Recent decisions in the Chrysler and General Motors Chapter 11 bankruptcy cases have focused attention on the use of § 363 of the Bankruptcy Code1 to sell substantially all of the assets of a debtor, rather than selling the assets pursuant to a duly confirmed Chapter 11 plan of reorganization.2 In those cases, bankruptcy judges in the Southern District of New York approved multi-billion dollar sales under § 363(b) of substantially all the assets of GM and Chrysler, prior to confirmation and without a Chapter 11 plan.3 In a Chapter 11 reorganization, a sale of substantially all of the assets of the debtor can be accomplished in two ways; either a sale prior to confirmation of a plan of reorganization, under § 363(b),4 or pursuant to a confirmed Chapter 11 plan providing for the sale. Plan confirmation is usually a time consuming process requiring Bankruptcy Court approval of a prospectus like disclosure statement describing the debtor’s business and the details of the proposed Chapter 11 plan.5 The Chapter 11 plan often requires the writing of multiple drafts and the holding of several hearings, followed by creditor voting on the plan, and a hearing to determine if the plan meets the statutory requirements for confirmation.6 If any class of creditor rejects the plan, confirmation can only be achieved by “cramming down” on the dissenting class, which can be a complicated procedure.7 Thus, as a practical matter in most Chapter 11 cases, a plan cannot even be proposed for many months after the commencement of the Chapter 11 case.
Bankruptcy Code § 1123(a), which governs the contents of a Chapter 11 plan states: “a plan shall- … (5) provide adequate means for the plan’s implementation, such as … (D) sale of all or any part of the property of the estate, …” Section 1123(b) states: “a plan may – (4) provide for the sale of all or substantially all of the property of the estate, and distribution of the proceeds of such sale among holders of claims or interests. …”8 However, § 363(b)(1), which applies to all bankruptcy cases, including Chapter 11 cases, provides: “The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate, ….”9 In a Chapter 11 case, the debtor, as “Adebtor in possession,” has ” all rights, …, and powers, . .., of a trustee . …”10 If substantially all of the assets of a debtor can be sold under § 363(b) without prior confirmation of a Chapter 11 plan, then the sale can be accomplished much earlier in the Chapter 11 process, resulting in significantly lower legal and accounting fees, and a much quicker sale. As the Second Circuit explained in the Chrysler case: Resort to § 363(b) has been driven by efficiency, from the perspectives of sellers and buyers alike. The speed of the process can maximize asset value by sale of the debtor’s business as a going concern. Moreover, the assets are typically burnished (or “cleansed”) because (with certain limited exceptions) they are sold free and clear of liens, claims and liabilities. … A § 363 sale can often yield the highest price for the assets because the buyer can select the liabilities it will assume and purchase a business with cash flow (or the near prospect of it). …” 11
As noted in the Chrysler and GM decisions, the requirements for a § 363(b) sale derive from the 1983 decision of the Second Circuit in Lionel.12 In Lionel, the bankruptcy court approved the § 363(b) sale by Chapter 11 debtor Lionel of its 82% common stock holdings in a subsidiary, prior to confirmation of a Chapter 11 plan. The Second Circuit reversed, noting that while “[o]n its face, Section 363(b) appears to permit disposition of any property of the estate of a corporate debtor without resort to the statutory safeguards embodied in Chapter 11 of the Bankruptcy Code, … Yet, analysis of the statute’ history and over seven decades of case law convinces us that such a literal reading of Section 363(b) would unnecessarily violate the congressional scheme for corporate reorganizations.”13 “Just as we reject the requirement that only an emergency permits the use of § 363(b), we also reject the view that § 363(b) grants the bankruptcy judge carte blanche.”14
The Lionel court acknowledged that there is an “apparent conflict” between Chapter 11 and § 363(b), but that the conflict “does not require an all or nothing approach.”15 “Every sale under § 363(b) does not automatically short-circuit or side-step Chapter 11; nor are these two statutory provisions to be read as mutually exclusive.”16 To balance these competing interests, the Lionel court fashioned a balancing test for pre-confirmation Chapter 11 asset sales which requires the bankruptcy judge to “expressly find from the evidence presented before him at the hearing a good business reason to grant such an application.”17 Creditor committee insistence on the sale, and the long delay from confirmation of a plan were insufficient reasons for a § 363(b) sale, under Chapter 11.18
