Forty First Annual Southeastern Bankruptcy Institute

Atlanta Georgia

March 27 2015

POST CLOSING ISSUES PITFALLS DISPLTt tlIVl FRUKLLM5 JIJAI CANARISEIN THEAFTERMATH OFA 363 SALE

Paul Steven SmgermanBrian IC Cart

Robbie Thames Doonc Jr

Berger Sin german LP

Introduction

The golden order is entered and the sale closes TI he hard part is over The buyer is

insulated from all claims associated with the debtor and the assets it has purchased right7 Not so

fast the answer to that question depends largely upon events leading up to the sale and upon the

nature of the claims from which the buyer wishes to insulate itself If the parties are not careful

post closing disputes can undercut the financial justification for conducting the sale in the first

place and upset the expectations of the buyer and debtor and perhaps the debtors creditors too

But disputes and pitfalls can be avoided through proactive planning and analysis throughout each

step in the sale process In this article we will cxamine the basic assumptions regarding sales

free and clear and discuss the lore economics and law surrounding section 363 of the

Bankruptcy Code Specifically wc will consider the substantive grounds supporting the sale

order under section 3630 conflicts with state and federal law appeals and collateral attacks of

sale orders special considerations regarding intangible property governmental liabilities post

sale claims notice and due pioeess and the bankruptcy courts jurisdiction to enforce its sale

order

This article will also offer the authors views of best piacticms in iespect of the planning

and execution of sales pu suant to section 363 in order to avoid post-closing disputes Ideally

the decisions made on the journey to tbe sale order will cieate the greatest certainty possible

regarding the transaction and minimize post-closing disputes for both buyer and seller

IL Law vs Lore Pragmatic Look at 363 Sales

The ability to sell an asset or substantially all of the assets of debtor free and clear is an

essential feature of any sale outside the ordinary course of the business of the debtor pursuant to

section 363 of the Bankruptcy Code 363 Sale for the past several years it appears that the

overwhelming majonty of chaptei 11 eases are commenced in order to effectuate 363 Sales

Indeed the type of comfort and protections provided to constituents in properly executed 363

Sale are simply unavailable under non bankruptcy law By undcrstanding the core requirements

of free and clear sale parties can avoid many common and foreseeable post closing issues

The Bankruptcy Code grants the power to sell assets free and clear of interests in the

debtor property offeied for sale hereinafter Free and Clear or Free and Clear Sale

The maximization of value to the bankruptcy estate is perhaps the principal reason for the

exitence of Free and Cleai Sales Participation in comCt ale vuLtld suffer 1f

it were not possible to provide assurance to buyer that the property offered for sale is not

encumbered in any way As onc court noted

purpose behind the free and clear language is to maximize the value of

the asset and thus enhance the payout made to creditors Without the flee and

cl ai language prospective buyers would be unwilling to pay fair price for the

piopeity subject to sale instead the price would have to be discourned perhaps

quite substintially to account for the liabilities that the buyer would face simply

as result of acquiring the asset

In addition Free and Clear Sales preserve the essential function of the bankiuptcy court

as he clearinghouse of claims It would frustrate the priority scheme provided for in thc

Bankruptcy Code if creditor were able to pursue its claim outside of bankruptcy against non

debtor purchaser of asscts5

Free and Clear of Interests

The basis for Free and Clear Sale is found in section i63fj of the Bankruptcy Code

which permits trustee to sell property free and clear of any interest in such property of an

entity other than the estate There is not common and precise judicial interpietation of the

term interest Some courts have defined interest only to mean in rem intcrcsts Flowcver

several courts have recognized trend in favor of broader interpretation of interest that

encompasses wide range of obligations flowing from ownership in property.8 The broader

rcading of intcrcst in section 363f has bccn applicd to wide varicty of claims including

personal injury toit claims and claims of employment disciimination The recent report from the

American Bankruptcy Institute Commission to Study the Reform of Chaptcr ii ABI Rcform

Commissior recommended adoption of the bioader reading of secton 3631 to permit

trustee or debtor in possession to tiansfer property free and clear of all liens interests and

claims including without limitation civil rights liabihtics succcssor liability in tort and

successoi liability in contract The ABI Refoim Commission also recommended that 3631

should be applied so that the debtor in possession could not transfer property Free and Clear of

easements covenants use restrictions usutructs or equitable servituctes that run with the

land environmental liabilities and social policies that run with the land successorship liability

undcr fedeial labor laws and partial competing or disputed ownership interests except to the

extent specified in section 363h or While these recommendations do not carry the force or

effect of law they provide an insight into how courts may construe section 363f in the future

Legal Conditions Precedent to Free and Clear Sale

The Bankruptcy Code provides live circumstances in which property of the debtor may

be sold Free and Clear

if applicable nonbankruptcy law permits sale of the property free and clear of

such interest

if the holder of the interest consents

the interest is lien and the price at which the property is sold is greater than

the aggregate value of all liens on such property

the intercst is in bona hde dispute or

the interest holder could be compelled in legal or equitable proceeding to

accept money satisfaction of its interest

If the piopunerit of the sale can show that one oi mote of these faLtols is mci and all

interest holders have received sufficient notice the debtoi in posscssion or tiustee is permitted to

sell Free and Clear of all interests

Preemption and Conflict with Other Statutes

The essential featuie of Free and Cleai Sale is to cut off rights of non debtor thhd

parties created by non-bankruptcy law In the ease of liens and other irad uonal securcd interests

in property the conflict is apparcnt Occasionally however non-bankruptcy law creates interests

that conflict with section 3631 in more subtle way bnt creatc conflict all the same

