United States: Bankruptcy Sales: "Free And Clear" – Round 2

Last Updated: February 26 2014
Article by Vicki Harding

In re Christ Hospital, 502 B.R. 158 (Bankr. D. N.J. 2013) –

The buyer of a chapter 11 debtor's assets sought to enforce a bankruptcy court order approving the sale "free and clear" of interests:  it asked the bankruptcy court to enjoin a state court action brought against it by a competitor that included economic tort claims relating to the buyer's acquisition.

The debtor was a community not-for-profit hospital.  The buyer (Hudson) acquired all of its assets in a bankruptcy auction sale.  The court order approving the sale provided that it was "free and clear" of claims.  The order also enjoined third parties from pursuing the claims or asserting them against the successful buyer.  After the sale the debtor confirmed a liquidation plan of reorganization, which reaffirmed the sale and incorporated the injunctive relief.

Prior to the debtor's bankruptcy, the competitor (Prime) had entered into a letter of intent, followed by an asset purchase agreement, with the debtor.  As part of this process, Prime assisted in providing funding to the debtor.  After execution of the purchase agreement, the debtor received unsolicited offers from Hudson and another party.  Although the debtor continued with the Prime acquisition notwithstanding the unsolicited offers, adverse developments caused Prime to withdraw its bid and financing.  Within a week, the debtor filed bankruptcy.

Although Prime entered an appearance in the bankruptcy, it did not file its own proof of claim, nor did it participate in the sale process or raise any objections to the sale order.  Instead, about a year after the bankruptcy sale and while the bankruptcy was still pending, Prime sued Hudson in state court alleging antitrust, tortious interference and unfair competition claims.  Prime sought damages, but did not attempt to seek any relief from the sale itself.

A key part of Prime's argument was its assertion that pre-petition Hudson intended to make it untenable for Prime to continue with its acquisition, so that the debtor would be forced into bankruptcy and Hudson could purchase the assets at a reduced price.  (In fact, Prime's purchase price was ~$80 million, while Hudson acquired the assets in the bankruptcy sale for ~$70 million.)

The threshold question for the court was whether the economic tort damage claims asserted by Prime constituted "interests" in the debtor's assets so that they could be sold "free and clear" of those interests under Section 363 of the Bankruptcy Code.  And if so, whether the sale was in fact free and clear and whether Prime was entitled to adequate protection of its interests.

Under Section 363(f) of the Bankruptcy Code, assets may be sold free and clear of "interests" if one of several conditions is met.  The bankruptcy court began by noting that some courts have limited the scope of Section 363(f) to in rem interests in the property, but that the trend appears to favor a broader definition of interests.

It noted a 4th Circuit case in which a buyer acquired assets free and clear of successor liability under the Coal Act because the relationship between the liability and the use of the assets brought it within the purview of Section 363(f).  In re Leckie Smokeless Coal Co.,  99 F.3d 573 (4th Cir. 1996), cert. denied, 520 U.S. 1118, 117 S.Ct. 1251, 137 L.Ed.2d 332 (1997).  Similarly, it noted a 3rd Circuit case that interpreted interests to mean any obligations that "are connected to, or arise from, the property being sold."  In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003).  In this case, travel vouchers and EEOC claims arising from the debtor's disputes with its employees were considered interests that could be avoided in connection with the sale of the airline's assets.

The discussion in TWA suggests that the relationship of the interests to the assets can be fairly attenuated:

Here the Airlines [debtor-seller TWA and purchaser American Airlines] correctly assert that the Travel Voucher and EEOC claims at issue have the same relationship to TWA's assets in the §363(f) sale, as the employee benefits did to the debtors' assets in Leckie.  In each case it was the assets of the debtor which gave rise to the claims.  Had TWA not invested in airline assets, which required the employment of the EEOC claimants, those successor liability claims would not have arisen.  Furthermore, TWA's investment in commercial aviation is inextricably linked to its employment of the... claimants as flight attendants, and its ability to distribute travel vouchers as part of the settlement agreement.  While the interests of the EEOC and the [travel voucher holders] and the assets of TWA's bankruptcy estate are not interests in property in the sense that they are not in rem interests, the reasoning of Leckie and Folger Adam suggests that they are interests in property within the meaning of section 363(f) in the sense that they arise from the property being sold.

In this case Prime alleged a chain of events that culminated in the transfer to and use of the debtor's hospital assets by Hudson.  Consequently, the court concluded that Prime's claims "are connected to, or arise from, the property being sold" so that they were subject to Section 363(f).  (The court also noted that the tortious interference claims were inconsistent with the court's finding that Hudson was a good faith purchaser entitled to protection pursuant to Section 363(m).)

Prime argued that it was not a party, and neither res judicata nor collateral estoppel prevented it from raising its objections.  The court agreed that neither res judicata nor collateral estoppel was applicable.  However, it emphasized that a bankruptcy sale "free and clear" is an in rem proceeding, and thus is enforceable against the "world" not just the parties.

As for the specific requirements of Section 363(f), given that Prime entered an appearance in the case, was clearly on notice of the sale and the scope of the sale order, and yet made no objections, the court held that Prime should be deemed to have consented to the sale free and clear of its interest (thus satisfying Section 363(f)(2)), and to have waived its rights to adequate protection.  The court also found that the notice was sufficient to satisfy any due process and fairness concerns.

Further, even if its interpretations of Section 363 were wrong, the court held that the bankruptcy sale and confirmation orders were not subject to collateral attack through the state court litigation.  Rather Prime's only option would have been to seek relief from the bankruptcy court under FRCP 60(b).

The court went on to review the specific language of the orders (which it found clearly covered Prime's claims and enjoined those claims), and a series of additional procedural matters involving its jurisdiction before concluding by granting Hudson's request for injunctive relief.

It is interesting that the court went as far as it did:  it resolved a dispute between non-debtor parties, and it brought economic tort damage claims within the purview of interests subject to its power to approve the sale of a debtor's assets free and clear.  The court characterized the debtor as "a functioning but financially desperate hospital" and the sale as "an effort to save an important community institution" – which are factors that may have helped tip the scales in favor of the buyer.  In any event, although not all courts would have ruled the same way, this case illustrates that in the right circumstances a bankruptcy sale can be a very powerful tool for acquiring assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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