The Lionel court identified a non-exhaustive list of factors to be considered in performing the § 363(b) balancing test: (a) “the proportionate value of the asset to the estate as a whole,” (b) “the amount of elapsed time since the filing,” (c) “the likelihood that a plan of reorganization will be proposed and confirmed in the near future,” (d) “the effect of the proposed disposition on future plans of reorganization,” (e) “the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property,” (f) “which of the alternatives of use, sale, or lease the proposal envisions,” and (g) “most importantly perhaps, whether the assets are increasing or decreasing in value.”19 Consideration must also be given to whether the parties opposing the sale “produced evidence before the bankruptcy court that such sale was not justified.”20 In General Motors, the bankruptcy court added to the list of Lionel factors: “(h) Does the estate have the liquidity to survive until confirmation of a plan? (i) Will the sale opportunity still exist as of the time of plan confirmation? (J) if not, how likely is it that there will be a satisfactory alternative sale opportunity, or a stand-alone plan alternative that is equally desirable (or better) for creditors? And (k) Is there a material risk that by deferring the sale, the patient will die on the operating table?”21
For more than 25 years, the courts have applied the Lionel balancing test to determine whether to permit a Section 363(b) sale prior to plan confirmation.22 Since Lionel, at least five decisions of the Second Circuit have reaffirmed that “even the entirety of a debtor’s business may be sold without waiting for confirmation when there is a good business reason for doing so.”23 The Supreme Court has recognized the use of Section 363(b) for sale of substantially all of a debtor’s assets “before seeking or receiving plan confirmation.”24
The concern, and often the grounds for objection to a § 363(b) sale, is that the sale is a “sub rosa” Chapter 11 plan, circumventing the requirements and safeguards of the confirmation process.25 As the Second Circuit said in Chrysler, “commentators and courts including ours – have sometimes referred to improper § 363(b) transactions as ‘sub rosa plans of reorganization.'”26 However, in Chrysler the Second Circuit adhered to its earlier decisions that a § 363(b) asset sale need not be rejected simply because it is a sale of all or substantially all of a debtor’s assets. Thus a § 363(b) sale may well be a reorganization in effect without being a prohibited sub rosa plan of reorganization.27 In the Second Circuit, “the sale of an asset of the estate under § 363(b) is permissible if the ‘judge determining [the] § 363(b) application expressly find[s] from the evidence presented before [him or her] at the hearing [that there is] a good business reason to grant such an application.'”28
The Second Circuit further noted in Chrysler, that “[a]s § 363(b) sales proliferate, the competing concerns identified in Lionel have become harder to manage. Debtors need flexibility and speed to preserve going concern value; yet one or more classes of creditors should not be able to nullify Chapter 11’s requirements. A balance is not easy to achieve, and is not aided by rigid rules and prescriptions.”29 “Lionel’s multi-factor analysis remains the proper, most comprehensive framework for judging the validity of § 363(b) transactions.”30
Some examples of business reasons found sufficient to justify a Section 363(b) sale include: (a) sale of a hospital “as a going concern before it ran out of money, saving about 2,300 jobs and [it was]a critical supplier of medical services in the Bronx;”31 (b) sale of Adelphia’s assets in lieu of sale under plan “when intercreditor disputes made it impossible to confirm a plan in time to save the sale opportunity, and more than $17 billion in sale proceeds nearly was lost;”32 (c) the absence of other viable bids or options to preserve the going concern value of GM’s business;33 (d) sale of LTV’s Aerospace assets because of risk of loss of value if the sale was not concluded, the sale was a necessary step for confirmation of a plan, and the value received was the highest and best available;34 (e) sale of Chrysler’s assets where the Fiat transaction was the only currently viable option to liquidation, the entire enterprise was worth more than the sum of its parts, and the sale was necessary to preserve going concern value and maximize the value of debtor’s estate.35