The In re Skyline Manor case involved the sale of health care facility that under state

law was entitled to use depreciation as fixed cost in its calculation to receive reimbursement

for Medicaid care However applicable state law pcrmitted Nebraskas Department of Health

Human Services DHHS to seek repayment referred to as depreciation recapture fiom

such facility if it were evcr sold for profiti DHHS objected to the proposed sale of the

facility It argued that the right of rccapture was not an interest in property.4 And in the

alternative DI-IHS argued that the buyer of the facility should bc assigned lower cost basis

which would essentially preserve DHHS recapture rights at later date to the detriment of thc

purchaser

lilti nately the Skyline court held that the recapture right was an intcrcst within thc

meaning of section 363f and specifically held that that the property could be sold Free and

Clear because the recapture interest could be satisfied through monetary payment under section

36315 In reaching this conclusion the court relied heavily upon the reasoning found in In rc

WBQ Partnership.5 Like in Skyline the WBQ court was faced with state law concerning

Medicaid depreciation iecaptuie16

Specifically the WBQ couit consideied whether thc state law

iecaptrue right was preempted by the Bankruptcy Code At the outset the court explained

Congress has not displaced state regulation entuely it niay nonethcless pre

empt state law to the extent that the state law actually conflicts with federal law

Such conflict arises when compliance with both state and federal law is

impossible or when the state law stands as an obstacle to the accomplishment and

execution of the full purposes and objectives of Congiess

The WBQ court found conflict existcd between the applicable state law recapture rights

and the Bankruptcy Code and held that the recapture right contiavencd the Bankruptcy Code

Free and Clear language by creating statutory form of successor liability18

It then entered

the sale order providing for the sale of the property Free and Clear of the iecapture right.9

Federal Statutes in Conflict

Federally created interests are not subject to special protection from Free and Clear Sales

For example the Bankruptcy Court for the District of Delaware held in In re Ormct Coip that

ERISA2 and MPPAA2 liabilities do not survive Free and Clear Sale22

Ohecting to the sale

of the debtors assets the Steelworkers Pension Trust aigued that Congress expressed strong

public policy to protect workers iights through the enactment of ERISA and the MPPAA the

lattcr of which statutorily creates successor liability where the buyer had notice and there was

continuity of opctations between the seller and the buyer23

Rejecting this argument the Ormel

court held that

Although Congress has expressed strong policy in favor of protecting multi

employer pcnsion plans it has also articulated strong policy in favor of

preventing sex and employment disciimination including the creation of successor

liability for those claims Nonethehss the Third Circuit in TWA held that sale

under section 363 can be free and clear of successor liability claims Similarly

Congress has expressed strong interest in protecting the medical benefits of coal

workers including the imposition of successor liability Nonetheless the Fourth

Circuit concluded that claims foi successor liability for thosc benefits may also be

extinguished by sale of assets under section 363 of the Code24

Thus the Bankruptcy Codc provides the ability to sell Free and Clear despite federally

mandated successor liability That is not to say that ongoing regulatory obligations arc

suspended his issue is explored further infra

Conflict Within the Bankruptcy ode Sections 3630 and 365h

There is some inconsistency within the Bankruptcy Code itself specifically in regard to

the interplay between sections 363f and 365h Scction 365h allows non debtor party who

is lessee of non-residential real cstate where the debtor is the lessor to elect to remain in

possession upon debtors rejection of the lease Courts are divided as to whether conflict

exists and whether the right to ietain possession in section 65h can trump section 363f

Id at

Id at citation omitted

25Section 365hIA providcs in relevant part as follows

If the trustee lejects an uncxpired lease of real property indei whch the deb or he lessoi

and ii if the te of such lease ha commenced the lessec may tutu its right und such

lease icluding rights such d5 those rclating to the amount and timmg of payment of ient and

othm amounts payable the lessec and any right ot use posse-sion quiet enjoyment -ubiettirg

as igrment hypotfecation that arc in or appurtenant to the real operty tor the balance of the

term of such lease and foi ny rcncwal or extension of such rights to th cxtent that such righ are

ifoi ceab undei applicable nonhankruptcy law

a

as a matter

it

or

courts

29

statutes

B.R. Ill. I

161-2 Rec. Ill 0752-0

between thent31 The court concluded that the woid interest in section 63f subsumed the

lessees posscssory intciest under the subject lease32

The court also noted that neither

section 3631 nor section 365h cross teference the other as one basis to rcjcct the prevailing

view that section 365h trumps section 365f Next the Seventh Circuit concluded that

section 365h applied only upon rejection and that Free and Clear Sale was not rejection

and drew distinction between rejection and repudiation

Cases following the minority view that section 63f controls primarily rcason that

Free and Clear Sale doesn implicate section 65h because there is no rejection of the lease

As noted in Drshi Sons the reasoning behind this viewpoint is as follows section 363f

authorizes the sale of any interest in pioperty so long as one of the five conditions set forth

therein is met and neither section 363W nor section 365h cross-reference the other both

statutes should be construed to avoid conflicts when possible and here both can read in

hanuony and ni lessees can rely on section 63e to preserve their rights6

Plainly whether property offered in Free and Clear Sale is subject to the continued

possession of tenant could severely impact the value of that property Therefore the debtor

should scck to eliminate any doubt before proceeding with the sale process and purchasers of

assets which include the debtors interest in properties leased to thud parties should take special

