Section 363(m) Circuit Split Headed for SCOTUS Review

Bankruptcy sales under section 363 of the Bankruptcy Code are a pervasive feature of modern chapter 11 practice, and section 363(m) protects the reliance interest of buyers by providing that the “validity of a sale” to a good faith purchaser cannot be affected by a later reversal or modification on appeal of the order authorizing the sale, unless the order was stayed pending appeal.¹

The United States courts of appeals are divided as to whether section 363(m) of the Bankruptcy Code is “jurisdictional” such that failure to obtain a stay of an order approving a sale or lease is a jurisdictional bar to appellate review, as the Second and Fifth Circuit Courts of Appeals have held,² or whether section 363(m) is not jurisdictional and only limits the remedy that an appellate court may fashion that “does not affect the validity of the sale,”³ as the Third, Sixth, Seventh, Ninth, Tenth, and Eleventh Circuit Courts of Appeals have held.⁴ Although this distinction may seem technical, the differing approach of appellate courts can have a significant practical effect because bankruptcy court sale orders in value-maximizing transactions often address matters that are of immense importance to asset purchasers and other parties, but which potentially fall outside the sale validity question.

Background

The instant dispute arose out of Sears Holding Corp.’s chapter 11 cases in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”).⁵ As part of those chapter 11 cases, debtor Sears, Roebuck and Co. (“Sears”) sold substantially all of its assets to Transform Holdco LLC (together with its affiliates, “Transform”) pursuant to a Bankruptcy Court order pursuant to section 363 of the Bankruptcy Code (the “Sale Order”). In addition to acquiring assets, Transform acquired designation rights (the “Designation Rights”) for over 600 of Sears’ real property leases, including one with MOAC Mall Holdings LLC (“MOAC”) at the Mall of America in Minneapolis, Minnesota (the “MOAC Lease”). The sale closed on February 11, 2019, but the Designation Rights allowed Sears and Transform to “seek to have [the MOAC Lease] (i) assumed by Sears and (ii) assigned to Transform” post-closing.

Sears later filed a post-closing notice of assumption and assignment of the MOAC Lease to Transform. MOAC objected, arguing that Transform was not an appropriate assignee under section 365(b)(3) of the Bankruptcy Code because it intended to sublet rather than occupy the premises itself. The Bankruptcy Court overruled MOAC’s objection and approved the assignment of the MOAC Lease (the “Assignment Order”). MOAC appealed the Assignment Order to the District Court for the Southern District of New York (the “District Court”) and concurrently moved before the Bankruptcy Court for a stay of the effectiveness of the Assignment Order pending appeal.

MOAC sought a stay to foreclose the possibility that its appeal would be mooted by section 363(m), relating to sales of property. The Bankruptcy Court suggested that section 363(m) might be inapplicable because the Assignment Order was governed by section 365 (relating to lease assignments) rather than section 363, and Transform’s counsel agreed. The Bankruptcy Court ultimately concluded that section 363(m) did not apply and denied the stay pending appeal. As succinctly stated by the District Court, “Judge Drain plainly relied on Transform’s representations – both that § 363(m) did not apply to [the Assignment Order] and that Transform had no intention of arguing otherwise.”⁶ The Bankruptcy Court also stated that Transform “would be judicially estopped” from arguing to the contrary on appeal.

The District Court’s Decision

The District Court reversed the Assignment Order, finding that Transform was not a proper assignee under section 365(b)(3) of the Bankruptcy Code.⁷ Transform moved for and obtained a rehearing, at which Transform argued for the first time, and contrary to its position in the Bankruptcy Court, that section 363(m) did apply to the Assignment Order and therefore deprived the District Court of jurisdiction over the appeal. Although “appalled by Transform’s behavior,” the District Court agreed, citing controlling precedent from the Second Circuit Court of Appeals (the “Second Circuit”) holding that section 363(m) is jurisdictional.⁸ Because “jurisdictional” implicates a court’s authority to adjudicate a case, the court found it was not subject to waiver or judicial estoppel. The District Court found that because Transform paid consideration for the lease via cure payments, the assignment of the MOAC Lease constituted a “sale” under section 363, thereby implicating section 363(m). As a result, the District Court concluded that it did not have jurisdiction and, “with deep regret,” dismissed the appeal.⁹ MOAC appealed to the Second Circuit.

