Sale Free and Clear

SALE FREE AND CLEAR OF LIENS

Generally

If authorized by the court, property of the bankruptcy estate may be sold by the debtor in possession (Chapter 11 or 13) or by the trustee (Chapter 7) free and clear of liens. Code, Sec. 363(f). The motion for the order to sell free and clear of liens must be served on all lien holders, and notice of the sale must be given to all parties in interest. It must be verified that any creditor whose lien is divested received notice of the sale. The court may order the sale free and clear of all liens, or free of a certain class of liens but subject to others.

In order to insure a sale of scheduled property free and clear of liens, the following is required to be recorded in the Public Records:

1. Proof that all parties having an interest in the property and all creditors whose lien is divested were given proper notice of the motion and hearing.
2. The court docket showing no objections to the motion, and also that there was no appeal of the order authorizing the sale.
3. Any sale procedures set forth in the order are followed exactly. Including any ratifications of auction or bid processes.
4. Certified copy of the Order of the bankruptcy court authorizing the sale free and clear of liens and over-ruling any objections that had been filed.
5. The deed conveying title should state that it is free and clear of liens pursuant to the bankruptcy court order.

However, because of decisions by the United States Supreme Court, WFG will not rely on a bankruptcy court order that property be sold free and clear of liens of the state, a county or a municipality. This includes ad valorem taxes. WFG will require that such liens be specifically released by the governmental entity.

Key Elements Of The Section 363 Sale Process

Law360, New York (August 20, 2013, 11:54 AM ET) -- Neil E. Herman %> Source: [1]

Section 363 is extremely flexible and each 363 sale can be customized to fit the particular needs and timeline of the debtor and the size and complexity of the transaction. This article contains summaries of key elements of the sale process for a “typical” 363 sale utilizing a public auction procedure since this is the most common procedure used in bankruptcy cases. In a typical 363 sale, a debtor or trustee will execute a formal asset purchase agreement (APA) with an initial proposed purchaser whose bid will set both the minimum floor of the purchase price and the proposed structure of the transaction. This initial bid is called the “stalking-horse” bid and will be subject to higher or better offers that may be received at a subsequent auction.

After signing the APA and receipt of a wire transfer for the deposit (usually 10 percent of the cash portion of the purchase price), the debtor or trustee, as seller, will file a motion seeking two separate hearings and two separate orders.

The first hearing will be to obtain a “bid-procedures” order approving the proposed bid procedures to be used at the auction and the schedule for deadlines to submit competing bids and/or objections to the sale. The second hearing would occur after the auction and the seller will present to the court the highest or best offer received at the auction and seek approval of such sale and entry of the “sale order.”

Required Notice

Since a 363 sale is outside of the ordinary course of business, notice must be given of the proposed sale and court approval must be obtained. 11 U.S.C. § 363(b). The type of notice (and the parties entitled to notice) for a 363 sale are governed by Federal Rules of Bankruptcy Procedure 2002(a)(2) and 6004(a), which require 21 days’ notice unless such period is shortened by the court “for cause.”

All parties-in-interest required to be served under applicable bankruptcy rules and local rules or prior orders entered in the case (usually the U.S. Trustee’s Office, largest creditors of the debtor, key constituencies such as labor unions or indenture trustees for bondholders, etc.) and parties who have previously filed a notice of appearance and request for service of pleadings. Federal Rules of Bankruptcy Procedure 9014 and 7004 specify the method of service of the necessary notice. In general, notice of a “typical” 363 sale will be given to:

1. Secured lenders who have an interest in any of the assets to be sold;

2. The debtor-in-possession (DIP) lender (i.e., the party financing the bankruptcy case);

3. Government agencies and tax authorities;

4. Nondebtor parties to any contracts, leases or licenses proposed to be sold or assigned to the winning bidder;

5. All official committees formed in the bankruptcy case;

6. Any person or entity who has previously expressed an interest in purchasing any of the assets and/or all known potential competing bidders who may be interested in appearing at the auction;

7. All parties-in-interest required to be served under applicable bankruptcy rules and local rules or prior orders entered in the case (usually the U.S. Trustee’s Office, largest creditors of the debtor, key constituencies such as labor unions or indenture trustees for bondholders, etc.) and parties who have previously filed a notice of appearance and request for service of pleadings.