Id at 544 citations orritted

Id at 545 cit ng Black Law Dictiona 816 7th Ed 1999

Id at 547 The absence of any cross ieference also uts against Vie propo itio that Ban iotcy Code scctior

363f trumps section 365h

Id ciiauon omiited

care in respect of the notice given to lessees and the pre sale detcrmination of the nondebtor

lessee rights

Ensuring that the Sale Order is Entered on Valid Urounds

In order to avoid or minimize post closing ssues it is important to be mindful of the

conditions piecedent to valid Free and Clear Sale and likewise any potential grounds that

could be raised in an appeal of Free and Clear Sale Often party objecting to Free and Clear

Sale will allege that its claim cannot be satisfied monetarily7 Even if the 363 Sale implicates an

interest that is not typically satisfied monetarily several courts have chosen to find that section

36305 is satisfied so long as the interest has the potential to be reduced to pecuniary terms

which greatly broadens the scope of section 36305 For example the In re Trans World

Airlines Inc ease involved proposed sale of substantially all of TWAs assets to American

Airlines The Equal Employment Opportunity Commission the EEOC which asserted

discrimination claims against TWA along with former airlinc flight attendants who received

travel vouchers in connection with settlement objected to the sale The objectors argued that

the sale was improper because they could not he compelled to accept money in satisfaction of

their claims38

he Third Circuit held that both the EEOC and flight attendants travel voucher

claims were subject to valuation and therefore met the requirements of section 363fj59

Courts citing TWA have largely neglected to address the applicability of the subject to monetary

valuation test outside the Third Circuit40

The monetary satisfaction languagc found in section 36305 states that property may be

sold Free and Clear if the interest holder could be compelled in kgal or equitable

pi acceding to accept moncy satisfaction of such interest41

lie reference to proceeding

has caused split in inteipretation Some courts have held that hypothetical proceeding is

sufficent to find that claim may be satisfied by monetary payment while others ha

construed section 6305 more iestrictively and held that such proceeding must be actually

possible under the facts of the case before the court43

For example the Bankruptcy Court foi the DistIict of Washington upheld sale Free and

CleaI of junior lien where legal and equitable proceedings existed under non bankiuptcy law to

compel junior lienholder to accept monetary satisfaction Among the hypotheticals listed in

the opinion the court offered liquidation of probate estate personal property sale and federal

tax lien sale as examples to support its conclusion.45 Factually the sale in Jo/an did not involve

any of these types of proceedings it was sale of personal property consisting of bar furnishings

to the debtor land ord46

In similar fashion Judge Ray in the Bankruptcy Court for the

Southern District of Florida in Levitt ons read section 6305 to mean that hypothetical

11 13 363f5 2012 cmphasis added

In lolan Inc 403 866 870 Banki Wash 2009

In re Harris 10 74280 WSD 2011 WL 5508861 at Bankr ED Mich Nov 72011 hypothetical

proceeding con emplated by 3635 ccd the very least to be legally possible cit ng Clear Channel

Outdoor Icc Knupfe In re PW LLC 91 25 4546 B.AP 9th Cir 2008

Jolan 403 at 869 70

Id ai 870

Id at 867

proceeding would hc sufficient Judgc Ray emphasized that is important to focus the

hypothetical nature of language of section 36305

But not all courts interpret the proceeding requirement ot section 363f5 to bc satisfied

by hypothetical proceeding not possible under the facts of the case under consideration

Rejecting an argument that an eminent domain taking satisfied section 36305 the Bankruptcy

Court for the District of Massachusetts held that thc only logical interpretation of the language

of scetion 36305 is that the statute requires that the trustee or thc debtor be the party able to

compel monetary satisfaction for the interest which is the subject of the sale48

Some have opined that under the more iestrictive vicw loan secured by mortgage

would havc to be in default before foreclosure could be used as proceeding to qualify undcr

section 363f5 But according to Haskcll foreclosurc could not under normal

circumstances be compelled by debtor or trustee and would thus not be availablc to satisfy the

proceeding requirement On thc other hand broad reading of section 363f5 could mean that

hypothetical proceeding would almost always be availablc part culaily in the ease of real

estate which is arguably always subject to an eminent domain action

HI ChaHengng 16 S1e

The certainty that buyer is receiving the assets it is buying Free and Clear is what

makes 363 Sales the holy grail of asset sales But the lynchpin of the Dee and Clear Sale is its

finality Rule 6004 of the Federal Rules of Bankruptcy Pioeedure iequires that sale be stayed

for fourteen days after entry of the sale order unless the couit oiders otherwise court may

waive the stay pet iod if it concludes that time is of the cssenee in order to close the sale

Appeal of Sale Pursuant to Son363m

The Bankiuptcy Codc cleaIly indicates that absent unusual circumstances including

stay pending appeal 363 Sale is not subject to typical appellate review Under section

363m unless sale is stayed pending appeal reversal or modification on appeal does not

affect the validity of the sale Standing to obtain stay iequires that the party be

aggrieved An aggrieved person has financial stake in the order when that order

diminishes their property increases their burdens impairs their rights

Typically parties that will seek to challenge sale include those who will allege that their

rights weie wrongfully terminated by the sale trustee who alleges that the sale was subject to

collusive bidding or dissatisfied competing bidder who has standing to appealDO

party wishing to lodge serious challenge to Free and Clear Sale order must seek to

stay the sale pending the appeal If stay of the sale pending appeal is not granted barring