The Second Circuit’s Decision

On appeal, the Second Circuit affirmed the District Court’s dismissal, explaining that section 363(m) “creates a rule of statutory mootness . . . which bars appellate review of any sale authorized by 11 U.S.C. 363(b) . . . so long as the sale was made to a good-faith purchaser and was not stayed pending appeal.”¹⁰ The Second Circuit added that the jurisdictional bar extended to “any transaction that is integral to a sale authorized under § 363.”¹¹ Finding that the assignment of the MOAC Lease was “integral” to the sale, the Second Circuit held that section 363(m) barred appellate review of the Assignment Order. Because there was no stay of the Assignment Order, the Second Circuit held that section 363(m) deprived it of jurisdiction and dismissed the appeal.

Key Takeaways

Sale transactions are a key feature of modern chapter 11 practice because of the ability to close a value-maximizing transaction for the benefit of the estates outside of the longer timelines and other requirements for confirmation of a chapter 11 plan. The flexibility of section 363 sales has been used by debtors for transactions ranging from the sale of non-core assets to the global restructurings famously accomplished in the General Motors and Chrysler cases during the Great Financial Crisis. At the same time, most buyers require finality in their willingness to close on a purchase and provide consideration to the estates without bearing the risk that an appeal—often not decided for years—could undo the transaction or result in a loss of the full intended consideration to the buyer.  Given the complexity of these transactions, the sale orders often contain key provisions for the benefit of buyers—such as the post-sale designation rights at issue in Transform—that arguably do not go to the essence of the validity of the sale itself. If section 363(m) is found to be a jurisdictional bar to appellate review, that risk would be practically negligible because the sale could close with finality unless the objecting party obtained a stay of a bankruptcy court’s sale order pending appeal, which even when granted would often require the posting of a significant bond. Moreover, if unsuccessful in obtaining a stay pending appeal, the disgruntled party would be prevented from any further appellate remedy (other than seeking an appeal of the stay denial).

By contrast, if section 363(m) is found to be non-jurisdictional, appellate courts would retain jurisdiction to review sale orders for closed transactions. Under this view, appellate courts would retain jurisdiction and could potentially fashion a remedy that is prejudicial to the buyer and others so long as the appellate court determined that the remedy “d[id] not affect the validity of [such] sale or lease.”¹² This would create uncertainty to buyers and could potentially affect the willingness of buyers to close in the face of even a single appeal—and correspondingly provide leverage to objecting parties.

¹ 11 U.S.C. § 363(m) (2020):

The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

² See, e.g., In re WestPoint Stevens, 600 F.3d 231, 247 (2d Cir. 2010); In re Walker Cnty. Hosp., 3 F.4th 229, 234 (5th Cir. 2021). 

³ 11 U.S.C. § 363(m). 

⁴ See, e.g., In re Energy Future Holdings Corp., 949 F.3d 806, 820 (3d Cir. 2020); In re Brown, 851 F.3d 619, 622–23 (6th Cir. 2017); Trinity 83 Dev., LLC v. ColFin Midwest Funding, LLC, 917 F.3d 599, 603 (7th Cir. 2019); In re Spanish Peaks Holdings II, LLC, 872 F.3d 892, 896 n.4 (9th Cir. 2017); In re Stanford, 17 F.4th 116, 122 (11th Cir. 2021).     

⁵ MOAC Mall Holdings LLC v. Transform Holdco LLC, No. 21-1270, cert. granted 6/27/22.

⁶ Sears Holdings Corp. v. Transform Holdco LLC, 616 B.R. 615, 627 (S.D.N.Y. 2020).

⁷ Sears Holdings Corp. v. Transform Holdco LLC, 613 B.R. 51 (S.D.N.Y. 2020), vacated, 616 B.R. 615 (S.D.N.Y. 2020).

⁸ Sears Holdings Corp., 616 B.R. at 627.

⁹ Id. at 634.

¹⁰ MOAC Mall Holdings LLC v. Transform Holdco LLC, Nos. 20-1846-bk, 20-1953-bk, 2021 WL 5986997 at *2 (2d Cir. Dec. 17, 2021) (citing In re WestPoint Stevens, 600 F.3d 231, 247 (2d Cir. 2010)).

¹¹ Id.

¹² 11 U.S.C. § 363(m).