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Business Bankruptcy Issues Recent Developments

Supreme Court Decision Settles The Section 1146(a) Transfer Tax Exemption Issue

On June 16, 2008, the United States Supreme Court issued its decision in Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc., the case involving whether Section 1146(a) of the Bankruptcy Code, which exempts from stamp or similar taxes any asset transfer “under a plan confirmed under section 1129 of the Code,” applies to transfers of assets occurring prior to the actual confirmation of such a plan. The issue has taken on added importance in recent years because so many sales of assets in Chapter 11 bankruptcy cases — including the one in the Piccadilly case — are made through Section 363, well before any plan of reorganization is confirmed.

(For more background on the issue, and the oral argument before the Supreme Court last March, you can read a prior post entitled "What Happened At the Supreme Court Oral Argument In The Section 1146(a) Transfer Tax Exemption Case?")

The Supreme Court’s Holding. In a 7-2 decision written by Justice Clarence Thomas, the Supreme Court held that Section 1146(a) applies only to post-confirmation transfers made under the authority of a confirmed plan of reorganization. Follow the link for a copy of the Supreme Court’s decision. The Court reversed the Eleventh Circuit (opinion below available here), which unlike the Third and Fourth Circuits, had held that pre-confirmation transfers could also be covered by the exemption. The Supreme Court summed up its holding as follows:

The most natural reading of §1146(a)’s text, the provision’s placement within the Code, and applicable substantive canons all lead to the same conclusion: Section 1146(a) affords a stamp-tax exemption only to transfers made pursuant to a Chapter 11 plan that has been confirmed. Because Piccadilly transferred its assets before its Chapter 11 plan was confirmed by the Bankruptcy Court, it may not rely on §1146(a) to avoid Florida’s stamp taxes. Accordingly, we reverse the judgment below and remand the case for further proceedings consistent with this opinion.

Keys To The Decision. In examining the statute and the parties’ arguments, the Supreme Court found Florida’s reading of the statute far more reasonable:

While both sides present credible interpretations of §1146(a), Florida has the better one. To be sure, Congress could have used more precise language—i.e., “under a plan that has been confirmed”—and thus removed all ambiguity. But the two readings of the language that Congress chose are not equally plausible: Of the two, Florida’s is clearly the more natural. The interpretation advanced by Piccadilly and adopted by the Eleventh Circuit—that there must be “some nexus between the pre-confirmation transfer and the confirmed plan” for §1146(a) to apply, 484 F. 3d, at 1304—places greater strain on the statutory text than the simpler construction advanced by Florida and adopted by the Third and Fourth Circuit.

Later, the Court added the following:

Even if we were to adopt Piccadilly’s broad definition of “under,” its interpretation of the statute faces  other obstacles. The asset transfer here can hardly be said to have been consummated “in accordance with” any confirmed plan because, as of the closing date, Piccadilly had not even submitted its plan to the Bankruptcy Court for confirmation. Piccadilly’s asset sale was thus not conducted “in accordance with” any plan confirmed under Chapter 11. Rather, it was conducted “in accordance with” the procedures set forth in Chapter 3—specifically, §363(b)(1). To read the statute as Piccadilly proposes would make §1146(a)’s exemption turn on whether a debtor-in-possession’s actions are consistent with a legal instrument that does not exist—and indeed may not even be conceived of—at the time of the sale. Reading §1146(a) in context with other relevant Code provisions, we find nothing justifying such a curious interpretation of what is a straightforward exemption.

In dismissing another of Piccadilly’s arguments, the Court had occasion to make an interesting comparison between the mechanics of assumption and rejection of executory contracts and the timing of a transfer for Section 1146(a) purposes:

We agree with Bildisco’s commonsense observation that the decision whether to reject a contract or lease must be made before confirmation. But that in no way undermines the fact that the rejection takes effect upon or after confirmation of the Chapter 11 plan (or before confirmation if  pursuant to §365(d)(2)). In the context of §1146(a), the decision whether to transfer a given asset “under a plan confirmed” must be made prior to submitting the Chapter 11 plan to the bankruptcy court, but the transfer itself cannot be “under a plan confirmed” until the court confirms the plan in question. Only at that point does the transfer become eligible for the stamp-tax exemption.