Fed Bankr 6004

extrao dinary circumstances the sale is for all practical purposes final7 The Third Circuit

explained that Unless the sale is stayed pending appeal the tiansaction survives even if it

should not have been authorized in the first place In the words of the Eleventh Cii ewt if

sale is not stayed the failure to obtain stay renders the appeal moot To obtain stay the

aggrieved party must show that the factors consideied in granting preliminary injunction have

been met And those factoi arc

whether the movint has shown likelihood of success on the merits

whether the movant has made showing of irreparable injury if the stay is not

granted whether the granting of the stay would substantially harm the other

parties and hether the granting of the stay would serve the public mterest

As practical matter the bankruptcy court that approved sale iarely grants stay

pending appeal unless new facts have come to light or clear legal error can be demonstrated

In practice most consider pursuit of an appeal without stay pending appeal an exercise in

futility

Ininority of courts hav questioned whether section 63m is intended to provide Free

and Clear Sales absolute imInunity when stay pending appeal is not granted In Clear Channel

saL of property puisuant to section 363 was approved over the objection of the junior lien

iough an appeal may he considered nal collateral sck on sale order remain po hle even if stay

pending appeal oi gianied The In re Global Eneigics cc discussed infra demo istraies il atihougF hghly

unlikely 363 Sale can be unwound years after it is consuismated

58

in te Coni Au lnes 91 3d 553 570 3d Cir 1996

holder for less than the total amount owing on all liens.62 Ihough the junior lien holder

appealed it did so without obtaining stay of the sale order pending the appeal.63 Thus the

senior lien holdei that credit bid closed on the sale before the appeal was heard

On appeal the trustee and purchaser argued that section 63m deprived the court of the

ability to affect the sale rendering the appeal moot65

Applying an unusual interpretation of

section 3630 the Bankruptcy Appellate Panel for the Ninth Circuit held that Section 363m

thus cleaves distinction between authoiizations to usc sell or lease property of the estate as

set forth in section 363b and authorizations under section 363f to sell property under

subsection or of this section free and clear of any interest in such property66

Under

this interpretation the BAP held that though the sale itself would not be reversed section 363m

did not bar icinstatement of the junior lien67 The BAP held that the provisions of section 363f

had not been met and therefore reversed the bankruptcy courts sale order with respect to the

junior lender lien68

Clear Channel represents shocking and unsettling outcome for purchasers of property

in bankruptcy The purchaser in Clear Channel believed it had acquired the real property in

question Fice and Clear of the junior lien It is not cleaI whether the BAP in Clear Channel

would have ruled diffeiently had the purcfaser been third party rathe than the senior

Clear Channel Outdoor Inc Knupfei In PW LLC 391 25 32 9th Cu 2008

611d

SI

Id at 30 32

Id at 35 39

66Id at 35

671d

UbId at 47

lienholdei who acquired the property via credit bid Clear Channel stands as warning not to

overestimate the importance of establishing that at least one of the section 363f factors has

been met and including fact specific findings and rulings in that regard rather than relying on the

magic language of Fiee and Clear order Because the Clear Channel intcrpretation of section

363m is so divergent from accepted jurisprudence throughout thc country it is difficult to

anticipate how best to adjust ones practices in light of Clear Channel Perhaps it is so unusual

that absent other courts adopting similar reasoning constituents need not doubt the finality of

appeals pursuant to section 363m

Collateral Attacks on Sale Orders

Aside from an appeal of sale order under section 363m an objecting partys only

other option is to challenge 363 Sale collaterally in accordance with Rule 60b of the Federal

Rules of Civil Procedure Rule 60b incorporated into the Federal Rules of Bankruptcy

Procedure in Rule 902469

rare example of successful appeal on these grounds is found in

the Eleventh Circuits recent and extraordinary decision In re Global Energies LLC7

Presented with evidence of alleged discovery and attorney misconduct the Eleventh Circuit held

that the appellant was entitled to relief from judgment under Rule 60b effectively unwinding

sale consummated several years before

In Global Eneigics the alleged paItial ownei of the debtor entity Wortley suspected

collusion among the other owners and petitioning creditors to wrest away his interests in the

company and moved to dismiss the involuntary bankruptcy case alleging the petition had been

filed in bad faith2 The motion was withdiawn for lack of ev denee and sworn testimony to the

contrary this testnnony was later found to be false73 Between the time that the motion to

dismiss was filed and then withdrawn the debtor sold substantially all ot its assets to Uhnspus

an entity controlled by another co owner of the debtor About ycai later in related state court

litigation Wortley obtaincd discovery that included emails evidencing plan to divest him of his

interest in the debtor through the filing of an involuntary case which directly contradicted prior

sworn testimo sy offered to rebut Wortleys allegations5 The Eleventh Circuit found that the

emails were responsive to diseoveiy requests made by Wortley in the bankruptcy ease and were

not produced76

Moreover the emails were dispositive on the issue of bad faith filing accoi ding

to the Eleventh Circuit77 Indeed the three judge appellate panel remarked that it would be

clear error to interpret the emails as showing anything other than conspiracy to have

Chrispus file the bankiuptcy petition in bad faith

The Eleventh Circuit reversed the district court which had affirmed the bankruptcy

court and ordered the bankruptcy court to vacate its order approving the sale to Chrispus and to

do so without prejudice to any innocent third parties whose rights and interests are derived and

dependent upon the sale

al 1345

at 134546

al 1346

at 1346 47

350

The facts in the Global Fncigies case are bad and bad facts are known to make had law

