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Section 363 Sales After the Covid-19 Pandemic.
Author: Steven Fruchte
Date: Spring 2021
From: American Bankruptcy Law Journal(Vol. 95, Issue 2)
Publisher: National Conference of Bankruptcy Judges
Document Type: Article
Length: 12,247 words
Lexile Measure: 2080L
Full Text:
I. INTRODUCTION
Chapter 11 bankruptcy provides distressed companies with the ability to satisfy their debts, shed their liabilities, and continue to exist
as a going concern. A company undergoing chapter 11 reorganization (a "debtor") cannot sell assets outside of the ordinary course of
usiness without court approval. Rather, to sell assets outside of the ordinary course of business, a debtor may conduct a sale eithe
(1) through a chapter 11 plan of reorganization under [section] 1123 of the Bankruptcy Code, or (2) outside of a chapter 11 plan
under [section] 363 of the Bankruptcy Code. (1)
Numerous disclosure and creditor voting safeguards apply to sales of assets pursuant to a chapter 11 plan under [section] XXXXXXXXXX)
In contrast, sales corn ducted outside of a chapter 11 plan under [section] 363 statutorily require only "notice" (3) to creditors and a
"hearing" before a debtor "may use, sell or lease, other than in the ordinary course of business, property of the estate." (4) Because
of the inherent tension that exists between the minimal statutory requirements of [section] 363 and the extensive disclosure and
voting requirements set forth in chapter 11, bankruptcy courts have come to expect debtors seeking to sell assets under [section] 363
to conduct a public auction in order to maximize the price obtained for the assets being sold. (5)
Historically, [section] 363 asset sale auctions have been conducted live and in person. However, in the latter half of 2020, owing to
the Covid-19 pandemic, bankruptcy asset sale auctions were almost exclusively conducted virtually. The preliminary evidence from
virtual auctions conducted during the pandemic shows that they are competitive and serve to maximize the sale price of assets sold
y debtors under section 363. This article argues that in light of this evidence, debtors should provide a virtual attendance option fo
participating in section 363 auctions--even in a post-pandemic world.
II. HISTORY OF [section] 363
The origins of [section] 363 can be traced to the Bankruptcy Act of 1867, which permitted a debtor to sell assets outside a bankruptcy
plan that were "of a perishable nature or liable to deteriorate in value." (6) Twenty years after the Bankruptcy Act of 1867 was
epealed in 1878, Congress passed the Bankruptcy Act of 1898 (the "Bankruptcy Act"), which was the controlling bankruptcy law in
the United States from its enactment until its replacement by the modern Bankruptcy Code in XXXXXXXXXXUnder the Bankruptcy Act,
there was a split of authority among the Circuit Courts of Appeals regarding whether a court could approve the sale of all or a
substantial portion of a debtor's assets outside of a bankruptcy plan absent a showing of an "emergency." (8)
The more restrictive view held that courts could only approve a sale of assets outside of a bankruptcy plan upon a showing of "an
actual emergency, defined perhaps as virtual or near catastrophe." (9) Under the less restrictive view, courts could approve sales of
assets outside of a bankruptcy plan merely to avoid erosion of the value of the assets being sold. (10) Even under the less restrictive
view, courts usually approved sales outside a bankruptcy plan only after finding that there would be a severe diminution in the value
of the assets being sold if a sale were not conducted expediently. (11)
Before enacting the modern Bankruptcy Code in 1978, Congress established the Commission on the Bankruptcy Laws of the United
States (the "Commission") to study, analyze, evaluate and recommend changes to the bankruptcy laws. (12) On July 30, 1973, the
Commission sent the 93rd Congress a proposed statute, titled the "Bankruptcy Act of 1973," which included a provision providing that
"[a] sale or lease of all or substantially all of the property of the estate may be authorized by the court if in the best interests of the
estate after notice and hearing." (13) In an explanatory note, the Commission stated that "[t]here is a split of authority in the case law
presently, with some courts allowing this type of sale, but others requiring some showing of emergency. This section makes it clea
that a showing of emergency is not necessary." (14)
On January 14, 1975, the 94th Congress was sworn in and the Commission's proposed changes to the bankruptcy laws, which had
not yet been enacted, were taken up again in earnest. Congress held fifty-six days of hearings to consider the Commission's
proposals in XXXXXXXXXXIn connection with those hearings, the Justice Department took the following position:
Sale or lease of 'all or substantially all of the property of the estate' goes beyond the language of the statutes presently applicable.