As the bankruptcy court noted in GM, “[w]hile, because of the size of this case and the interest at stake, GM’s chapter 11 case can hardly be regarded as routine, GM’s proposed section 363 sale breaks no new ground. This is exactly the type of situation where under the Second Circuit’s many holdings, there is good business for an immediate sale. GM does not have the luxury to wait for the ultimate confirmation of a plan, and the only alternative to an immediate sale is liquidation.”36
In Chrysler, the Second Circuit noted that: “In the twenty-five years since Lionel, § 363(b) asset sales have become common practice in large-scale corporate bankruptcies,” and the court quoted a recent law review article: “Corporate reorganizations have all but disappeared. … TWA filed only to consummate the sale of its planes and landing gates to American Airlines. Enron’s principal assets, including its trading operations and it most valuable pipelines, were sold within a few months of its bankruptcy petition. Within weeks of filing for Chapter 11, Budget sold most of its assets to the parent company of Avis. Similarly, Polaroid entered Chapter 11 and sold most of its assets to the private equity group at BankOne. …”37 “Lehman Brothers sold substantially all of its assets to Barclays Capital within five day of filing for bankruptcy.”38 “In the current economic crisis of 2008-09, § 363(b) sales have become even more useful and customary. The ‘side door’ of § 363(b) may well ‘replace the main root of Chapter 11 reorganization plans.'”39 In Chrysler, the Second Circuit described the criticism of § 363(b) sales as remaining what it was in Lionel, “fear that one class of creditors may strong-arm the debtor-in-possession, and bypass the requirement of Chapter 11 to cash out quickly at the expense of other stakeholders, in a proceeding that amounts to a reorganization in all but name, achieved by stealth and momentum.”40 The court also recognized that, “[a]s § 363(b) sales proliferate, the competing concerns identified in Lionel have become harder to manage. Debtors need flexibility and speed to preserve going concern value; yet one or more classes of creditors should not be able to nullify Chapter 11 requirements. A balance is not easy to achieve, and is not aided by rigid rules and prescription. Lionel’s multi-factor analysis remains the proper, most comprehensive framework for judging the validity of § 363(b) transactions.”41
In GM and Chrysler, the bankruptcy judges both noted that use of a Section 363(b) sale is an appropriate strategy “when there is a need to preserve the going concern value because revenues are not sufficient to support the continued operation of the business and there are no viable sources for financing.”42 “Each of the factors that the Lionel court listed, and the additional ones that this Court suggests go to the ultimate questions that the Lionel court identified: Is there an ‘articulated business justification’ and a ‘good business reason’ for proceeding with the sale without awaiting the final confirmation of a plan.”43 Both courts noted prior approval of sales seeking to preserve going concern value in the Southern District of New York where debtors could not otherwise survive.
Although General Motors and Chrysler are the most recent high profile mega cases to successfully employ a § 363(b) sale in lieu of confirmation of a Chapter 11 plan of reorganization to sell debtor’s business as a going concern, the same standards apply to smaller cases and the Lionel test is frequently used in many Chapter 11 cases to dispose of debtor’s assets and lock in the value of those assets, particularly where the assets are dwindling or delaying the sale until completion of the plan process would significantly reduce the value of the assets. What usually follows from a § 363(b) sale is a liquidating Chapter 11 plan distributing the proceeds of the sale to creditors pursuant to the priorities of the Bankruptcy Code.44 Another variation is to convert the case to Chapter 7, following consummation of the § 363(b) sale, which will result in appointment of a Chapter 7 trustee who will vigorously pursue any avoidance actions such as fraudulent conveyance or preference claims against insiders (shareholders, officers, and directors) or other creditors. A further twist noticed in recent cases is that some bankruptcy courts will approve provisions in Section 363(b) sale orders that transfer debtor’s books and records and creditor/trustee avoidance causes of action to the buyer, which may hamper or prohibit trustee actions against insiders and other recipients of otherwise avoidable pre-petition transfers.