The Eleventh Circuits opinion is diamatic and the practical ramifications of its oider and its

mandate that its ruling is without prejudice to the rights of third parties who transacted business

with the debtor successoi company for ovei three years are nearly inconceivable80

But there

is language in the Eleventh Circuit opinion in Global Eneigies that is sure to find its way into

cases with less dramatic facts brought by disappointed parties

IV Pi in Poke Know What You are Buying

It is said that unsuspecting buyers in medieval Europe fell victim to scam whcrein they

were sold what was advertised as pig in bag or poke in the parlance of the time sight

unseen When the buyer opened the bag it was not pig hut cat or dog hence the

expression pig in poke8i As outlandish as this scenario is today it teaches valuable

lesson with significance far beyond purchases of bagged livestock In the post-Internet era what

buyer seeks to acquire may be less about tangible property and more in the nature of intangible

or intellectual property including anti or non-competition covenants proprietary information

supply contracts and customer data that comprise the heart of the enterprise the buyer seeks to

icquire

Look in the Bag

Comprehensive pre closing due diligence can prevent an ariay of post closing issues

Often because of the financial distress of the debtor seller meaningful due diligence may be

difficult to conduct due to lack of access to knowledgeable employees who iy no longer be in

thc employ of the debtor ii adequate books and records and othcr factois Regardless of these

obstacles the purchaser needs to know what it is buying and the tiustee needs to know what it is

selling rarely does any constituent benefit from ambiguity on this point in the long run

Uncertainty as to ownership and iights to transfer propcrty are mote likely to occur when

the propcrty is intangibic dcbtor or trustcc may mistakenly believe that it holds interests in

property that it does not For instance in the case of In rc Girton the trustee had in prioi

action dismissed preference and fraudulent transfer proceeding in connection with an

agreement calling for the preference defendant to purchase the debtors inventory and all of the

intangible property of the Debtor 82

Subsequently thc trustce offered releases of non

competition and non disclosure covenants contained in employment agreements as part of later

settlement with another party.83 The BAP foi the Sixth Circuit held that the non competition and

non disclosure covenants were intangible property that had already been transferred as part of

the first settlement with the preference defendant and therefore were no longer property of the

trustee.84

Girton teachcs very practical and seemingly obvious lessotr avoid using broad

lannuage in contracts transfeiring intanuibles unless the sale truly contemplates the transfer of all

intangible property owned by the dcbtor

prospective purchaser should evaluate the bundle of property rights it wishes to

acquire both tangible and intangible and perform due diligence to ensure that the debtor does

52In rc ron Cakes Burgei Inc 326 901 6th Cir 2005 In prior action the trustee smissed

pieteience ard iaudu ent tran fer oceedi ig ii etw tor ihe creditor purchase oft ie debtors invento at

pa ment of $50 000 md credit bid of $20 000 for specified operty of the debtor ncluding all of the intangible

pioperty of the Debtor Id The BAP foi the Sixth Ci cuit held that non co npetition and non disclosure covenants

contained ii an employment ag cement weie intangible opeity rm isferred as part of the agreement ard therefore

the rustee could no offei ieleasc of hose covc Mn in subsequert settlerie it Id

indeed have the power to convey such property What is the value of customer list in deal

involving the purchase of retail opciation Is supply contIact make or break term of thc

deal7 Arc cniployees of the debtor hound by non-compete agreements that arc cnforccahlc after

the Free and Cleal is consummated even if the consummation of thc 363 Sale results in the

liquidation of the debtor and the cessation of its operations These are just few examples of the

questions purchaser should consider in order to thoughtfully approach 363 Sale

Employment Agreements Covenants Not to Cojte

When acquiring substantially all of debtors assets many purchasers want assurance

that thc employees of the debtor will not become new source of competition by organizing

new entity or joining another competing company in the same industry To resolve this

pioblem potential purchaser may request that it be assigned any existing non competition

and/or confidentiality agreements with the debtor employees Additionally the employees of

the seller/debtor may be willing to enter into new non competition agreements if offered

continued employment or other compensation

Non competition agreements are governed by state law And not all states agree on the

appiopriate scope in respect of the enforceability of non compete agreements or whether such

agreements arc enforceable at allIS Thus buyer should very early in the process evaluate

applicable state law to determine whether non compete agiccment would be valid and

enforceable in the relevant jurisdictions

If puich sci seeks assignment of prc existing non compete agreements such purchaser

should be aware of certain pitfalls First an objecting party may argue that the agreement

which is likely part of an employment agreement is an agreement for personal services that is

not assignable86 However some courts have found little trouble in assigning contract that

attempts to keep the employces from performing rather than an attempt to assign the

pcrformanee of personal service87

The next hurdle is to analy7c whether the employment

agreement will be executory at the time of thc sale If for example an employee bound to non

compete agreement resigns or is tenninated prioi to salc court could find that the non-

compete can no longer be assigned to purchaser because the undeilying contract is no longer

executory.88 Such contract would not be executory in part because the obligation to continue

to abide by the terms of non-compete agreement by itself is not enough for court to deem

contract executory.89 The Bankruptcy Court for the District of Hawaii has held that non

compete agrcement that obligated the employer to make severance payments did not preserve the

executory status of an employment agreement containing covenants not to compete.9 If buyer

purchases substantially all of debtors assets and is not assigned the relevant employment