The Court also found that the placement of Section 1146(a) in a subchapter entitled "POSTCONFIMRATION MATTERS" was yet another factor which, while not decisive, helped to undermine Piccadilly’s arguments.

Canon Fodder. The Court next held that even if the statute were ambiguous, which the Court did not expressly decide, two canons of statutory interpretation would compel a decision in favor of Florida’s reading of the statute.

  • First, changes were made to Section 1146 as recently as the 2005 amendments to the Bankruptcy Code, and Congress is generally presumed to be aware of judicial interpretations of a statute (here decisions from the Third and Fourth Circuits refusing to apply the exemption to pre-confirmation transfers, both of which predated the Eleventh Circuit’s 2007 decision in Piccadilly) when the statute was revised.
  • Second, a federalism canon directs courts to proceed carefully before recognizing an exemption from state taxation that Congress has not clearly expressed. Given Piccadilly’s arguments that the statute was ambiguous, the Court found this canon to be "decisive in this case."
  • The Court rejected the canons advanced by Piccadilly, most notably viewing Chapter 11 (and Section 1146) as a remedial statute to be liberally construed to facilitate reorganizations.

The Dissent. Justice Stephen G. Breyer, in a dissent joined by Justice Stevens, focused on "whether the time of the transfer matters." Finding the language of the statute ambiguous, he looked to the policy Congress was trying to implement with the statute. He concluded that Congress would not have "insisted upon temporal limits" in Section 1146(a) since, in his view, "it makes no difference whether a transfer takes place before or after the plan is confirmed."

Other Bloggers Weigh In. For an excellent and entertaining review of the decision, be sure to read Steve Jakubowski’s post on his Bankruptcy Litigation Blog. Hat tip as well to the SCOTUS Blog for first reporting on the decision (and updating its excellent wiki on the case) and to the Delaware Business Bankruptcy Report for its post as well.

Minor Impact On Chapter 11 Cases? Of course, the most immediate impact of the decision is that pre-confirmation Section 363 sales will no longer be exempt from stamp or transfer taxes in any circuit, and those taxes will have to be paid.  What remains to be seen is whether sales will be delayed until plan confirmation in order to take advantage of the Section 1146(a) exemption. Given how many asset sales in Chapter 11 cases these days are conducted at the early stages of a case because of financing limitations and declining asset values, a move to delay those sales until plan confirmation seems unlikely. With an economic downturn upon us, the pressures that have led to the expanded use of Section 363 are not likely to abate, regardless of how attractive a stamp or transfer tax exemption may be.

Business Bankruptcy Issues Recent Developments

What Happened At The Supreme Court Oral Argument In The Section 1146(a) Bankruptcy Transfer Tax Exemption Case?

On Wednesday, March 26, 2008, the United States Supreme Court heard oral argument in the case of Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc. A link to the transcript of the oral argument can be found below. The case presents the following question:

Whether section 1146(a) of the Bankruptcy Code, which exempts from stamp or similar taxes any asset transfer “under a plan confirmed under section 1129 of the Code,” applies to transfers of assets occurring prior to the actual confirmation of such a plan?

With so many asset transfers in Chapter 11 cases taking place through Section 363 asset sales before plan confirmation, rather than when plans are consummated after confirmation, how the Supreme Court answers the question presented will have a significant impact on the extent to which debtors end up paying stamp and other transfer taxes as a practical matter.

The Eleventh Circuit’s Decision And Aftermath. The Supreme Court case results from a decision by the U.S. Court of Appeals for the Eleventh Circuit holding that pre-confirmation sales can be subject to the exemption under Section 1146(a) if followed by plan confirmation later in the case. Use the link in this sentence to read the Eleventh Circuit’s decision in Piccadilly.

The Language of Section 1146(a). The one-sentence section, Section 1146(a), was previously numbered Section 1146(c) but its language has not changed. (Many court orders and opinions still use the old designation.) The statute provides as follows:

The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax.

As discussed below, much of the dispute over the scope of this exemption is based on interpretation of the phrase "under a plan confirmed."