A. Scott Mandelup is a founding partner of Pryor & Mandelup, L.L.P. 675 Old Country Road, Westbury. He concentrates his practice in bankruptcy, creditors’ rights, and commercial litigation.
1. Bankruptcy Reform Act of 1978, as amended, 11 U.S.C. § 101, et seq.
2. In re General Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y. 2009), aff’d, In re Motors Liquidation Co., 2010 WL 1524763 (S.D.N.Y. 4/13/2010) (“GM”); In re Chrysler LLC, 405 B.R. 84 (Bankr. 2009), aff’d, 576 F.3d 108 (2d Cir. 2010), judgmt vacated, In re Ind. State Police Pension Trust v. Chrysler LLC, _ U.S._, 130 S. Ct. 1015 (2009) (“Chrysler”).
4. 11 U.S.C. § 363(b).
5. 11 U.S.C. § 1125.
6. 11 U.S.C. § 1129; 11 U.S.C. § 1122.
7. 11 U.S.C. § 1129(b).
8. 11 U.S.C. § 1123(a)(5)(D) and 1123(b)(4).
9. 11 U.S.C. § 363(b)(1).
10. 11 U.S.C. § 1107(a).
11. 576 F.3d at 115-116.
12. Comm. Of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063 (2d Cir. 1983) (“Lionel”).
13. Id. at 1066.
14. Id. at 1069.
15. Id. at 1071.
16. Id. at 1070.
17. Id. at 1071. (Emphasis added.)
21. 407 B.R. at 488.
22. Id. at 489.
23. In re General Motors Corp., 407 B.R. at 489. See also, Motorola v. Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007) (“Iridium”); Licensing By Paolo, Inc. v. Sinatra (In re Gucci), 126 F.3d 380 (2d Cir. 1997); Customer News & Bus. Channel P’ship v. Fin. News Network Inc. (In re Fin. News Network Inc.), 980 F.2d 165 (2d Cir. 1992); Official Comm. of Unsecured Creditors of LTV Aerospace & Defense Co. v. LTV Corp., (In re Chateauguay Corp.), 973 F.2d 141 (2d Cir. 1992); and Chrysler, 576 F.2d 108.
24. Florida Dept. of Revenue v. Picadally Cafeterias, Inc., BU.S.B, 128 S. Ct. 2326, 2331, n.2, (2008).
25. In re Chrysler LLC, 576 F.3d at 116.
26. 576 F.3d at 117; Iridium, 478 F.3d at 466.
27. 576 F.3d at 117.
28. 576 F.3d at 117-118, citing Lionel, 722 F.2D at 1071.
29. In re Chrysler LLC, 576 F.3d at116.
30. Id. at 116-117.
31. In re General Motors Corp., 407 B.R. at 491, citing In re Our Lady of Mercy Hospital, No. 07-10609(REG), ECF #284.
32. Id. at 491, citing In re Adelphia Commc’ns Corp., 368 B.R. 140, 169 (Bankr. S.D.N.Y. 2007).
33. Id. at 493.
34. The Official Committee of Unsecured Creditors of LTV Aerospace and Defense Co. v. The LTV Corp. (In re Chateauguay Corp.), 973 F.2d 141, 143 (2d Cir. 1992).
35. In re Chrysler LLC, 405 B.R. at 96.
36. 407 B.R. at 493.
37. 576 F.3d at 115 (internal citations omitted).
40. Id. at 117.
41. 576 F.3d at 116.
42. General Motors, 407 B.R. at 491. 43. Id. at 490. 44. See 11 U.S.C. § 507(a) for the priority of distributions to creditors under the Bankruptcy Code.
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