Insights

Who Speaks for the Seller?

Chapter 11

Management remains in place unless extraordinary remedy of appointment of Chapter 11 Trustee

Chapter 7

Chapter 7 Trustee randomly appointed from pool of panel trustees; though creditors have the ability to elect a trustee.

Chapter 13

Chapter 13 Trustee is bureaucrat only; debtor remains in control of assets. 

Fiduciary Duties

DIP or Trustee is fiduciary to creditors and estate.

Many Chapter 11 cases are commenced with the plan of achieving a sale of assets, either through a 363 sale or reorganization plan.  Many others end up in a sale process, after company’s efforts to reorganize have failed.  Secured creditors may, or may not, endorse the sales process.  If they do not, secured creditors can be significant obstacle to achieving sale. 

In Chapter 7, business has normally ceased operations, but assets remain.  Chapter 7 trustee will only pursue negotiations for sale of encumbered assets if (i) there’s equity in the property in excess of all secured claims; or (ii) secured creditor (a) consents to the sale process (b) agrees to payment of trustee’s fees and expenses from sale proceeds; and (c), normally, also agrees to free up some proceeds from the sale for benefit of general unsecured creditors, failing which, trustee may simply abandon assets to secured creditor’s foreclosure. 

A bankruptcy case may be initiated, in cooperation with a secured creditor, which would prefer to see its collateral disposed of outside the foreclosure context. 

Similarly, a bankruptcy sale may be initiated on insistence of purchaser which conditions its purchase on a quick 363 sale process, and entry of an order authorizing the sale free and clear of liens.
 

Receiver

Receiver appointed by Court.  Normally selected by secured creditor based on skills needed for project.  Courts generally defer to creditor’s selection of person or entity to serve as receiver, but are not required to. 

Fiduciary Duties

Receiver is officer of court, and must be careful to act in the interests of the estate, and not just the interests of the creditor seeking receiver’s appointment.

Frequently, receiver is “care-taker” pending completion of foreclosure by secured creditor, and thus does not seek to sell receivership assets.

Receivership case may also be commenced by secured creditor with the intent that receiver be responsible for ultimate sale of collateral, rather than the lender foreclosing on the collateral itself:

• Collateral is operating business, such as restaurant, and going concern sale maximizes value
• Construction defect concerns
• Environmental liability concerns
• Receiver’s ability to maximize value, particularly in ordinary course condo sales,  rather than more traditional distressed or bulk sale by secured lender

Order appointing Receiver will define starting scope of Receiver’s authority and responsibility. 

Order appointing Receiver in condo project where it is contemplated that Receiver will sell out unsold inventory in ordinary course will typically provide that Receiver may sell remaining inventory, without further court order.  Otherwise, separate court order will be required for authority to proceed with real property sale. 

Assets of Estate

Order Appointing Receiver defines assets that are subject to receivership proceeding – typically limited to assets that are the subject of the secured creditor’s claim. 

Assets normally do not include causes of action unrelated to the collateral itself. 

Management Authority

Chapter 11

Debtor is “debtor-in-possession” with authority to operate company in ordinary course of business. 

Debtor is prohibited from paying pre-petition debts without court approval.

Debtor may not borrow funds on secured basis without court approval.

Debtor may not sell assets outside ordinary course of business without court approval.

Debtor may not retain or compensate professionals without court approval.

Chapter 7

Typically does not contemplate operating business, though Chapter 7 trustee may seek interim authority to operate business if going concern sale is feasible.

Authority of receiver is defined in Order Appointing Receiver. 

Creditor seeking appointment has significant discretion in vesting receiver with authority to continue business operations without additional Court approval.  Typical Order Appointing Receiver authorizes receiver to:

• Operate business in ordinary course
• If subject of receivership is development project, to complete pending construction and/or to sell completed units/lots/houses in ordinary course without further Court approval
• Pay pre-petition claims if in best interest of Receivership estate
• Borrow funds (typically from creditor seeking appointment) secured by Receiver’s certificates and first lien on debtor’s assets
• Retain and compensate employees and professionals needed to assist receiver in performing duties
• Sale of assets outside ordinary course of business is usually conditioned on entry of separate court order

 Court Approval

For court to approve sale, debtor/trustee must establish that (a) a sound business reason exists for the sale; (b) there has been adequate and reasonable notice to interested parties; (c) the sale price is fair and reasonable; and (d) the proposed buyer is proceeding in good faith. 