Reynolds Reynolds Co Hardce 932 Supp 149 155 E.D Va 1996 aJJd 133 3d 916 411 Cir 1997

Dividmg lefendants contract and allowing portions of it to hr assigned while disC Ilowing assignment the

whole is inconsistent th this Virginia piecedent applying rginia law

571n Hearing Centers of Am mc 106 719 722 Barkr M.D Fla 1989

Even if the Bankruptcy Code does rot provide for assgnment nc provisions of the relevant contract or applicable

sta law can provide alternative grounds for assign itent With the aid of Tennessee law permating assignment of

noncompetition agreement in the absence of language to the contrary thc bankruptcy court in in it Vi zonArneri

in held hat the debtors cou assign non compcte agreements even ifthc undei lying employment grccments were

ound io be non executury No 01 4ol5 uOl WL 09i iqi at tbankr WD Tenn Sept 12 uul

in re Schneeweiss 233 28 32 Banki 1998 An obligation to cnmp with restrictive

cover ant such cover art not to compete cs not constitute material obligation and contract und wh ch

one party trus iefrain from competing is therefore noi executoiy unde the Countryman definition of an exccutory

contnct

agreements that buyer would likewisc not havc standing to enforce those non-compete or non

disclosurm agi cements1

buyer may seek to eliminate the issue of whethcr particular contract is executoiy or

non executory at the time of the proposed tiansaction by agreeing to employ all employees of the

debtor upon closing llowcver if huycr agrees to hire some or all of the debtois employees

the buycr should be prcpaied to hire the employees designated in the asset purchase agreement

APA if the buyer fails to do so those employees may seek enforcement of the \P as

third paIty beneficiaries In the case of In re Quincy Medical Ccntcr two fonner employees of

the debtor Employees sought relief against the buyer of the debtors assets alleging that they

were owed severancc pay he Employees argued that the buyer agreed to employ all of the

debtors employees associated with the medical facility at the time of closing and if the buyer

terminated the employment of any of these employees the APA obligated the buyer to pay

severance payments The buyer asserted that the Employees lacked standing because the APA

contained an express disclaimer of third party rights96

Quincy court held that the buyers

agreement in thc APA to employ the debtors employees manifested an explicit intent to benefit

See In re Fifty Below Sales Mktg Inc 490 B.R 885 Bankr Minn 013

92For the sake of simp icity the term APA includes all ancillary agreerrents attcndant to thc sale

In Quincy Med Ctr Inc 479 B.R 229 237 Bankr Mass 2012 holding that spite the cxi tence of

hoilcr plate no4hird-party-bencticiary clause the APA evidenced an intent to make employees ot dcbtor

beneficiei ies under the APA3

479 229 230-31 Banki Mass 2012 The two former employees Iso ft ed idministrativc expense

claims which wcrc dcnicd Id

class of non party beneficianes to the APA and that this intent trumps the boilerplate no

third party beneficiary clause found elsewheie in the APA97

Jiranchise Agreements

Though conceptually they share similarities with non compete covenants in employment

cortncts franchise agreements aic subject to section 365cl and without consent are

generally not assumablc and assignable if such assignment is impermissible undeI state law 98

State law supporting franchisor rights seem to have influenced widespread preclusion of the

unfettered assignment of franchisee rights under such contracts

Government and Regulatory Concerns

Just the mention of environmental regulatoiy or tax liability can causc some to shudder

With forethought however these kinds of issues should not pose post-closing surprises For the

most part the debtor may convey its property flee of interests related to pre closing obligations

but the buyer must comply with continuing regulatory environmental and tax obligations

Governmental inteIests not immune from the Free and Clear provisions Tax liens in

the context of 63f for example are treated like all other liens As for taxes attenda it to the

sale transaction itself Piccadilly Cajeterias clarified that the documentary stamp tax exception

under section 1146 is only ipplicable to sale conducted pursuant to confirmed plan thereby

excluding most 363 Sales from the tax saving provisions of section 1146 c9

Idai2J7

98/n re Pio ieer Foid Sales Inc 729 2d 27 Is Cw 1984 In re Van Ne uto Plan Inc 20 BaikCal 990

Environmental Liabilities

Fnvironmental issues pose problems that generally span years and create liabilities that

attach to property which local and federal agencies such as the Environmental Piorccuon

iency the LPA may pursue against subsequent purchasers of the affected rcal property

And it has become increasingly important whether the iemediation ordcrcd cm be reduced to

monetary obligation Much of the jurisprudence on this issue is in the context of discharge and

whether the environmental liability is claim within the meaning of section 1015 of the

Bankiuptcy Code The seminal case in the context of environmental liability is Ohio

Kovacs In that case the Supreme Court held that an ordei to clean up environmental waste

was claim dischargeable in bankruptcy because it had been reduced to an obligation to pay

moneyiOi

Subsequent to Kovacs many courts have drawn distinction between environmental

liabilities that can be reduced to monetary obligation and those that cannot

Though the Comprehensive Environmental Response ompensation and Liability Act

CERCLA2 is perhaps the most rccognizable statute used by the EPA to remediate

environmental damage the Resource Conservation and Recovery Act RCRA3 presents an

important issue for consideration Unlike CFRCI the RCRA does not provide for monetary

compliance and only permits injunctions104

This issue arose in United States Apex Oil where

Circuit Judge Posner held that an injunctive order requiring successor owner of an oil refineiy

to clean up contaminated site did not give use to claim within the meaning of the Bankruptcy