Sale of so much of the estate's property amounts to a liquidation which should be handled under Chapter V (the liquidation, as
opposed to reorganisation, chapter) and not in the context of an a
angement or reorganisation. Only in an unusual emergency
should such an extensive sale or lease of property be authorised without formal transfer of the case to a liquidation proceeding. (15)
In other words, the Justice Department believed that a company undergoing bankruptcy proceedings should not be allowed to
dispose of all or substantially all of its assets outside the bankruptcy plan process, absent a showing of an unusual emergency.
After lengthy discussion and debate, Congress enacted the Bankruptcy Reform Act of 1978 (the "Bankruptcy Code"), which includes
as [section] 363(b) a modified version of the above-quoted provision that was originally proposed by the Commission. Section 363(b)
of the Bankruptcy Code provides that a debtor, "after notice and a hearing, may use, sell, or lease, other than in the ordinary course
of business, property of the estate." (16) In a notable departure from the language originally proposed by the Commission in 1973,
the version of [section] 363 that was enacted by Congress does not expressly state that the sale of "all of the property of the estate"
may be conducted outside of the chapter 11 plan of reorganization process through a [section] 363 sale. (17)
III. THE BUSINESS PURPOSE TEST
While the simplicity of the statutory language in section 363 seems to grant courts almost unlimited discretion to approve asset sales
following notice and a hearing, the courts have never interpreted their mandate so
oadly. (18) After the Bankruptcy Code was
enacted, bankruptcy courts used various standards to determine if a debtor would be permitted to sell substantially all of its assets
under [section] 363. These conflicting standards resulted from (1) the fact that [section] 363 does not expressly permit the sale of all
of a debtor's assets outside of a chapter 11 plan, and (2) the incongruity between the relatively lax procedural requirements for court
approval of the dispose tion of assets under section 363 and the extensive plan disclosure and voting requirements with which a
debtor would have to comply in order to sell assets through a chapter 11 plan. (19)
It is black letter law that in selling an asset, "a debtor may not use the provisions of [section] 363 to deny creditors the protections
they would receive under Chapter 11 if the [sale] were part of a plan of reorganization." (20) On that basis, some courts took the
position that if a [section] 363 asset sale would "have the practical effect of dictating the terms of a future reorganization plan," a
debtor must satisfy all of the "requirements for confirmation of a reorganization plan--including voting, confirmation, and disclosure" in
order for a court to approve an all-asset sale. (21) The reasoning behind requiring a debtor to comply with chapter 11's plan voting
and disclosure requirements for all-asset sales is straightforward: if debtors could avoid having to satisfy chapter 11's plan approval
voting and disclosure requirements by selling assets under [section] 363, then chapter IPs creditor protections could be easily
avoided and thereby rendered meaningless. (22)
Other courts, however, took a more liberal and text-based approach in addressing when a debtor was permitted to sell substantially
all of its assets under [section] XXXXXXXXXXMost notably, the Second Circuit, in its highly influential Lionel decision, articulated the
"sound business purpose" test as the appropriate means of determining whether to approve a [section] 363 sale--a standard that has
een nearly universally adopted by courts nationwide. (24)
After reviewing "the history su
ounding the enactment in 1978 of cu
ent Chapter 11 and the logic underlying it," the Second Circuit
in Lionel held that "there must be some articulated business justification, other than appeasement of major creditors, for using, selling
or leasing property out of the ordinary course of business before the bankruptcy judge may order such disposition under section
363(b)." (25) Importantly, the Lionel court rejected the argument "that only an emergency permits the use of [section] 363(b)" for the
sale of all of a debtor's assets. (26) Rather, the court found that a debtor must have flexibility to maximize the value of its bankruptcy
estate. Therefore, a debtor is permitted to expediently sell all its assets, outside the chapter 11 plan process under [section] 363,
even absent a showing of emergency. (27)
"Neither the [bankruptcy] code nor Lionel provides any specific definition of 'good business reason"' (28) Indeed, although the Lionel
court gave factors to consider in evaluating whether a debtor had a "sound business purpose" to sell its assets under section 363, the
court expressly declined to "shackle" bankruptcy judges with rigid rules governing the exercise of their administrative powers unde
the Bankruptcy Code. Instead, bankruptcy courts are (1) to consider "all salient factors pertaining to the proceeding" to determine if
the debtor has exercised sound business judgment, (29) and (2) afforded wide latitude in deciding how [section] 363 sales should be
conducted. (30)
Because section 363 sales can generally be conducted more quickly and efficiently than sales under a plan of reorganization, (31) "in
the last twenty-five years, [section] 363(b) asset sales have become standard practice in large corporate bankruptcies." (32) During
the XXXXXXXXXXfinancial