Last year, the Ninth Circuit BAP determined that the Bankruptcy Code does not permit a secured creditor to credit bid its debt, and purchase estate property free and clear of non-consenting junior liens, outside a plan of reorganization. Uncertainty resulting from the decision in Clear Channel Outdoor, Inc. v. Nancy Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. B.A.P. 2008) may chill bidding and asset sales in the Ninth Circuit. The BAP, however, stressed that the decision was limited to the facts of the case; so how broadly Clear Channel will affect asset sales has yet to be seen.  

The debtor in Clear Channel filed chapter 11 on the eve of a foreclosure sale by its senior lien holder (“Burbank”). The appointed chapter 11 trustee (“Knupfer”) negotiated a detailed agreement with Burbank that specified the sale procedures for an auction and sale of substantially all of the debtor’s assets. The bankruptcy court approved the sales procedures (“Sale Order”), and Burbank acted as the stalking horse, agreeing to credit bid approximately $41.4 million of its $43 million secured claim (per section 363(k)).  

No conforming bids were received—the closest offer was about $25 million with contingencies. Over an objection by the junior lien holder (“Clear Channel”), the bankruptcy court confirmed the sale to Burbank free and clear of liens and interests under section 363(f)(5), with a good faith finding under section 363(m) (“Sale Confirmation Order”).  

Clear Channel appealed both orders and unsuccessfully sought a stay pending appeal from the bankruptcy court and the BAP. In its order denying Clear Channel’s motion for a stay, the BAP stated that Clear Channel had “not established a sufficient likelihood of success on the merits to warrant a stay.” Burbank closed the purchase, assumed executory contracts and unexpired leases, and paid more than $1.5 million (to the estate, a pre-petition receiver, a more senior lender, real estate taxes and closing costs).  

Appeal of Completed Sale

On appeal, the BAP first considered whether the appeal was moot, examining the constitutional, equitable and statutory grounds. It found, there still was a live case or controversy because the possibility remained for the court to fashion some relief. Although the sale had been completed, it could be reversed in full or preserved with the lien stripping reversed. Since complexities that could not be easily undone had occurred, review of the sale itself was deemed equitably moot.  

The same was not true, however, for the lien-stripping issues because reattaching the lien was not theoretically or practically difficult.  

Both parties were before the court, and no third-party action was required. Furthermore, Burbank had not identified any third party who would be prejudiced.

In the opinion of BAP, “ultimately, the decision as to whether to unscramble the eggs turns on what is practical and equitable.”  

Turning last to statutory mootness, the BAP concluded that section 363(m) does not apply to lien stripping under section 363(f). Congress intended that section 363(m) address only changes of title or other “essential attributes” of a sale, together with the changes of authorized possession that occur with leases. A “free and clear” term of a sale is not protected from review by section 363(m).  

Lien-Stripping Claim

Having found the appeal was not moot, the BAP considered “the legitimate and difficult questions of statutory interpretation” as to whether section 363(f) permitted the stripping of Clear Channel’s lien. Two of the five grounds for a sale free and clear (as provided by sections f(3) and f(5)) were at issue.  

The bankruptcy court had found, and the BAP agreed, that section 363(f)(3) could not be used to support the sale to Burbank free and clear of Clear Channel’s lien. The court rejected the Trustee’s assertion that the “aggregate value of all liens” meant the economic value of such liens rather than their face value. The BAP found that a sale free and clear of a lienholder’s interest under §363(f)(3) is not authorized if the price of the property being sold is equal to or less than the aggregate amount of all claims held by the creditors that hold a lien or security interest in the property.  

Simply stated, the price of the property being sold must exceed all claims secured by that property.  

Elements of ‘Free and Clear’ Sale

The parties’ primary dispute concerned the application of section 363(f)(5), which permits a sale free and clear of an entity’s interest in estate property if “such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”  

Breaking the section into three elements, the BAP first found that Congress intended the term “interest” to have an expansive scope, and that a lien is a type of interest. The court cited as support for this determination the Bankruptcy Code’s definition of the term “lien” (charge against or interest in property) and a “plain reading” of sections 363(f) and 363(f)(5).  

The BAP next engaged in a lengthy and somewhat unclear analysis of the second element, whether Clear Channel could be compelled to take less than full payment in satisfaction of its interest. The court concluded that section 363(f)(5) should be given a narrow interpretation, that the bankruptcy court must make a finding of the existence of a satisfaction mechanism, and that a showing must be made by the trustee as to how the “satisfaction of the lien could be compelled.”  