Code and thus the governmenfs claim was not dischargeable.5 After Apex Oil some

wondeied whether section 363t could accomplish what ieorganization under plan could not

or now it appears that property can be sold free and Clear of injunctive interests despite the

fact that Apex Oil teaches that such an outcoinc is not possible within the confines of chapter

11 reorgamzation For example the 1A1 court approving sale of substantially all of the assets

of the GM debtors Free and Clear of environmental liability including injunctive orders that

existed at the time of the sale and held

The Enviromnental Matters Objectors understandably would like New GM to

satisfy cleanup obligations tl at wcrc thc responsibility of Old GM on theories of

successor liability For ieasons articulated above however the property maybe sold free and clear of such clanns Under section 363f there be no

successor liability imposed on the purchaser for monetary obligations related

to cleanup costs or any other obligations that were obligations of the seller But

the purchaser would have to comply with its environmcntal responsibilities

starting with the day it got the piopcrty and if the property required remediation

as of that time any such remediation would be the buyer responsibilityi06

Though the precedcntial value of GM is uncertain most practitioners agree that property

may be sold Free and Clear of environmental claims if those claims are fines penalties or orders

that can be reduced to some monetary sa isfaction

Post Closing Protections

In asset sales outside of bankruptcy purchasers typically seek to define their expectations

in the sale contract through rcprcscntations and wai ranties If the buyer later discovers that the

purchased assets fall short in some material respect to the representations and warranties the

buyeI typically has recourse against the seller for certain period of time In bankruptcy it has

becomc mcrcasingly common to mcorporate su ilai mechanisms If debtor is reoiganizing

then buyei may be satisfied with negotiating for the post closing survival of certain

representations and warranties much like typical non bankruptcy asset sale However

buyer iecourse will bm severely curtailed if debtor is liquidated and ceases to exist even if

certani representations and warranties survive closing In such situation representations and

warranties or even an agreement to indemnify the buyer are usually meaningless

Because debtor may not be in position to provide an on-going indemnity in regard to

any of the foregoing issues purchaser may protect itself by holding back portion of the

purchase price in eseiow until issues defined in the escrow agreement are resolved For

example buyer may wish to negotiate hold back in order to verify that the environmental

liabilities including ongoing obligations comport with what was represented in the APA

Another protective nieehanism available in larger eases is for non-debtor perhaps non-debtor

affiliate of the debtor or creditor to provide an indemnity because it has an interest in secing

the sale close

Representations and warranties indemnification agreements and eserows all help to

mitigate loss but the best means of minimizing the need to rely on any such measure is to gather

as much information as possi le at the front end of the transaction

Late to the Party Notice Successor Liability and Unknown Claims

Notice is thc constitutional rinc qua non to give the provisions and safeguards of section

630 teeth In Gi uniman Olcon case involving an unknown claimant the District Court for

the Southern District of New York explained that Generally speaking jnadequate notice is

defect which precludcs discl arge of claim in bankruptcy07

In addition thc Grumman Olson

court noted that Courts have held in general that for due process reasons party that did not

ieceive adequate notice of hankruptcy proceedings could not be hound by orders issued during

those proceedingsI5 And other courts have likewise found that publication in several national

publications cannot serve as prophylactic in regard to claims arising post-confirmation9 If

party has notice that partys failure to timely raise an objection under scction 363 of the

Bankruptcy Code in accordance with court order requiring objections to be made by certain

date iesults in waiver of the objection10

Claims Accruing PostSale

Wheie notice and 363 Sales intersect in one of thc most impactful ways is in the context

of unknown claimants who may have claims arising in connection with products puichased pie

petition that accrue post petition The term claim is defined in the Bankruptcy Code in section

1015 In order to determine when such claim arises the Eleventh Circuit fonnulated the

Piper Test which determines whether one has bankruptcy claim as follows

individual has 1015 claim against debtor manufacturer if events

occurring before confirmation create relationship such as contact exposure

impact or privity between the claimant and the debtors product and ii the basis

for liability is the debtors prcpctition conduct in designing manufacturing and

selling the allegedly defective or dangerous product he debtors prepetition

conduct gives rise to claim to be administered in case only if there is

relationship established befoie confinnation between an identifiable claimant or

group of claimants and that prepetition conduct

Id at 706

If the alleged claim falls under he Pipci lest then the claimant cannot be deprived of his

or her claim without due process notice12

The piospect of unknown claims and claimants

has been relevant in both the CM and Chrysler bankruptcy eases However neither the

Chrysler nor GM courts squarely addressed in their holdings whethei sale could be made Free

and Clear of future claims114

Addrcssing fact pattern that is highly foreseeable for the

purchasers in both the GM and Chrysler cases in the years to come the United States District

Court for the Southern District of New York in Grumman Olson held that the plaintiff was not

barred from pursuing successor liability claim against purchaser of assets on the basis of an

injury suffcred after entry of the sale order despite the order containing very broad Free and

Clear language115

Though the truck allegedly causing the injury in Grumman Olson was

manufactured by the debtoi approximately nine years prioi to the 363 Sale the court held that

Enforcing the Sale Order against the to take away their right to seek redress under

state law theory of suecessoi liability when they did not have notice or an opportunity to

participate in the proceedings that resulted in that order would deprive them of due process16

