The Bottom Line

The Third Circuit recently held, in Schepis v. Burtch (In re Pursuit Capital Management, LLC), No. 16-3953, 2017 WL 4783009 (3d Cir. Oct. 24, 2017), that under section 363(m) of the Bankruptcy Code, if a party does not seek a stay pending appeal of a sale order, it is highly likely that any appeal of such sale will be determined statutorily moot. That was certainly the case here.

What Happened?


Pursuit Capital Management, LLC and its related entities (collectively, “Pursuit” or the “Company”), an investment company, were founded by Anthony Schepis and Frank Canelas (together with Pursuit, the “Pursuit Parties”). After Pursuit became liable on $5 million worth of legal judgments, the Company filed for Chapter 7 bankruptcy protection on March 21, 2014 and a Chapter 7 trustee (the “Trustee’) was appointed. Pursuit had nearly no assets when it filed. However, the Company’s financial statements revealed that Pursuit secretly transferred almost $650,000 to Schepis and Canelas in early 2013. The Trustee determined that because the bankruptcy estate had no funds to pursue avoidance claims for these transfers, it was in the best interests of the creditors to sell the potential claim.

The Trustee negotiated with certain of Pursuit’s creditors (the “Creditor Group”) and filed a motion to approve an agreement to settle, transfer and assign the avoidance claim and other potential claims (the “Claims”) to that group for $125,000. The Pursuit Parties objected to the motion, arguing that the deal did not maximize the value of the Claims. The Trustee determined that an auction was the best method to determine the highest and best offer.

After the Trustee filed a motion for approval of auction procedures, the Bankruptcy Court approved a set of bidding procedures that allowed the Trustee to unilaterally modify the procedures and to reject any bid he deemed inadequate. The auction took place on July 7, 2015, with the Creditor Group and the Pursuit Parties being the only interested bidders. After a few rounds of bidding, the Pursuit Parties stated that they needed to abruptly end the auction due to a scheduling conflict. Before adjourning, the Trustee stated that the Pursuit Parties’ most recent bid of $170,000 was preferred to any others that were made at the auction.

After the adjournment of the auction, the Trustee requested that the Pursuit Parties and the Creditor Group each submit final sealed bids no later than July 30, 2015. The Trustee only received a bid from the Creditor Group on that date, in the amount of $180,001. The Pursuit Parties failed to submit a bid and also informed the Trustee that they were withdrawing their prior bids. A day later, the Trustee announced that he would sell the Claims to the Creditor Group.

Prior to the scheduled hearing to approve the sale of the Claims to the Creditor Group, the Pursuit Parties requested an adjournment of the hearing and attempted to submit a new offer for a higher dollar amount than the Creditor Group proposal. The Bankruptcy Court declined to adjourn, stressing that the Pursuit Parties did not submit a bid in accordance with the Trustee’s request and there was concern that the Court’s orders were being ignored by the Pursuit Parties. At the sale approval hearing, the Pursuit Parties once again attempted to submit a new bid, but the Trustee objected, arguing that the Creditor Group submitted the best and highest offer “in accordance with the rules.” The Pursuit Parties then argued that the Claims could not be sold to the Creditor Group, as only the Trustee had authority prosecute avoidance claims. The Bankruptcy Court approved the sale of the Claims to the Creditor Group, stating that the Court needed to uphold the integrity of the auction process, but did not take a position on the Pursuit Parties’ substantive objection.

The Initial Appeal

The Pursuit Parties promptly appealed the Bankruptcy Court’s decision, but did not first seek a stay of the sale order. On appeal, the Pursuit Parties again argued that only the Trustee was authorized to prosecute the Claims, and that the Trustee lacked authority to sell the Claims to non-fiduciary third parties. In the meantime, the Creditor Group promptly pursued the Claims and filed an adversary proceeding against the Pursuit Parties in the Bankruptcy Court.

The District Court ruled that the appeal of the sale order was statutorily moot under section 363(m) of the Bankruptcy Code because: (i) the Pursuit Parties failed to obtain a stay pending appeal and (ii) any reversal or modification of the sale order would naturally affect the validity of the sale. The District Court specifically declined to rule on the issues of whether a trustee can properly transfer avoidance claims and whether non-trustee parties can prosecute such claims.

Third Circuit Opinion

On appeal to the Third Circuit, the Pursuit Parties once again argued that the Trustee could not transfer its avoidance powers. However, the Court held that it could not consider the substantive arguments, as the appeal was statutorily moot under section 363(m).

The Third Circuit explained that section 363(m) moots a challenge to a sale if two conditions are met: (1) the underlying sale or lease was not stayed pending the appeal, and (2) the court, if reversing or modifying the authorization to sell or lease, would be affecting the validity of such a sale or lease. The Court noted that there is a third step in the process, which is first determining whether the buyer purchased the property in good faith.

On the question of good faith, the Third Circuit looked to the Bankruptcy Court’s determination of good faith, noting that the Bankruptcy Court found no collusion, and that the Creditor Group followed the bidding procedures in purchasing the Claims. The Circuit Court found that there was no clear error in this ruling and that the Pursuit Parties’ own behavior during the bidding process caused their failure to acquire the Claims. The Third Circuit also held that appropriate value was delivered by the Creditor Group, as a public competitive auction strongly indicates the appropriate value for estate property.

The Court next turned to the discussion of the stay and validity prongs of the 363(m) test. Even though the Pursuit Parties argued that a stay pending appeal was unnecessary because their legal arguments were preserved in the sale order, the Third Circuit disagreed. The Court emphasized that the statutory language is clear that a challenger must seek a stay pending appeal to avoid a mootness determination. Because that was not done, the Pursuit Parties could not defeat mootness on that basis.

Turning to the second prong of the test, the Court noted that it is a very rare circumstance where the reversal or modification of a sale order will not affect the validity of the sale, as a challenge to the “central element” of a sale will inevitably challenge the validity of the sale. The Third Circuit determined that the Pursuit Parties also failed this prong of the test because a claw back of the Claims would necessarily affect the Claims’ value, and a central feature of the transaction would be frustrated.

Why This Case is Interesting

This case reiterates that fact that the highest bid is not always the best bid if the so-called higher bidder does not following the bidding rules. The Pursuit Parties’ failure to abide by the court-ordered bidding procedures caused the Bankruptcy Court to rule in favor of the Creditor Group. Additionally, the Pursuit Parties’ failure to obtain a stay pending appeal, a standard rule for appealing sale orders, caused their appeal to be statutorily moot. The Third Circuit noted in its decision that if the Pursuit Parties had obtained a stay, they could have avoided the mootness ruling on that basis alone and potentially received a decision on the merits. This serves as an important reminder for parties and practitioners that following bidding procedures and, if dissatisfied seeking a stay pending appeal, is critical in asset sales.