‘Fatal Means Fatal’: 5th Circuit’s Wide Reading of 363(m) Continues to Face Section 363 Appeals After Sale | Bracewell LLP

Recent decisions of the United States Court of Appeals for the Fifth Circuit and its lower bankruptcy courts have emphasized the Circuit’s expansive interpretation of Section 363(m) of the Bankruptcy Code, which protects bankruptcy sales against reversal on appeal.

In its opinion of September 23 to In re Royal Street Bistro, LLC, et al.No. 21-2285, District Judge Sarah S. Vance provided a comprehensive summary of Fifth Circuit case law while discussing a debtor’s attempt to appeal a sale under Section 363 of the bankruptcy code.

The royal street The case arose when the owner of three properties on New Orleans’ Royal Street filed for bankruptcy protection with the United States Bankruptcy Court for the Eastern District of Louisiana. The buildings were also subject to leases and were occupied by tenants. A secured lender also held a lien on each property.

During the course of the case, the court-appointed Chapter 11 trustee and the secured lender reached a settlement that required the properties to be sold. In response, the tenants asked for adequate protection of their interests in the properties and asked the court to require the debtor to assume or explicitly reject the leases. The bankruptcy court granted the trustee’s motion for sale and settlement and its motion on bidding proceedings, and it denied the tenants’ motion for adequate protection and the motion to compel the debtor to assume or reject the leases. The tenants appealed. They then requested a stay pending appeal of the order from the bankruptcy court, the district court and, ultimately, a writ of mandamus from the Fifth Circuit. Each court denied the claim.

The bankruptcy court then issued final orders approving the settlement and the proposed sale of the properties, approving the bidding procedures, and fixing the auction of the property. The Tenants appealed those orders to Judge Vance’s District Court, and the appeals were consolidated.

At the auction, one property was sold to the secured lender and the other two to third parties. The proceeds from the sale were then used to repay the secured lender and cover the trustee’s fees.

Judge Vance heard the consolidated appeal in district court, where the Chapter 11 trustee sought summary judgment dismissing the appeal as moot under section 363(m). This section reads as follows:

(m) The cancellation or variation on appeal of an authorization under paragraph (b) or (c) of this section of a sale or hire of goods does not affect the validity of a sale or rental under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity was aware of the expectation of the call, unless such authorization and such sale or lease has been suspended pending appeal.

The tenants responded that their appeal was not moot because it only challenged the disposition of the sale proceeds under the settlement agreement, rather than the sale itself. Specifically, as Vance J. summarized, the Tenants sought “to set aside the settlement between the Trustee and the [secured lender]but only with regard to the syndic.[1] The tenants also argued that they were entitled to damages from the trustee in connection with the sale and the termination of the lease.

Vance J. held that the appeal was moot. The Fifth Circuit precedent is clear, she explained, and failure to obtain a stay is “fatal to a challenge to a bankruptcy court’s authorization to sell property.”[2] She pointed out that in the 5^e Circuit “fatal means fatal: challenges to authorized bankrupt sales are dismissed when the party challenging the sale fails to obtain a stay”, citing Walker County case. Hosp. Corp.3 F.4e 229, 234 (5th Cir. 2021).

The appellants’ argument that they sought to challenge the settlement and distribution of the sale proceeds rather than the sale itself was insufficient to save their appeal, Vance J. held. The Fifth Circuit is considering how closely a contested settlement provision is related to a sale itself to determine the applicability of Section 363(m), she wrote. When the sale is “integrally linked” to the settlement, both are spoken of, she concluded.[3]

Judge Vance noted that other circuits, particularly the Seventh and Ninth, take a more lenient view of Section 363(m), citing to Trinity 83 Dev., LLC vs. ColFin Midwest Funding, LLC, 917 F.3d 599, 601 (7th Cir. 2019). In Trinity, the Seventh Circuit held that “§ 363(m) does not render any litigation moot or prevent a bankruptcy court from deciding what to do with the proceeds of a sale or lease”.

Judge Vance also cited the opinion of a district court of a Seventh Circuit court, Regarding X-Treme Bullets, Inc., 2020 WL 4455582, at *7 (D. Nev. Aug. 3, 2020), where Judge Miranda Du collected cases on how courts interpret section 363(m). This opinion notes that the Sixth and Ninth Circuits appear to recognize a “narrower view of moot section 363(m)” that may preserve some appellate challenges after a sale. But X-Treme balls also acknowledges that the “majority of circuits” have read section 363(m) to create “a in itself automatically settles appeals for failure to obtain a stay of sale in dispute.[4]

The Fifth Circuit’s reading of Section 363(m) is broader than the Seventh and Ninth Circuits’ interpretation, Judge Vance concluded. Ultimately, the distribution of the sale proceeds was “an integral part of the sale – they guaranteed that the sale would accomplish its purpose” of satisfying the secured creditor’s claim while allocating funds to the trustee to administer the estate. This disposition of the proceeds was “necessary to facilitate the transaction” and was therefore “entirely related to the underlying sale”.[5] According to the Fifth Circuit reading, a call from this cast is moot.

Potential buyers and debtors considering a sale under Section 363 should consider this difference when planning the disposition of assets and proceeds. Additionally, commentators have noted that this circuit split could be indirectly addressed when the Supreme Court hears in MOAC Holdings LLC vs. Transform Holdco LLC, 21-1270 (Sup. Ct.) on December 5, 2022, which will address the issue of whether section 363(m) limits the jurisdiction of appellate courts over any sale order or deemed “entire” order to a sale order. Bracewell continues to monitor this issue.