Section 363 Sales And Transfer Taxes. As bankruptcy professionals know, Section 363 asset sales often precede confirmation of a plan by months. When confirmed, the plan may simply distribute the cash generated from prior sales of the debtor’s assets or may enable a reorganized but smaller debtor to emerge from bankruptcy. Courts around the country have taken very different views on whether Section 1146(a)’s exemption should apply to these pre-confirmation transfers.

Some courts will include findings in Section 363 sale orders that the sale, even though prior to plan confirmation, is exempt from stamp and similar taxes. This sale order from the Southern District of New York illustrates that approach:

The sale of the Purchased Assets . . . is a prerequisite to the Debtors’ ability to confirm and consummate a plan or plans. The Sale Transaction is therefore an integral part of a plan or plans to be confirmed in the Debtors’ cases and, thereby, constitutes a transfer pursuant to section 1146(c) of the Bankruptcy Code, which shall not be taxed under any law imposing a transfer tax, a stamp tax or any similar tax.

Cases filed in Delaware will likely receive a very different response. In 2003, the Third Circuit in In re Hechinger Inv. Co. of Del., Inc., 335 F.3d 243 (3d Cir. 2003) — unlike the Eleventh Circuit in Piccadilly — held that the Section 1146(a) exemption does not apply to pre-confirmation transfers. (The Third Circuit’s opinion was authored by then Circuit Judge, and now Associate Justice, Samuel Alito.) Delaware’s new local rule governing Section 363 sales requires sale motions to make express disclosure of an effort to obtain such a provision in a sale order:

Tax Exemption. The Sale Motion must highlight any provision seeking to have the sale declared exempt from taxes under section 1146(a) of the Bankruptcy Code, the type of tax (e.g., recording tax, stamp tax, use tax, capital gains tax) for which the exemption is sought. It is not sufficient to refer simply to "transfer" taxes and the state or states in which the affected property is located.

Other courts have taken a similar view. The Section 363 sale guidelines adopted by the Bankruptcy Court for the Northern District of California call out various provisions that the Bankruptcy Court generally will not approve in a sale order, including the following:

Any provision that purports to exempt the transaction from transfer taxes under section 1146(c). By its own terms, that section applies only to a sale pursuant to a plan of reorganization, not a sale outside of a plan under section 363(b).

The Supreme Court Oral Argument And Transcript. Against this background, the Supreme Court heard oral argument in the Piccadilly case on March 26, 2008. A copy of the transcript of the oral argument is available by clicking on the link in this sentence.

It’s difficult to tell how the decision will come out based on the questions asked by the various Justices, but the questions are themselves quite interesting. Some focused on why Congress would want to exempt post-confirmation but not pre-confirmation transfers. Others implied that the plain language of the statute limited the reach of the exemption only to transfers made, literally, "under" a confirmed Chapter 11 plan of reorganization. Still others inquired about the administrative impact on states if pre-confirmation transfers were initially exempt but subsequently could be taxed in the event that no plan was ever confirmed. An additional topic raised was whether, if the statute were held to exempt pre-confirmation transfers, the exemption should cover only those transfers "necessary" for a later plan confirmation or also transfers merely "instrumental" to a later plan confirmation. 

The State’s Arguments. During the argument, the State of Florida contended that the statute was unambiguous and that the word "under" meant a transfer made at or following confirmation of plan. Arguing for this bright-line rule, the State asserted that if pre-confirmation transfers could also be exempt taxing authorities would not know, at the time a transfer was recorded, whether a Chapter 11 plan would in fact later be confirmed to validate the exemption. From a policy perspective, the State argued that tax exemptions should be narrowly construed, that stamp and other transfer taxes generate millions of dollars in revenues, and that it would be an administrative burden to require states to monitor Chapter 11 cases to see if plans were later confirmed to validate exemptions claimed on earlier asset transfers.