Auction Procedures

In order to ensure that the sale process is efficient and well-organized, most debtors or trustees seek approval (at the “first” hearing and as part of the bid procedures) of a set of formal auction procedures. Such procedures will set forth, among other things, the following:

1. The date, time and location of the public auction;

2. The contact information of the person who competing bidders should contact for questions, copies of documents and access to any diligence materials;

3. The deadline for submission of competing bids;

4. The amount and procedure for submitting a good-faith deposit;

5. The various documents and information required to be submitted in order to qualify as a “qualified bidder” (and the contact information of each person who must receive a copy of the bidder’s package of bid materials);

6. The amount of the “initial overbid” that must be received in order to be deemed higher than the stalking horse’s bid. This initial overbid is usually equal to (a) the amount of the stalking horse’s purchase price, plus (b) the amount of any breakup fee and expense reimbursement to be paid to the stalking horse, plus (c) some additional cash amount designed to cover legal and other costs of the estate to be incurred by switching to a new buyer and a modest profit above the stalking horse’s bid;

7. The amount of each “subsequent overbid” to be used by bidders for each additional round of the auction;

8. A reservation of rights by the seller to modify the bid procedures at any time, if necessary, to maximize the value of the assets; and

9. The date and time of the hearing to approve the sale (the “second” hearing) and the deadline and procedures for filing an objection to the sale.

Bankruptcy auctions are typically held at a conference room in the debtor’s counsel’s office (or at another location other than the courthouse). The prior practice of conducting auctions in the courthouse with the bankruptcy judge attending (or available in chambers if a dispute arises) has ceased because (a) most auctions last many hours and judicial intervention is rarely needed, and (b) the proper role of the judge is to resolve disputes and not to oversee business operations or general case administration.

In attendance are representatives of the seller (i.e., the debtor or trustee) and seller’s counsel and investment banker and/or financial advisors, the secured lenders, any official committees, each “qualified bidder,” and a court reporter who transcribes the entire auction.

After spending time meeting with each bidder in separate conference rooms and resolving remaining issues and answering questions, the formal auction will begin in a larger room with all attendees present together in person and “on the record” (with the stenographer transcribing everything that is said).

The debtor (or trustee) will usually recite an opening statement regarding the auction procedures to be followed and will announce which bid is currently the highest or best bid. The amount of the minimum “overbids” will be announced and each bidder will designate one person to speak.

The bidding portion of the auction will then commence, and the bidders will be given multiple opportunities to increase their bids. Bidders will also be given multiple “breaks,” if needed, whereby they can caucus in a separate room and/or make calls to their principals.

At the conclusion of the bidding, the debtor (or trustee) will confer with its advisors, the committees and secured lenders and will then announce on the record which bid (or collection of bids on separate assets) have been deemed, in the seller’s business judgment, to be the highest or best bid. After any final statements or instructions, the formal auction will end and the record will be closed.

Bid Procedures Order

In a typical 363 sale, the seller (the debtor or the bankruptcy trustee) will seek an order (the “bid procedures order”) of the bankruptcy court that, among other things:

approves a formal set of bid procedures to be followed by all potential bidders;

approves the form, scope and content of notices to be sent to necessary parties of the auction and proposed sale;

fixes deadlines for competing bids, objections to the proposed sale, and/or for parties to leases and contracts to file a statement of their “cure amounts” (11 U.S.C. § 365 provides that certain arrears and defaults must be “cured” as a condition to having the contract or lease assumed and assigned to a third party) to be satisfied as a condition for assuming and assigning the contract or lease to the winning bidder; and

approves any breakup fee or expense reimbursement to be paid to a stalking horse bidder, if any, if such bidder is outbid at the auction.

At the hearing to approve the bid procedures, the creditors’ committee, secured lenders, the U.S. Trustee and/or other interested parties will often raise concerns about the marketing process for the assets and the proposed timeline for the auction. After hearing argument (or, in some cases, live testimony), the bankruptcy court will then rule on the time, date and location for the auction and subsequent sale hearing, and such dates will be included in the bid procedures order.

Assumption and Assignment of Contracts and Leases

In many bankruptcy cases, the debtor’s rights under various contracts and/or leases are among the most valuable assets of the bankruptcy case. Section 365 of the Bankruptcy Code was designed to maximize such value by, among other things:

allowing a debtor or trustee in bankruptcy to assign unexpired leases or executory contracts to purchasers despite any clause that purports to prohibit, limit or condition assignment or which mandates consent of the nondebtor party (11 U.S.C. § 365(f)(1)), and

rendering unenforceable any so-called “ipso facto” clauses that purport to limit or terminate (or modify key terms or declare a default) in a contract or lease arising solely from the debtor’s insolvency, appointment of a bankruptcy trustee, or status as a debtor in a bankruptcy case (11 U.S.C. § 365(e)(1)).