This analysis appears to assume that the section referred to a proceeding or mechanism to extinguish the lien or interest in which the creditor could be compelled to take less than the value of the claim. The court discussed examples of potential qualifying mechanisms, including buy-out arrangements, liquidated damages clauses, and sales free and clear under UCC §9-320. The BAP also endeavored to construe the section consistent with sections 363(f)(3) and 1206. The bankruptcy court’s finding that section 363(f)(5) applied whenever a claim or interest could be paid with money was rejected as too simplistic.

‘Cramdown’ Mechanism

Addressing the third element required for a “free and clear” sale under section 363(f)(5) (the requirement for a legal or equitable proceeding), the BAP found that no qualifying “legal or equitable proceeding” had taken place, and that nonconsensual confirmation—so-called cramdown—in bankruptcy does not qualify. Use of the cramdown mechanism to allow a sale free and clear under section 363(f)(5) would sanction circular reasoning, approving the effect without requiring any of the substantive and procedural protections.  

The BAP noted that if a proceeding used to justify the “free and clear” sale was one that derived its authority from another section of in the Code, there would be no need for section 363(f)(5). Further, the BAP rejected the Bankruptcy Court’s reasoning that there was no need to prove the existence or possibility of a qualifying proceeding when the interest at issue was a lien because all liens, by definition, are capable of being satisfied by money.  

The case was remanded for the parties to “attempt to identify a qualifying proceeding under non-bankruptcy law (if one exists).” An appeal was taken to the U.S. Court of Appeals for the Ninth Circuit and later settled.  

Going Forward

The Clear Channel decision has significantly altered the ability of debtors, trustees and secured parties to structure a sale free-and-clear of liens, and has provided previously unheard of leverage to underwater junior secured creditors. It also has added yet another variation to the now several judicial interpretations of section 363(f)(5). Apparently, the “legal or equitable proceeding” that could compel a lien holder to accept a money satisfaction for “less than what its interest is worth” must be found under nonbankruptcy law.  

The decision also may cause a loss or reduction in value of assets that could have been sold for the benefit of creditors. While the trustee still can attempt to negotiate carve-outs and relief from stay, apparently the trustee cannot agree to deliver clear title when the sale is negotiated or does not bring in enough money to pay off all liens in full. To do so may put the estate at risk for a post-petition claim for breach of warranty.  

The BAP’s ruling on mootness may deter senior lenders from consenting to asset sales and will complicate the ability to obtain title policies. The decision seems inconsistent with section 363(m) and the Congressional goal of maximizing value of property of the estate, as well as the policy favoring finality of bankruptcy sales.  

The ruling is not limited to senior lenders; any purchaser that is a party to the appeal could be subject to the same “worst of both worlds” trap. They can’t unwind the sale, yet they are stuck with a lien that would have been wiped out if a closure sale had gone forward. How can the parties know when some aspect of a sale order is not moot? The resulting uncertainty may well chill bidding and asset sales in the Ninth Circuit.  

On the other hand, Clear Channel may be limited to its facts. Perhaps in the future, a senior lien holder in Burbank’s position will resell the property to a bona fide purchaser before the appeal can be heard, thereby possibly rendering the appeal equitably moot even as to the section 363(f) issues. The opinion repeatedly states that the holdings on mootness are based “upon these facts.”  

The BAP appears to have reacted to the fact that the senior lender was intimately involved both pre- and post-bankruptcy in the negotiations for the terms of the sale of the property, the marketing of the property, the setting of the “strike price” and the setting of the “overbid price.” Although the BAP declined to find the bankruptcy court’s determination that Burbank was a “good faith purchaser” as “clearly erroneous,” the court’s determination that Burbank “should have known” other risks of reversal appears to reflect an undercurrent that Burbank was not acting in good faith.  

Also, it appears that it was important to the court that obtaining a bond for a stay pending appeal was not practical because the cost of the bond would far exceed the interest to be protected. That disparity may result in a finding that an appeal is not moot.  

The lesson for “out of the money” junior secured creditors is to focus on the degree of control the senior lender or other purchaser is exerting over the sales process. The more control the latter exert, the more likely the scenario will fall within the scope of this case, and the greater chance a junior creditor has to preserve the issue for appeal in the hopes of either prevailing an appeal or reaching an advantageous settlement.