. This claim was secured by all of the debtors’ properties, including Bay Circle’s.
Pursuant to a post-bankruptcy settlement between the debtors and Wells Fargo, the debtors agreed to make milestone payments to Wells Fargo on certain dates. Upon default of those milestone payments, Wells Fargo (or its successor) was allowed to foreclose on all of the debtors’ properties. Wells Fargo agreed to release its liens on each parcel of property, however, upon a sale by the debtors for an agreed-upon price or upon payment of all of the secured debt owed to Wells Fargo. Wells Fargo (or its successor) also would be allowed to credit bid its secured claims as to any parcel of property in the event of a sale, in accordance with section 363(k) of the Bankruptcy Code.
In come the junior lienholders. Prior to the bankruptcy but after Wells Fargo’s security interests were perfected, two parties (the “Junior Lienholders“) obtained judgments in the amounts of $2.5 million and $12 million against the debtors’ principal. These judgments were recorded in Georgia, and notwithstanding certain title transfers of the properties, gave the Junior Lienholders junior liens on Bay Circle’s two properties.
When the debtors were unable to make one of the milestone payments under the settlement, Bay Circle filed a motion to sell its two properties for $5 million, free and clear of any liens, pursuant to section 363(f) of the Code. As of that point, Wells Fargo’s successor in interest by purchase, Bay Point Capital Partners, LP (“Bay Point“), was owed in excess of $15 million, and the two Junior Lienholders were owed the full amount of their judgments, which exceeded $14 million.
Over the objection of the Junior Lienholders, the bankruptcy court ordered an auction of Bay Circle’s properties between a proposed third-party purchaser and Bay Point, which inherited Wells Fargo’s credit bid rights. The auction ultimately netted a sales price of $5.3 million, which was insufficient to satisfy the full amount of the first lienholder’s (Bay Point’s) claim, leaving the Junior Lienholders out of the money.
While the debtors, through the proposed sale (free and clear), attempted to satisfy several of the alternative conditions under section 363(f), the condition that merited the most discussion was section 363(f)(3), which required a sale price above the aggregate value of all liens on Bay Circle’s properties. If the Junior Lienholders’ argument that section 363(f)(3) required the satisfaction of the face value of all such liens, then the sale could not proceed unless all liens were satisfied by the sale. The Bankruptcy Court for the Northern District of Georgia, however, disagreed with the Junior Lienholders’ position.
The Bankruptcy Court first noted that there exists a split in authority as to the interpretation of section 363(f)(3). For example, the Ninth Circuit Appellate Panel has held that section 363(f)(3) requires that the purchase price be in excess of the face amount of all liens on a property, see Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (BAP 9th Cir. 2008), while other courts merely require the purchase price to exceed the value–not the face amount–of the liens asserted against a property, see In re Beker Industries Corp., 63 B.R. 474 (Bankr. S.D.N.Y. 1986); In re Flyboy Aviation Props. LLC, 501 B.R. 828 (Bankr. N.D. Ga. 2013); and In re Atlanta Retail, Inc., 456 F.3d 1277 (11th Cir. 2006).
The Bankruptcy Court agreed with the latter line of cases for a couple of reasons. First, the Court noted that section 363(f)(3) mentions the term “value,” not the term “amount,” with respect to the liens. The term “value” has particular meaning within section 506(a) of the Code, which provides, in relevant part:
An allowed claim of a creditor secured by a lien on property in which the [bankruptcy] estate has an interest . . . is a secured claim to the extent of the value of such creditor’s interest in the [bankruptcy] estate’s interest in such property . . . and is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.
11 U.S.C. § 506(a). This section implicitly–although not explicitly–requires a court to make a valuation, in certain circumstances, of the secured portion of a secured party’s claim. Depending on the value of the collateral and the amount of other competing claimants, the secured portion, in many instances, could be valued at zero. That clearly appeared to be the case with the Junior Lienholders in the Bay Circle Properties case.
The Bankruptcy Court also reasoned that if section 363(f)(3) required the satisfaction of the face amount of all liens on a property, it would be a superfluous provision, as the satisfaction of the face amount of all liens would logically satisfy (and cause the release of) all secured claims supported by such liens, irrespective of any Bankruptcy Code provision.
Because there was no evidence that Bay Circle’s two properties were worth more than $5.5 million and since Bay Point (as successor in interest) held a first-priority security interest in excess of $15 million, the Bankruptcy Court readily concluded that the $5.3 million purchase price satisfied the value of all liens on the properties under section 363(f)(3) of the Code. This was another way of saying that the Junior Lienholders’ liens were essentially worthless, given the valuation of the collateral.
The Bankruptcy Code does attempt to protect the interests of all secured claimants, but in many instances, it does not clearly spell out how a court should address situations where multiple secured parties are claiming interests in collateral that has a much lower value than the claims it secures. This lack in clarity allows courts to interpret protective provisions in the Code, like section 363(f)(3), in a manner that elevates the reorganization interests of a debtor above the interests of junior secured parties.
Indeed, in the Bay Circle Properties case, if the Court had not allowed the sale to proceed and Bay Circle was not allowed to raise some needed revenue to pay Bay Point, the first lienholder would have been entitled to foreclose its interests in all of the debtors’ properties (not just Bay Circle’s), upon an expected default of the payment obligations under the Wells Fargo settlement. This would have only benefitted one party, Bay Point, and not the debtors or the Junior Lienholders.
The takeaway from the case is that junior lienholders will, in many bankruptcy settings, face a precarious position when the value of their collateral is not even sufficient to satisfy a first lienholder. These junior lienholders will thus need to plan ahead in order to protect their positions vis-a-vis their collateral.