As a result, 363 sales often contain a proposed “sale” (i.e., “assignment”) of certain contracts and/or leases either as a stand-alone sale of just the contracts or leases, or a sale thereof as part of the larger sale of other assets or the entire going concern of the debtors’ business.

As a condition to assigning an unexpired lease or executory contract to a buyer/assignee, the bankruptcy seller must demonstrate to the court at a hearing that:

• the assignee has the ability to pay the purchase price and to comply with the lease/contract terms going forward (which, under Section 365, is called providing “adequate assurance of future performance,” 11 U.S.C. §§ 365(b)(1)(C), (f)(2)(B)), and

• the monetary arrears and certain other defaults under the contracts or lease will be “cured” (i.e., paid or provisions made for a prompt cure of the defaults).

• In order to assume and assign a lease or contract, proper notice must be given to certain creditors, the U.S. Trustee’s Office, the creditors’ committee, secured lenders, parties who filed a notice of appearance, and to each nondebtor party to a contract or lease being assigned.

Federal Rules of Bankruptcy Procedure 6006 and 9014 govern the timing and method for giving notice of the proposed assignment of a lease or contract. A common practice utilized by debtors and trustees when seeking to assign leases and contracts is to include in the notice what is, in effect, a “bar date” for the filing of cure claims by the nondebtor parties to the leases and contracts.

Specifically, a common practice is to attach a schedule that lists the contract/lease, the name of the nondebtor party, and the amount of monetary arrears and defaults that the debtor or trustee believes is owed. The notice will state that if the nondebtor party disagrees with the calculation of the arrears to be cured, such party must affirmatively file an objection and provide their proposed cure amount by a specific deadline — or else the amount asserted in the notice will be deemed to govern and shall be the only amount to be cured upon assignment.

This can create a significant burden and risk to the nondebtor party who must review the proposed cure amount, calculate the proper amount of arrears to be cured, retain counsel and have them prepare an objection prior to the deadline (or else lose its right to assert a greater amount).

If an objection to the proposed assignment is filed and cannot be resolved consensually, the bankruptcy court will then hold a hearing to resolve the objections. The most common types of objections to lease/contract assignments involve (1) the calculation of the cure amount to be paid; (2) the ability of the assignee to provide “adequate assurance of future performance;” and (3) a dispute as to whether the lease is “unexpired” or the contract is “executory” (i.e., if not, then such lease or contract may not be assigned under Section 365).

Good-Faith Deposit

There is no requirement for a deposit to be paid by a bidder for assets in a 363 sale in the Bankruptcy Code or Federal Rules of Bankruptcy Procedure. In the absence of a mandatory provision, sellers of assets have approached the issue of requiring a deposit in a wide variety of ways and on a case-by-case basis depending upon, among other factors, the size and complexity of the sale transaction, the amount of the purchase price, the potential risk and harm to the estate if the buyer fails to close, the potential number of competing bidders, and local custom and precedents.

However, the amount of the deposit to be paid by bidders generally ranges from 5 percent to 10 percent of the cash portion of the purchase price. A typical bid procedures order requires that such deposit must be in the form of a wire transfer to an escrow agent and must be paid either simultaneously with the submission of a formal bid or prior to the start of the public auction.

A typical 363 sale will also require that the entire deposit is forfeited by a winning bidder if it defaults and fails to close. Whether the deposit will be liquidated damages and the sole source of recovery (or if the estate can seek additional damages) is also an issue that is negotiated and determined on a case-by-case basis.

Sale Hearing and Sale Orders

After the bid procedures and bidding protections for any stalking-horse bidder have been approved (at the “first” hearing), and after the auction has been held and a winner selected, there is a second court hearing called the “sale hearing.” At the sale hearing, the seller (the debtor or bankruptcy trustee) will make a presentation to the bankruptcy court summarizing, among other items, the following:

1. The marketing efforts undertaken, the results of the auction and the winning bid;
2. The notice given for the auction and sale hearing;
3. Objections, if any, received to the proposed sale and/or to any cure amounts to be paid to nondebtor parties to leases and contracts being assigned;
4. Settlements, if any, of objections;
5. The buyer’s ability to pay the purchase price and to provide “adequate assurance of future performance” (as required by 11 U.S.C. §§ 365(b)(1)(C), (f)(2)(B));
6. The factual and/or legal basis for some of the proposed findings of fact and/or conclusions of law set forth in the proposed sale order (among the key findings that the buyer will request are a “good-faith” finding under 11 U.S.C. § 363(m) and a broad finding that the sale is “free and clear” of liens and claims under 11 U.S.C. § 363(f); and
7. Full disclosure of any unusual provisions or transactions with “insiders” of the debtor.