Sale order itself is frequently heavily negotiated.  Sale order should include necessary findings of debtor’s exercise of business judgment, fair price achieved under circumstances, good faith of purchaser.

Code requires notice to all creditors and other interested parties.  Bankruptcy court is court of nationwide jurisdiction, and thus all creditors with notice or knowledge of sale are bound by sale order, whether or not they actively participate in the process.

If court finds as part of sale order that purchaser has purchased assets in good faith, sale cannot be unwound even if the order authorizing the sale is reversed on appeal. 

While most asset sales are achieved through sales under 363 of the Bankruptcy Code, sales may be accomplished through plan of reorganization, or even after confirmation of plan, through negotiations with plan trustee charged with selling assets. 

Sale may be unwound if collusive bidding is found.

Sales are generally exempt from state and local transfer taxes. 

Some courts limit DIP’s ability to sell all or substantially all of estate assets outside a plan confirmation process.

 For court to approve sale, receiver must establish that a reasonable price has been achieved for the assets, under the circumstances.

Receivership proceeding may be in either federal or state court.  Regardless, court has personal jurisdiction only over parties to proceeding, and in rem jurisdiction over assets of the estate. 

When other secured creditors are not otherwise parties to receivership proceeding, due process concerns may arise, and it may be advisable to join all secured creditors as parties to proceeding, to be sure all are bound by sale order. 

Purchaser may want to require as part of its APA that receiver provide notice to all known creditors, to minimize risk of successor liability claims.

If all secured parties are parties to receivership proceeding, title company may not require affirmative releases of their liens upon recordation of the sale order.  If court order authorizing sale free and clear of liens is premised only on notice to all secured creditors (without joining them as parties to proceeding), title companies will normally require affirmative releases from secured creditors.  

Become familiar with procedure for release of IRS tax liens:  IRS Publication 783 and Internal Revenue Code § 6325(b)(2).  No comparable procedure for release of state liens. 

Sales Free and Clear of Liens, Claims, Interests, and Encumbrances

Short sales are typically done with consent of secured lender.  It is possible, however, that debtor can successfully “value” undersecured lender’s secured claim in an amount equal to the value of the property, and secure court authority over lender’s objection to sell for the value of the property, leaving a deficiency for the secured lender. 

Nothing in bankruptcy precludes the secured lender from pursuing recovery of its deficiency claim from unencumbered assets of estate, or guarantors. 

A sale free and clear of liens will not immunize the purchaser from liabilities that run with the land or that are imposed on the owner of real property, such as environmental obligations.   Thus, easements, declarations, rights of way, plats, PUDS, etc., generally survive sale.  In Banning Lewis Ranch Corp. bankruptcy case, litigation is pending over whether sale can occur free of obligations imposed under annexation agreement. 

Notwithstanding court approval, purchaser may be at risk as to some creditors’ claims:  (i) present creditors without notice or knowledge of sale; (ii) future creditors if purchaser is determined to be “successor” under “product line liability” analysis adopted by certain courts:  (a) creditors’ remedies against seller have been effectively terminated by sale; (b) purchaser continues to manufacture same product lines under same product names; (c) purchaser continues to use seller’s corporate name or identify; and (d) purchaser represents to public that it is an ongoing enterprise. 

A sale free and clear of liens will not immunize the purchaser from liabilities that run with the land or that are imposed on the owner of real property, such as environmental obligations. 

While caselaw is much less extensive, it is reasonable to assume courts would analyze successor liability concerns in a fashion similar to that applied in bankruptcy proceedings.

Because receivership proceeding is typically initiated by, and therefore for the benefit of, a secured creditor, courts will not be concerned if no proceeds are available for other creditor constituencies. 

