Challenging a Bankruptcy Sale: You Snooze, You Lose

Reynolds v. Rushton, 473 B.R. 436 (D. Utah 2012) –

Reynolds involves a challenge to a Chapter 7 trustee’s Section 363 sale of an underground coal mine together with an adjoining scale house located on leased land.  The scale house contained two separate units: one served as a scale office and warehouse and the other as a residence.  An individual, Charles Reynolds, claimed that he had a right to use and occupy the residence.  According to Reynolds, he and his family (including 10 children) had inhabited the residence for over 25 years.  However, the bankruptcy court entered an order authorizing the sale free and clear of his claims, and Reynolds appealed to the district court.  While acknowledging the hardship to Reynolds, the district court upheld the bankruptcy court decision. One of the key factors was Reynolds’ failure to obtain a stay of the bankruptcy court sale order and the sale.

As background, prior to the sale the trustee had obtained a ruling that Reynolds was a tenant at will and that the debtor had the exclusive right to use and occupy the scale house.  Reynolds requested a stay of the tenancy order which was denied.

In the meantime the trustee reached an agreement to sell a majority of the debtor’s assets, including the mine and scale house.  The sale order specifically found that the purchaser was a “good faith purchaser” entitled to the protection of Section 363(m) of the Bankruptcy Code.  Under Section 363(m):

The reversal or modification on appeal of an authorization … of a sale … of property does not affect the validity of a sale … under such authorization to an entity that purchased … such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale … were stayed pending appeal.”

Reynolds raised various issues on appeal of the sale order, including the finding of good faith.  However he did not even request, much less obtain, a stay of the sale order.

As a threshold matter, the district court noted that Reynolds failed to properly challenge the good faith purchaser finding since he did not raise the issue before the bankruptcy court.  However, the court nevertheless reviewed his arguments.  Under 10th Circuit precedent, a finding of good faith requires that the purchaser must “(i) buy the property without ‘fraud, collusion between the purchaser and other bidders or the trustee, or an [sic] attempt to take grossly unfair advantage of other bidders’ and (ii) pay ‘at least 75% of the appraised value of the asset.’”  (Note that the specific facts required to support a finding of good faith will vary by jurisdiction.)

The court determined that if it were to reach the issue of good faith, Reynolds’ arguments were without merit.  Not only did Reynolds not dispute the relevant findings, but also did not obtain a stay pending appeal.  The court noted that under Section 363(m) an appeal is moot, whether or not the purchaser knew of the objection, unless the order is stayed pending appeal.

Reynolds tried an alternate argument that the court could fashion relief giving his family the right to remain in the home without affecting the validity of the sale order.  However, the court disagreed, finding that it could not grant Reynolds the right to remain in the scale house without reversing the sale order in contravention of Section 363(m).

For good measure, the court found that there was an alternate ground for denying the appeal under the doctrine of equitable mootness.  This allows a court to decline to hear an appeal even when relief may be available if the relief would be inequitable.  The 10th Circuit uses a six part test to determine equitable mootness that includes consideration of (1) whether the appellant sought and/or obtained a stay pending appeal,  (2) whether the plan of reorganization has been substantially consummated,  (3) whether rights of innocent third parties would be adversely affected, (4) the public policy need to be able to rely on a confirmed plan, (5) the impact on the debtor’s successful reorganization if the appeal is upheld, and (6) whether the appeal is meritorious or equitably compelling.  Based on a review of these factors, the court determined that the Reynolds appeal was equitably moot.

Section 363(m) can be a powerful tool for purchasers.  Although there are a few cases that have provided openings to challengers, in general a purchaser is protected unless the challenger obtains a stay of the sale pending appeal.  A similar result may be obtained under the equitable mootness doctrine.  However, that requires a fact specific evaluation within the discretion of the court with far less predictable results.  So, a purchaser of assets in a bankruptcy sale would be well advised to do whatever is necessary to obtain a finding that it is a good faith purchaser entitled to the benefits of Section 363(m).

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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