After a chapter 7 trustee sold assets of the debtor in a bankruptcy sale, he sought to dismiss various pending appeals involving issues relating to the sold assets. After the district court dismissed the appeals as moot, the parties appealed to the 10th Circuit.
Prior to bankruptcy, the debtor (CW Mining) had the exclusive right to mine coal on land owned by two affiliates (ANR and COP) under leases. Originally another company (Hiawatha) operated ANR’s mine. However, after it ran into regulatory problems, Hiawatha and ANR agreed to pass control to CW Mining. An individual (Reynolds) ran CW Mining’s operations at the COP mine and lived with his family in the scale house connected to the mine. Although COP owned the house, it was under CW Mining’s exclusive control.
CW Mining ended up in bankruptcy after a customer obtained a $24.8 million judgment for breach of contract and then filed an involuntary petition. After the bankruptcy was filed, the debtor tried to transfer its operations to Hiawatha, and COP and ANR entered into post-petition agreements with Hiawatha to mine coal in the debtor’s place.
CW Mining’s bankruptcy was converted to a chapter 7 liquidation, and a bankruptcy trustee was appointed. The trustee brought various proceedings to recover assets, including the coal mining operations at the active COP mine, the scale house at the COP mine (occupied by Reynolds) and the debtor’s contracts with ANR and COP (which had been replaced by the agreements with Hiawatha).
The bankruptcy court ordered that all assets be returned to the bankruptcy estate. ANR, COP, Hiawatha and Reynolds each appealed. While the appeals were pending, the trustee sold the COP mining operations, the scale house, and the ANR and COP mining contracts to another company for $15 million. The court found that the buyer was a good faith purchaser entitled to protection under Section 363(m) of the Bankruptcy Code. No one moved for a stay pending appeal, and the sale closed. After closing, the trustee and buyer moved to dismiss the appeals as moot – under Section 363(m) or an equitable mootness doctrine. The district court agreed and dismissed the appeals.
No one disputed that Section 363(m) applied to asset sale. So the only question was whether Section 363(m) would permit relief if an appellant prevailed. Under Section 363(m) the reversal or modification on appeal of authorization to sell property will not affect the validity of the sale, unless the appellant obtains a stay of the sale pending appeal.
Initially the appellants argued that Section 363(m) applied only to appeals of the sale order itself. However, the 10th Circuit determined that the scope of this section was not limited to appeals of the sale order, but rather extended to other orders that would effectively modify the sale order. To hold otherwise would be contrary to the text of the Code and would frustrate the purpose of protecting the public interest in finalizing bankruptcy sales. Thus, an appeal will be moot if the only remedies available would affect the validity of the sale.
Turning to the individual appeals: ANR sought a determination that its agreement with the debtor had been terminated. The bankruptcy court denied this request since ANR did not provide a required notice of default. Alternatively, ANR requested all unpaid royalties. This was denied because ANR did not provide documentation to support that any royalties were owed.
While its appeal was pending at the district court the sale was approved and ANR’s mining agreement was included in the assets sold. The district court found that ANR’s request for declaratory relief regarding the contract would necessarily call into question the bankruptcy court’s interpretation, and thus the validity of the sale. In response, ANR argued that it did not substantially affect the sale order, and besides it was entitled to monetary relief in the form of constructive trust. The 10th Circuit disagreed since Section 363(m) applied to any remedy regardless of whether it was substantial, and ANR waived its right to a constructive trust by not pursuing the argument in the lower courts.
When the trustee sought to recover assets transferred post-petition to Hiawatha, Hiawatha contended that it was entitled to protection under Section 549(d), which disallows avoidance of transfers in the gap between the filing of an involuntary petition and a court entering an order for relief to the extent of any value given for the transfer. Hiawatha claimed it gave value by hiring former employees and paying trade creditors, royalties, property taxes and interest on pre-petition debt. However, there was no evidence that Hiawatha itself made the payments, as opposed to the debtor, or that the payments were in exchange for the assets as opposed to part of its ongoing business operations.
Hiawatha also sought an improver’s lien under Section 550(e) as a good faith transferee for its supposed expenditures to improve the property. Again, there was no evidence it used its own money, and the bankruptcy court concluded Hiawatha was not a good faith transferee. When it received the debtor’s assets, it knew CW Mining was an involuntary in bankruptcy and that there was a $24 million judgment outstanding against it.
After the sale, Hiawatha argued that the appeal was not moot since it was making a claim to the proceeds. Instead of trying to recover the sold assets, Hiawatha suggested the court could order that it be paid the value of the assets from the estate. The trustee argued in response that there is a “bright-line rule” that if the proceeds are not segregated, a claimant cannot recover the proceeds.
While the 10th Circuit rejected the bright-line rule, it still affirmed dismissal of the appeal as moot since the only proposed remedy that would not affect the sale was imposing a constructive trust. In order to impose a constructive trust under applicable state law, Hiawatha had to (1) trace the property to the proceeds and (2) show that there would be unjust enrichment if the estate retained the property without paying its value. Given that (i) Hiawatha could not trace its claimed assets to sale proceeds, (ii) it did not contest that “it mined a million tons of coal in willful violation of the automatic stay, making an equitable remedy impossible in light of such inequitable behavior,” and (iii) it did not identify any wrongful conduct by the trustee, it could not prevail.
With respect to Reynolds, Reynolds had argued that he owned the scale house, not the debtor, and also filed a counterclaim under a state statute seeking $175,000 for supposed improvements.
While his appeal of the determination that he did not own the scale house was moot (since any remedy would affect the sale), Reynolds contended that he sought only the value of his home, or alternatively the value of the improvements, from the sale proceeds. Although Reynolds could not establish a constructive trust, the trustee also did not establish that Reynolds could not assert a claim for the value of the improvements. Reynolds could not recover the scale house and his appeal of that issue was moot, but his request for monetary relief under the state statute for the value of improvements was not moot.
Finally, COP claimed that its mining agreement with the debtor had terminated under various theories. While appealing an adverse decision by the bankruptcy court, the contract was sold. The court concluded that COP could not continue the appeal because changing the interpretation of the contract would alter the definition and value of the assets that were sold.
Although COP argued that it was only seeking compensation from the sale proceeds, that theory was not adequately presented to the lower courts: A statement in a footnote that “monetary relief is another available remedy that will not disturb the Sale Order” was not sufficient to preserve the argument.
In response to various arguments by the trustee, COP contended that it was sufficient to show the “mere existence” of theories of relief that would not be subject to mootness. “But COP is mistaken: the mootness question does not turn on what relief ‘merely exists.’ Rather, ‘[t]he mootness question turns on what relief is available to COP if it were to prevail in this appeal.’”
Consequently, the 10th Circuit agreed that COP’s appeal was moot.
Even if a party’s objection is not a direct attack on a bankruptcy sale, as this case demonstrates, it still may be precluded from proceeding if the requested remedy has even an indirect impact on the sale or the sale assets. Obtaining a stay of the sale pending appeal (if possible) is certainly the way to go.
Vicki R. Harding, Esq.