The Debtor’s Arguments. The debtor made both policy and statutory interpretation arguments. On the policy side, Piccadilly argued that a debtor cannot get a Chapter 11 plan confirmed without cash, debtors often make Section 363 asset sales to preserve value and raise funds needed to confirm a Chapter 11 plan later in the case, the exemption was designed to save cash for the benefit of creditors, and these pre-confirmation sales should receive the same benefit from the exemption. The debtor also asserted that the key phrase in Section 1146(a), "under a plan confirmed" appears in Section 365(g)(1). Section 365 was interpreted by the Supreme Court in N.L.R.B. v. Bildisco &. Bildisco, 465 U.S. 513 (1984), to require pre-confirmation, not post-confirmation, decisions on executory contracts. The debtor contended that because the phrase "under a plan confirmed" means before confirmation when used in Section 365(g)(1), it must mean before confirmation in Section 1146(a) as well. In contrast, the debtor argued, Congress used the different phrase "confirmed plan" in Sections 1142(b) or 511(b) when it intended to refer to a point after plan confirmation.

Conclusion. Whether Section 1146(a)’s exemption from transfer taxes applies to pre-confirmation transfers has split circuit and bankruptcy courts alike over the years. The questions asked during the Supreme Court’s oral argument in the Piccadilly case suggest a similar split among the Justices over how the statute should be interpreted. With the Supreme Court’s term ending in the next few months, however, debtors, creditors, and taxing authorities should not have to wait much longer for a definitive answer to this open issue.  

Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Adopts New Local Rule For Section 363 Sales

The Delaware Bankruptcy Court has recently adopted amended Local Rules, which became effective on February 1, 2008, and they include meaningful changes to the procedures governing Section 363 sales of assets. New Local Rule 6004-1, entitled "Sale and Sale Procedures Motions," requires additional disclosure and the highlighting of certain key provisions often seen in sale motions.

By following the links in this sentence you can find the redline version and clean version of the new Delaware Bankruptcy Court Local Rules.

The Section 363 Sale. As a reminder, a bankruptcy asset sale often happens in the first few weeks or months of a Chapter 11 case, rather than as part of a plan of reorganization. Frequently this will involve a sale of all or substantially all of a debtor’s business as a going concern. The sale is generally referred to as a "Section 363 sale" because Section 363 is the key Bankruptcy Code section that governs a debtor’s sale of assets in bankruptcy. The debtor must seek bankruptcy court approval of a sale that is not in the ordinary course of business and of any effort to transfer executory contracts, intellectual property licenses, or commercial real estate leases to the buyer.

Sale Motion Requirements. The new local rule first addresses motions to sell property of the estate. A copy of the proposed or near-final purchase agreement must be attached to the motion, as well as a proposed sale order, and any request for a consumer privacy ombudsman under Section 332 of the Bankruptcy Code must be included. The most interesting changes, however, are in the list of provisions which, if included in the motion or sale order, must be highlighted together with a justification for each such provision. These include the following:

  • Sale to insiders
  • Agreements with management
  • Releases
  • Private sale or no competitive bidding
  • Closing and other deadlines
  • Good faith deposit
  • Interim agreements with proposed buyer
  • Use of sale proceeds
  • Section 1146 tax exemption
  • Retention of records
  • Sale of avoidance actions
  • Successor liability findings requested
  • Sale free and clear of leases or licenses
  • Credit bid
  • Waiver of 10-day stay under Rule 6004(h)

A Few Specifics. To get a sense of the changes made, here’s what the amended rule now requires for disclosure of agreements with management included as part of a sale motion:

Agreements with Management. If a proposed buyer has discussed or entered into any agreements with management or key employees regarding compensation or future employment, the Sale Motion must disclose (a) the material terms of any such agreements, and (b) what measures have been taken to ensure the fairness of the sale and the proposed transaction in the light of any such agreements.

Similarly, if a finding is requested regarding a tax exemption under Section 1146(a) of the Bankruptcy Code, the motion must now detail the following:

Tax Exemption. The Sale Motion must highlight any provision seeking to have the sale declared exempt from taxes under section 1146(a) of the Bankruptcy Code, the type of tax (e.g., recording tax, stamp tax, use tax, capital gains tax) for which the exemption is sought. It is not sufficient to refer simply to "transfer" taxes and the state or states in which the affected property is located.