Short sales are done with lender’s consent.  It is unlikely that court would approve sale over lender’s objection.

Borrower may object to receiver’s sale of property on theory that it deprives borrower of statutory cure rights under foreclosure statute.  Courts in Colorado have ruled both ways on the issue, but have approved sales over borrower’s objection if sale occurs beyond the time frame for borrower’s cure, had foreclosure been commenced simultaneously with receivership proceeding, and court finds sales price to be reasonable under circumstances.

Nothing in receivership precludes the secured lender from pursuing recovery of its deficiency claim from any other assets of the borrower, or guarantors. 

Title Company Requirements

Sale order should contain correct, complete legal description; order should be reviewed and approved by title company at commencement of process

Sale order should specifically identify all liens of record, and confirm that title is being conveyed free and clear of all liens and encumbrances

Title company may wish to review certificate of service – especially if extensive liens of record – to insure complete and correct notice, prior to issuing title policy.  It is common in bankruptcy court for certificate of service to reference only “all creditors appearing on matrix,” rendering it challenging to determine, later, who actually received notice.  Title company may wish to require detailed service list. 

Title insurance companies generally recognize court’s authority to order sales free and clear, and will insure title in purchaser, regardless of affirmative lien release by secured creditors or taxing authorities. 

If sale order contains finding that buyer is purchaser in good faith (a “363(m) finding”), sale may not be unwound even on appeal, and title company may insure title even though time for appeal is still pending, or appeal has actually been filed (unless an order staying appeal has been entered).  Time for appeal of bankruptcy court order is 14 days from entry of order. 

Sale order should contain correct, complete legal description;  order should be reviewed and approved by title company at commencement of process

Sale order should specifically identify all liens of record, and confirm that title is being conveyed free and clear of all liens and encumbrances

Despite provisions of sale order authorizing sale free and clear of all liens, claims and encumbrances, title company will typically require affirmative releases.  Exception may be made if lienholder is party in receivership proceeding with notice of the motion.

A court order authorizing an asset sale is, typically, an interlocutory order that does not have the effect of a final judgment.  Nevertheless, such an order would likely be certified by the judge as final for purposes of appeal, as it would fully dispose of issues related to the real property.  The sale order is automatically stayed for 15 days after its entry, even though an appeal may be filed for 45 days after the entry of the order.  After expiration of the 15-day stay, an appellant may seek a further stay pending appeal, and typically will be required to post a bond. Absent a stay pending appeal, the order becomes final and may be acted upon.

As a practical matter, closings on receivership sale orders frequently occur prior to the expiration of the 15-day automatic stay.  So long as notice has been properly given, and no party has objected to the sale, the title company may normally feel comfortable insuring title in connection with a closing occurring in the first 15 days.

If a party objected to the original sale order, title companies may want to await the expiration of the 15-day automatic stay, and confirm that no stay pending appeal has been requested, prior to proceeding with closing and issuing a title policy. 

Additional Resources

Distressed Asset Sales:  Selling and Acquiring Assets from the Debtor Estate, Leibow, et al., Practicing Law Institute – Commercial Law and Practice Course Handbook Series, PLI Order Number 5989, March-April, 2005 – 27th Annual Current Developments in Bankruptcy & Reorganization

Section 363 Issues – Acquiring Troubled Companies and Assets – Houser, et al.; American Law Institute – American Bar Association Continuing Legal Education, ALI-ABA Course of Study, March 29-31, 2007

The Purchase and Sale of Assets in Bankruptcy, Heroy, et al.; Practicing Law Institute – Commercial Law and Practice Course Handbook Series, PLI Order No. 11219; April 9-10, 2007

Practical Issues Surrounding Section 363 Sales, Reidel, et al.; University of Florida Journal of Law & Public Policy, April, 2008, 19 U.Fla. J. L. & Pub. Pol’y 75

Insulating Purchasers from Debt through Bankruptcy Sales, Reed, Norton Journal of Bankruptcy Law & Practice, December, 2006, 15 J. Bankr. L. & Prac. 6 Art. 2

Comments or inquiries may be directed to:
Caroline C Fuller.