The court will then hear any other parties who support the sale followed by any remaining objectors. Local custom and/or rules will dictate whether the presentations can be by oral argument of counsel, a “proffer” of witness testimony (provided that the witness is in attendance and objecting parties consent to the proffer) or by the process of direct and cross-examination of fact witnesses.

To approve a sale of assets under 11 U.S.C. § 363, the court must find that the sale (a) is in the “best interests” of the estate and its creditors; (b) has a legitimate business justification; (c) was negotiated in good faith and at arm’s length; and (d) satisfies the various tests and conditions for “adequate assurance” for nondebtor contract parties under Section 365 and for a sale “free and clear” of liens and claims under Section 365.

At the conclusion of the sale hearing, if the legal tests have been met, a sale order approving the proposed sale will be signed by the court.

The form of sale order is perhaps the most important item for the buyer. It is this key document that the buyer will rely upon after the sale closing to protect the buyer from, among other things, claims of the seller’s creditors, successor liability, cure amounts in excess of those approved by the court, liens, taxes, government and local law permits or requirements (to the extent the federal Bankruptcy Code and court can override same), and the assertion of any “anti-assignment” clauses by any parties to leases or contracts who seek to interfere with the assignment of those agreements to the buyer.

Accordingly, a sale order in a bankruptcy case is often extremely broad, extensive and complex.

Finality of Bankruptcy Sales and Appeals

Pursuant to Federal Rules of Bankruptcy Procedure 6004(h) and 6006(d), any order approving a sale of property of the bankruptcy estate is subject to an automatic stay of effectiveness of such order for a period of 14 days after entry of the sale order. This is designed to allow any objectors an opportunity to file an appeal or to make a motion for reconsideration.

However, the 14-day stay of sale orders may be shortened (or lengthened) if “the court orders otherwise.” Federal Rule of Bankruptcy Procedure 6004(h). In order to avoid the additional economic burden of paying 14 more days of “carry costs” for the assets, most debtors or trustees routinely request at the sale hearing that the 14-day stay under Federal Rule of Bankruptcy Procedure 6004(h) be waived so that the closing can occur immediately (and a finding supporting the waiver of the 14-day stay would be included in the proposed sale order).

Despite the opportunity for appeals, there is a strong federal policy of protecting the finality of sale orders in bankruptcy, which, in turn, creates certainty in the market and helps maximize the value of the assets. One reflection of this policy of “finality” is provided by the doctrines of equitable and statutory mootness that severely limit the ability of any party seeking to challenge a bankruptcy sale on appeal.

Under either doctrine, the appealing party will generally find its appeal to be rendered “moot” unless the party successfully obtains a stay of the sale during the pendency of the appeal. If not, the closing of the sale will usually provide a basis to dismiss the appeal without the appellate court even addressing the merits of the appeal.

Statutory mootness is based upon 11 U.S.C. § 363(m), which provides that the reversal on appeal of an order approving a sale does not affect the validity of the closing of the sale to the buyer if the purchaser acted in “good faith” and if no stay of the sale was in effect. 11 U.S.C. § 363(m).

As noted above, the seller and buyer will almost always make a “good-faith” presentation at the sale hearing, seek to obtain a “good-faith” finding in the sale order, and will attempt to have the 14-day stay of Federal Rule of Bankruptcy Procedure 6006(h) waived in an effort to thwart and moot any appeals (i.e., by closing the sale immediately following entry of the sale order and before the buyer can run to the district court or circuit court for a stay pending appeal).

Equitable mootness is similar to statutory mootness except that instead of being based on Section 363(m), it is based on equitable principals, and a showing of prejudice to the buyer and seller and the need for finality of sales. The procedure for obtaining a stay pending appeal of a sale order is governed by Federal Rule of Bankruptcy Procedure 8005 and local rules.

As a result of the mootness doctrines, a party seeking to challenge the sale must attend the sale hearing and, if unsuccessful, seek to challenge the Section 363(m) findings and/or seek to have a stay of the sale order in place — or else it is highly likely that the buyer and seller can close the transaction and moot the appeal.

--By Neil E. Herman, Morgan Lewis & Bockius LLP Article