The primary objective of any buyer at a Section 363 sale, whether one purchasing for cash or an existing secured creditor making a credit bid, is to obtain good title to the purchased assets free and clear of any liens, claims, or interests. However, a recent decision on this subject by the Bankruptcy Appellate Panel ("BAP") of the United States Court of Appeals for the Ninth Circuit is causing something of a stir in the bankruptcy world.

In Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), the Ninth Circuit BAP held that a senior secured creditor’s credit bid, in an amount less than the aggregate value of all liens against the property in question, did not satisfy the requirements of Section 365(f) and permit the sale to be "free and clear" of the existing junior liens on the property and reversed the bankruptcy court’s order on appeal. You can read the entire opinion by following the link in this sentence.

For an excellent discussion of the decision and the analysis employed by the BAP, be sure to read Steve Jakubowsi’s post on the case over at The Bankruptcy Litigation Blog. Instead of covering the same ground, I want to discuss some of the implications of the decision for Section 363 bankruptcy sales.

Credit Bid Or Foreclosure? First, the Clear Channel decision raises questions about how a senior secured creditor should proceed in a bankruptcy case.

• On the one hand, the BAP’s decision that a sale will not be "free and clear" of junior liens is not that surprising. It has generally been accepted that for a "short sale" under Section 363 (one in which the purchase price is less than the amount of liens against the property) to be free and clear of liens, the secured creditors must consent or one of the other exceptions under Section 363(f) must be satisfied. Those other exceptions include a lien subject to "bona fide" dispute or a situation in which the lien holder can be forced to accept a cash payment in satisfaction of the lien.
• What has surprised some about this new decision is the holding that a credit bid by a senior secured creditor also cannot be made free and clear of junior liens, even though the senior secured creditor could have wiped out the junior liens through a foreclosure under state law.
• Section 363(f)’s focus on the "aggregate value of all liens on such property" makes the existence of junior liens the issue, regardless of whether they are in the money. Put differently, even if the junior liens are worthless, they exist and a Section 363 sale to a credit bidding senior secured creditor will not be free and clear of those junior liens.  
• With the enormous increase in second lien lending over the past several years, including many second lien loans made as part of private equity buyouts, expect to see more Chapter 11 bankruptcy cases in which substantial junior liens are present.

This ruling seems to leave secured creditors seeking to take title to their collateral with two main choices. One is to seek relief from the automatic stay to foreclose on its collateral, avoiding the Section 363 sale and credit bid approach altogether. If the assets cannot be sold for cash in an amount greater than the senior secured creditor’s claim, and if a reorganization is not reasonably in prospect (the key factors in a bankruptcy court’s decision whether to lift the stay), this may be the preferred path. A second approach would be to complete the credit bid through a Chapter 11 plan of reorganization, something the Clear Channel court implied was also available. However, some secured creditors may find the delay and expense involved in being a plan proponent problematic. As a plan proponent, the secured creditor would take on the obligation to pay administrative expenses of the estate on the effective date of the reorganization plan, as well as satisfaction of all of the other requirements for confirming a plan.

The Risks Of An Appeal: The Limits Of Section 363(m) And The Mootness Doctrine. Second, perhaps the most important aspect of the Clear Channel decision is the risks it exposes even for "good faith" purchasers in Section 363 sales. Purchasers of assets under Section 363 regularly seek a finding that they are a good faith purchaser because a sale to such a buyer cannot be overturned on appeal. This protection is found in Section 363(m) and reads as follows:

The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

Here, the BAP held that although the sale itself to the senior secured creditor could not be overturned on appeal, the protection of Section 363(m) did not extend to the question of whether the sale was made "free and clear" of the junior liens. Instead, the BAP ruled that even in the absence of a stay pending appeal, the appellate court could reverse the "free and clear" determination because Section 363(m) is expressly limited to sale orders under Sections 363(b) and (c), which authorize the sale or lease of property, and does not extend to "free and clear" orders under Section 363(f).

Going hand in hand with the Section 363(m) ruling was the decision’s holding that the closing of the asset sale did not render the "free and clear" issue moot. Instead, even though no stay pending appeal was obtained, the BAP concluded that relief could still be granted on the "free and clear" question by ordering that the junior lien remained attached the property even after its sale. 

When Should A Buyer Close The Sale? The Section 363(m) and mootness rulings raise issues about when a buyer of assets under Section 363 should close on the sale. The BAP’s views on Section 363(m) and mootness do not appear limited to the credit bid situation involved in the Clear Channel decision. Instead, if a good faith purchaser for cash pays less than the "aggregate value of all liens" against the purchased assets — or perhaps a question exists whether a lien or interest is really in "bona fide" dispute — the "free and clear" aspect of the sale may be outside the protection of Section 363(m) and an appeal by a secured creditor or other interest holder may not be moot.

• Buyers usually prefer to close as soon as possible after entry of a bankruptcy court’s order approving the sale, especially if the value of the assets are declining or the debtor is running out of cash.
• A buyer that closes with an appeal threatened runs the risk of having the "free and clear" decision overturned months or even years later and the purchased assets suddenly subject to the debtor’s liens.
• While every sale objection or appeal will not raise these issues, if a serious objection to the "free and clear" aspect of the bankruptcy court’s sale order has been made, and the objector is likely to appeal, the buyer should consider whether to wait until the later of (a) the passage of the 10-day appeal period, or (b) a final appellate decision affirming the bankruptcy court’s denial of the objection, before agreeing to close the sale. 
• Buyers may want to consider including provisions in the asset purchase agreement to permit this type of flexibility on when to close or to terminate the agreement if the closing is substantially delayed.

The Precedential Effect Of A BAP Decision. Unlike a U.S. Court of Appeals itself, a BAP is made up of bankruptcy judges, not federal circuit judges. Given a BAP’s place in the judicial system’s hierarchy, its decisions are not given the same precedential weigh as U.S. Court of Appeals decisions, and this means that the U.S. Court of Appeals for the Ninth Circuit might reach a different conclusion. Moreover, BAP decisions generally are not binding on bankruptcy courts in the Ninth Circuit. That said, some bankruptcy judges make a practice of following BAP decisions and the BAP’s reasoning may influence other judges.

Conclusion. The BAP’s Clear Channel decision has important implications for Section 363 asset sales. Secured creditors intent on making a credit bid may now rethink that approach when junior liens are present. Cash buyers may be more cautious on when to close a sale if disputes exist over whether the sale should be "free and clear" of existing liens and interests. It will be interesting to see how other courts, in the Ninth Circuit and beyond, react to the decision, so stay tuned.