Chapter 11

Selling Chapter 11 Estate Property Free and Clear of Non-Debtor Interests

A Debtor in Possession ("DIP") may sell estate property free and clear of third party interests, such as liens, claims, and encumbrances.  Authority is found in 11 USC 363(f).  A sale free and clear of third party interests is authorized if one of the following conditions is found:

  1. A sale of the property free and clear of the interest is authorized by nonbankruptcy law;
  2. The third party affected consents;
  3. The affected interest is a lien and the sale price of the property is greater than the aggregate value of all liens on the property;
  4. The affected interest is in bona fide dispute; or
  5. The Third party whose interest will be affected could be be compelled in law or equity to accept a money satisfaction.

To qualify under item 3, above, several courts in the Ninth Circuit have held that the sales price must be greater than the aggregate amount of the debts encumbering the property so there will be some equity for the estate.  This may give leverage to junior lienholders to receive compensation from senior lienholders to let the sale go through.

Most importantly, property may be sold free and clear of nondebtor's interest that is in bona fide dispute.  The bankruptcy court need only determine that a dispute exists.  In re Gerwer (9th Cir. 1990), 898 F.2d 730, 733.  11 USC 363(f)(4).

The authority to sell free and clear is, of course, subject to adequate protection.  Courts typically order that the affects nondebtor interests attach to the sale proceeds. 

Don't forget that any secured creditor can "credit bid" at a sale.  This means that the secured creditor can offer a bid in the amount of the lien.

Sale orders involving Chapter 11 debtors in the Central District must include a provision requiring a certified copy of the escrow closing statement to be submitted to the U.S. Trustee within 10 days after the close of escrow or completion of the sale.

Mansfield Cheney, PC is here to help Chapter 11 debtors through the sale of assets.  

Selling Estate Property in a Chapter 11

The DIP must articulate a business justification for selling estate property out of the ordinary course of business.  Estate property may be sold through a confirmed plan, by public auction, or by private sale.  Most DIPs negotiate a sale of estate assets with a specific buyer, subject to overbidding by other parties at the court hearing on the sale.

The DIP should obtain court approval of the overbid and sale procedures before noticing the sale hearing.  Not doing so may make the sale vulnerable to objections at the hearing.  This can result in a delay of the hearing.

Special requirements apply to motions to establish sale procedures in the California Central District.  Those rules are found in Local Bankruptcy Rule 6004-1 to 6007-1.

  1. A hearing on a Motion to Establish Procedures for the Sale of the Estate's Assets may be scheduled on not less than 7 days notice (without an order shortening time).
  2. Notice must describe the proposed bidding procedures and include a copy of the proposed purchase agreement.  The notice must describe the marketing efforts undertaken.  
  3. The notice must provide that opposition is due on or before 1 day prior to the hearing.
  4. The moving party must serve the motion and notice of the motion and hearing by personal delivery, messenger, telephone, fax, or email.  
  5. A date and time for a hearing on the motion to approve the sale itself may be obtained at or prior to the hearing on the Sale Procedure Motion.  The hearing must be scheduled no more than 30 days following.
  6. If a break-up fee is requested for the purchaser, evidence must show:
    1. The fee is likely to enhance the ultimate sale price; and,
    2. The fee is reasonable.

If the seller has been contacted by parties who may overbid, the Motion for Order Authorizing Sale must be set for hearing pursuant to LBR 9013-1(a).  

The moving party must submit a declaration establishing the value of the property and that the terms and conditions of the proposed sale, including the price and all contingencies, are in the best interest of the estate.  A memorandum of points and authorities need not necessarily be filed.

The Notice of Hearing must include a description of the property and the terms and conditions of the proposed sale.  This includes price and all contingencies.  The Notice of Hearing must declare that the sale is or is not free of all liens, claims, or interests, and describe those liens, claims, or interests.  It must also state that the seller is accepting higher bids.  The Notice must include a description of the commission to be paid, the identity of the broker, and possible tax consequences to the estate.

Don't forget to use Form 6004-2.NOTICE.SALE, which must be completed and submitted to the clerk at the time of filing for purposes of publication by the clerk on the court's website.

Court approved conditions on the sale usually cover:

  1. The length of time the property is marketed;
  2. Access to inspect or conduct due diligence;
  3. Deadline for receiving offers;
  4. Required form of offer and deposits; 
  5. Deadline for objecting; and
  6. The minimum initial and later overbid increments.

 

Use, Sale, or Lease of Chapter 11 Estate Property in the Ordinary Course of Business

Unless the court order otherwise, a Debtor in Possession ("DIP") in a Chapter 11 case may use, sell, or lease property of the bankruptcy estate in the "ordinary course of business" without court approval.  The DIP has automatic statutory authority to run the business in Chapter 11 unless the court orders otherwise.

The Ordinary Course of Business

The question is, "what is the ordinary course of business?"

Courts often apply a two-part test.  The first part, call the "horizonal" dimension, looks at whether the proposed DIP transaction is typical industry-wide  in other similar businesses.  The second part, called the "vertical dimension," considers whether transaction subjects creditors to risks different from those undertaken by the business at the time the creditor extended credit.  One might ask, "is this a new activity for this particular business?"

There are, of course, limitations on the DIP use of estate property.  When the property that is going to be used is subject to liens or co-ownership, "adequate protection" might be necessary.  Further, the use of cash collateral, defined as cash or cash equivalents in which a third party has a security interest, always requires creditor consent or authorization after notice and hearing.

But what if the proposed sale or use is not in the ordinary course of business?  Then, the DIP must first give notice to creditors and parties in interest of the intended use, sale or lease outside the ordinary course of business.  The DIP must show reasonable business judgment to obtain court approval.  Selling property of the estate, apart from sales of inventory, is ordinarily not in the usual course of business.

Adequate Protection

When property of the estate subject to a security interest is used or sold, upon request of the creditor, adequate protection must be paid by the DIP.  Adequate protection may include cash payments, additional or replacement liens,  or other relief that provides "indubitable equivalent" of the creditor's interest in the property.  Cash payments can be made periodically to equal the decrease in value from the use or the passage of time.  An equity cushion in property may also provide adequate protection to a secured creditor.

Always consult an attorney if you face a Chapter 11 case as a creditor.  Mansfield Cheney, PC is available to assist in complex Chapter 11 matters.  Call us at 805-642-6406 or visit us on the web at http://www.hcmlawfirm.com.