Another part of the new rule requires more disclosure of efforts to sell free and clear of leases and licenses:

Sale Free and Clear of Unexpired Leases. The Sale Motion must highlight any provision by which the debtor seeks to sell property free and clear of a possessory leasehold interest, license or other right.

Sale Procedures Motions. In addition to an actual sale motion, the new local rule includes new provisions addressing motions for approval of sale and auction procedures. Although these provisions are already typically set forth in motions, the rule makes mandatory the highlighting of certain ones, including the following:

  • Financial qualification procedures
  • Deadlines for submitting bids
  • Format of overbids
  • Good faith deposit
  • No-shop or no-solicitation rules
  • Break-up/topping fee and expense reimbursement
  • Bidding increments and use of break-up fees
  • Details of auction procedures

Other Important Local Rule Changes. In addition to a number of minor changes, the amended Local Rules include three significant additions governing (1) discovery motions, (2) service of discovery materials, and perhaps most importantly, (3) electronic or e-discovery. These new rules are found at Local Rules 7026-1, 7026-2, and 7026-3, respectively. Local Rule 3007-1 on omnibus claim objections, discussed in a prior post, has been revised to reflect Delaware’s continued adherence to its local practice notwithstanding the recent national rule changes. (Click on the links in this sentence for more on the national rule amendments and Delaware’s decision to retain its own omnibus claim objection procedures.) Also of note, amended Local Rule 9010-1 now makes explicit the requirement that associated Delaware counsel file all papers and attend proceedings before the Court.

Conclusion. While many of the amended sale motion rules are not new to Delaware practice, Local Rule 6004-1 will change the way sale and sale procedures motions are prepared going forward. Chapter 11 debtors must comply with the new rule and that should give creditors and potential overbidders an easier time spotting the material provisions in these motions.

Business Bankruptcy Issues Recent Developments

Don’t Miss The Important Business Bankruptcy Rule Amendments That Just Took Effect

On December 1st of almost every year, amendments to the Federal Rules of Bankruptcy Procedure — the ones that govern how bankruptcy cases are managed — take effect to address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. Often the changes are relatively minor and of interest only to bankruptcy practitioners, but this year’s set has made some significant changes that will directly impact debtors, creditors and other stakeholders.

A Look At The Amendments. You may find it interesting to see the entire group of amendments together, so I have included two links. The first is to the full "clean" set of the amended rules. The second is to a redline showing the changes made by these amendments to the existing rules, together with the Advisory Committee’s comments.

The Omnibus Objection Problem. One of the most significant amendments will make changes to the popular practice of filing omnibus objections. In large cases the debtor or other estate representative has so many claims to address that they have combined objections to dozens — sometimes hundreds — of different claims in one single motion. The objection may have a name such as “Debtors’ Fourteenth Omnibus Objections To Claims (Substantive)” or some similarly titled document. Click here for one example. In a post last year called "Objections To Claims: Ignore Them At Your Peril," I discussed how it can be hard to tell which claims an omnibus objection is targeting.

  • The format has often meant that the only reference to an individual creditor is buried within the objection’s many pages of text and exhibits, typically in an attached list or chart.
  • If the creditor doesn’t respond to the objection timely, its claim will likely be disallowed and it will recover absolutely nothing from the bankruptcy estate.

The Amended Rule 3007: An "Anti-Gotcha" Solution. The new rules restrict the use of omnibus objections to certain limited circumstances and impose formatting standards. Otherwise, each claim will require its own separate claim objection unless the combined objection covers claims filed by the same person or entity. What grounds for objection can be made by an omnibus objection under the newly revised Rule 3007?

  • Duplicate claims;
  • Claims filed in the wrong case;
  • Original claims that were amended by later claims;
  • Claims that were not timely filed;
  • Claims that have already been paid or released;
  • Claims filed in a form that does not comply with applicable rules;
  • Claims that are really asserting an equity interest in the debtor; and
  • Priority claims that assert an amount in excess of the maximum amount in the Bankruptcy Code.

In short, if the claim is being challenged on substantive grounds, rather than more technical or procedural ones, then the objection will have to be filed one claimant at a time.