112discussi ig he Pipcr Test the Grumman Olson court otcd that Many of the decisions evalu it ng the ettect

bankruptcy cour orders on future claims se outside ihc Section 363 silo context and ilstMd turn on the scone of

the term cia itsclt the ba ikruptcy context and thc dcgree to which those future claims could be considered

claims dischaigcd in the bankruptcy Grumman Olnn 467 B.R at 703-04

113In te General Moims Coip 407 463 520 FN Bankr S.DN.Y 2009 approving sale no and clear

of future claims the fullcst cx cnt constitutionally permissiblc In rc irysler LLC 576 F.3d 108 2d Cir

2009 declining to addicss whethe sale order could be enforccd against claimants who although presently

unknown an umdertihcd might Fave claims the future arising from previously produced ve3ic1c vacated on

other grounds Indiana Stale Police Pensio Trust irysler LLC 558 U.S 1087 2009

Also the Secord Circu Fa not adopted he Piper Test exp essly 5cc Grumman Olson 467 B.R at 705

AltF ough the Second uirc ut has ncvci cribraced the Piper tesS the basic appiuach articulated in Pipei is

consistent with the Second Circuits Folding in Chateaugay wFich requircd pro-confirmation relationship between

the laimant and the debtor befric hc cia mant could iave its clams dcalt with in the bankruptcy citing/nrc

Chateaugay Corp 944 2d 997 1004 2d Cii 991

hough the shadow of successor liability looms large in light of Grumman Olson it is

important to note that no finding of successor liability was considered the court meicly allowed

the plaintitfs to pursue thm action in state court

Successor liability

It is critical that asset purchasers undci stand successor liability issues in connection with

their formulation of bid to buy the assets or enterprise of debtor and the protections that may

be expected from Free and Clcai order Successor liability is rooted in state law and varies

from state to state Many states consider the following factors in determining whcther successor

liability should be imposed upon an asset buyer

the existence of an express or implied agreement regarding the assumption of

debt between the companies whether the transaction amounts to dc facto

merger whether the purchasing company is mere continuation of the

selling company or whether the transaction is fraudulent attempt by the

selling company to escape liability for its debts

Because sale order is likely not enforceable against party that received no notice

actual or constructive purchaser should be cognizant of the applicable successor liability

factors when structuring the tiansaction and not rely on the languagc of Free ard Clear ordcr

alone particularly when the prospect of unknown claims is likely

Jurisdiction to Enforce The Sale Order

Assuming that the sale order is properly entered enforcement of that order can become

important issue post closing Title 28 of the United States Codc provides that bankruptcy courts

Bud AnUe Inc Festein Food Ii 758 2d 1451 145611 Cu 1985 applying Georga law Klcen

Laundry Total Waste Mgmt Cc ip 817 Supp 225 230 1993 see also Milliken Co Dc ro

Textiles LLC 88 44 Th4 Mass 2008 Forsee Fefams LI VA uiu vui oiur Vv 37584at 10 Ga Jan 26 2010 noting that coin non identity of the ofliccrs directors and stockholdcr in ihe

selling and purchasing corporations is ke element regarding mere continuation

enter

core

matters

can as a non-core matter.

a

matter must

most a

matter

estate.

S.

are defined

F.2d ( 11 H

In practical terms the lions shaie of disputcs attendant to 363 Salc will concern

disposition of property of the bankruptcy estate that do not implicate constitutional Stern Claim

issues and are likely core Whcre the jurisdictional issue arises is when an interest holder in

the relevant property has claim that is based on purely common law grounds or non debtor

parties commence an ancillary dispute on state law grounds127

For example declaratory action

brought by American Airlines as purchasci of TWA in iesponse to infoI mal assertions made by

Carl Icahn and his entities that the purchaser induced the debtor to file bankruptcy was found to

be non core because the action sounded in tort against non debtors pre petition actionsi28

The practical impact of Stern and its progeny is that parties to sale should identify any

issues that could be classified as non corc and request the court to entcr final order with

accompanying findings of fact and conclusions of law so that in the event that district court

deems matter non core but agrees with the outcome it may adopt the findings of the

bankruptcy court without disturbing the effect of sale order whatsoevcr129 On related note

bankruptcy courts arc of course constrained by the Bankruptcy Code And under the express

language of the Bankruptcy Code section 363 is only applicable pre confirmation Because of

this bankruptcy court lacks the lurisdtction to conduct 363 Sale post confinnation As thc

In Nor/hem Pipeline Justice Rehnqwst dicw an -i cane but useful distinction with the stuff of the traditional

actions at common law tried by coui ts at Wcstmi ister ii 1789 Pipelinc Const Co Marathon Pipe line

Co 458 50 90 1982 An instruclivc te whethei the action bcing brought is the stuff of Westminster

moaning that such cause of action existcncc pieceded not only bankruptcys statutory scheme in the Act and th

code but also the enactmert ary fedeial statu See md

In re rans Woi Id Airlines Inc 278 13 47 49 Bankr Del 2002

Bankiuptcy Court foi the District of Nebraska explained Post confirmation sales of asscts are

accomplished pursuant to terms of the confirmed plan or since the debtor is generally outside of

the jurisdiction ot bankruptcy court within short period 01 time alter contirmation of plan

such sales aie accomplished puIsuant to non bankruptcy lawi31

VL Conclusion

Much of the discussion regarding post closing issues revolves around decisions made at

or long before the time of the sale The recurring theme is that thoughtful analysis of the

transaction thorough due diligence adequate notice which can vary substantially depending

upon the natuie of the debtors business and the types of post-closing claims that may be of

special concern to the buyer and careful drafting will avert most post closing issues