When an omnibus objection does make the permitted objections, it will now have to list claimants in alphabetical order, cross-reference claim numbers, give the ground for the objection and cross-reference that to the text of the objection, describe the objector and the reason for the objection in the document’s title, and combine no more than 100 claims in a single objection. This is all designed to make it easier for the creditor to figure out whether its claim is included and the basis for the objection.

Amended Rule 4001: The Clearer Disclosure Rules. Changes have been made to the rule that governs motions and stipulations for use of cash collateral and obtaining debtor in possession (DIP) financing. The amended rules now require that more details about the key provisions of cash collateral and DIP financing terms and conditions be stated in the motion, that proposed forms of order be filed with the motion, and that cross-references be made in the motion to where in the cash collateral or DIP financing agreements and proposed orders the key provisions are reflected. Since some financing agreements can run hundreds of pages long, with complex formulas and provisions, this rule change is designed to make it easier for the court and the parties to understand their material features without wading through the entire document.

New Rule 6003: Putting The Breaks On Some "First Day" Orders. Another major change is the addition of Rule 6003. This new rule provides that "except and to the extent that relief is necessary to avoid immediate and irreparable harm, the court shall not, within 20 days after the filing of the petition, grant relief" regarding three key areas:

  • The employment of professionals;
  • A motion to pay any prepetition claims (read: critical vendors) or to use, sell, lease (Section 363 sales), or incur an obligation for property of the estate, other than cash collateral or DIP financing motions; or
  • Assumption or assignment of any executory contract or unexpired lease (including commercial real estate leases).

As drafted, unless there is an emergency, and then only to the extent it’s really necessary, the bankruptcy court should defer these decisions until after the 20th day following the filing of the Chapter 11 bankruptcy petition (although technically these apply under the other chapters of bankruptcy). One reason for the rule is to give time for a creditors committee to be appointed and retain counsel before important decisions are made. That said, the exceptions for cash collateral and DIP financing, as well as for rejection of leases and other executory contracts, means a lot can still be done during the early part of a case. When Section 363 sale or critical vendor motions come up on an emergency basis, it’ll be interesting to see how often courts, in applying this new rule, find the existence of irreparable harm.

Amended Rule 6006: Assumption, Assignment, And Rejection Of Executory Contracts. Similar to Rule 3007, Rule 6006 has been changed to put limits on when omnibus motions can be used to deal with executory contracts and leases. Under new Rule 6006(e), absent special court authorization, omnibus motions may be used for multiple executory contracts or leases only when all of the executory contracts to be assumed or assigned are (1) between the same parties, or (2) being assigned to the same assignee. This latter provision likely covers most Section 363 asset sales, so non-debtor contracting parties should continue to carefully review those motions, as discussed in this earlier post. An omnibus motion may also be used when a debtor or trustee seeks to assume, but not assign to more than one assignee, real property leases. In addition, omnibus motions may be used to request rejection of multiple executory contracts or leases.

New Rule 6006(f) provides that, when allowed, these omnibus motions can list no more than 100 executory contracts or leases in any one motion (unlike the chart on this fairly typical pre-amendment motion), and multiple motions will need to be numbered consecutively. The new rule also requires that permitted omnibus motions provide a variety of new information, including:

  • An alphabetical listing by party name;
  • The terms of the assumption or assignment, including for curing defaults; and
  • The identity of the assignee and the adequate assurance of future performance to be provided.

A Few Other Changes. The other amendments this year (1) permit a court to consider a change of venue, (2) clarify when corporate ownership disclosure needs to be made, (3) address constitutional challenges to statutes, and (4) specify procedures for protecting social security numbers and other private information in court filings. Check the clean or redline sets linked above to read these additional rule amendments.

Conclusion. This year’s amendments to the Federal Rules of Bankruptcy Procedure have more than their share of real changes and they will have an impact on business bankruptcy cases. The omnibus motion changes should help creditors from missing when their claim is the target of an objection and contract parties from failing to see that their executory contract or lease is part of a motion to assume and assign. Although cash collateral and DIP financing motions are not affected, the new irreparable harm standard for certain relief in the first 20 days of a case may prove interesting when emergency Section 363 sales are attempted. Stay tuned.

Business Bankruptcy Issues Recent Developments

Have Section 363 Sale Orders Gone Too Far?

Concerned about the broad-reaching and complex forms of Section 363 asset orders being submitted for approval, this past week the U.S. Bankruptcy Court for the Northern District of California issued a set of "Guidelines re Sale Orders" as well as a form of "Model Sale Order." (Each document is available by clicking on its respective title in the prior sentence.) The Bankruptcy Court’s opening discussion of the Guidelines expresses its reasons for issuing them now:

The bankruptcy judges of the Northern District of California have become increasingly concerned about the orders they are being asked to sign on motions to approve sales of property of the estate under section 363(b) and 363(f).  Many of the proposed orders submitted:  (a) seek relief beyond the scope of the motion before the court; (b) seek to affect parties not before the court; (c) seek advisory rulings where there is no case or controversy; (d) include findings of fact that should be stated orally or in a separate memorandum; and (e) are so wordy and complex that the court has difficulty determining their meaning. 

The crafting of orders is a judicial function. Accordingly, the judges have approved a model order for motions seeking authority to sell property of the estate and motions to sell such property free and clear of liens.  The following guidelines are intended to explain how to use the model order, and what provisions the court will and will not generally approve as additions to the model order or where the parties draft their own order.  These guidelines do not apply to any separate orders approving bidding procedures, break-up fees or other matters related to the sale of property.  In addition, these guidelines do not apply in Chapter 13 cases.

The model order is not mandatory, but the judges will use the model order on their own motion where parties vary from these guidelines without sufficient cause and explanation. 

In the event that a party submits a sale order that deviates from these guidelines, the party shall, unless otherwise instructed by the court, submit a declaration to the court in which the party identifies the provisions that vary from these guidelines and sets forth the justification therefore.

(Emphasis in original.) Many bankruptcy lawyers who practice regularly in the Northern District of California, with divisions in San Francisco, San Jose, Oakland, and Santa Rosa (and courthouses in Eureka and Salinas), have already understood the prevailing view of the bankruptcy judges on these issues. However, the new guidelines help clarify matters for everyone facing these issues in the Northern District of California. 

The Section 363 Sale. As a reminder, a bankruptcy asset sale often happens in the first few weeks or months of a Chapter 11 case, rather than as part of a plan of reorganization. Frequently this will involve a sale of all or substantially all of a debtor’s business as a going concern. The sale is generally referred to as a "Section 363 sale" because Section 363 is the key Bankruptcy Code section that governs a debtor’s sale of assets in bankruptcy. The debtor must seek bankruptcy court approval of a sale that is not in the ordinary course of business and of any effort to transfer executory contracts, intellectual property licenses, or commercial real estate leases to the buyer.

The Sale Order. For a buyer of assets in a Section 363 bankruptcy sale, a big question is what type of factual findings and legal rulings will the bankruptcy court include — or refuse to include — in the order approving the sale. Buyers typically desire that the sale be ordered "free and clear" of all liens, claims, interests, and encumbrances, rather than only certain ones specifically identified in the notice of the sale motion. They also prefer to have findings added to the order on issues such as fair value paid and no successor liability, and often ask for an injunction against actions affecting the buyer that are inconsistent with the sale order’s findings and provisions.

Big Differences From District To District. As bankruptcy lawyers know, courts in different districts around the country have taken surprisingly divergent views on what is, and is not, appropriate in Section 363 sale orders.

  • It’s hard not to notice the striking differences between the new Model Sale Order from the Northern District of California and examples of sale orders entered over the past few years by bankruptcy courts in the District of Delaware (example here), the Southern District of New York (example here), and the Northern District of Illinois (example here), three courts where a number of large Chapter 11 cases have been filed. 
  • The new Guidelines issued by the Northern District of California appear to be in reaction to the submission of sale orders more in keeping with the accepted practice in Delaware and New York than in Northern California.

Although one wonders if the Northern District of California’s approach will spread to other courts, the more likely scenario is that each district will continue to follow its own path.