Lynch v. Vaccaro, 566 B.R. 290 (E.D.N.Y. 2017) –

Both the debtor and the ultimate purchaser appealed bankruptcy orders relating to auction of the debtor’s property by a state court receiver. The district court emphatically dismissed the appeals as moot because neither party obtained a stay of the relevant orders pending appeal.

This battle played out over the course of several years:

• 2010: The debtor’s husband commenced divorce proceedings.
• Late 2012/early 2013: The state court ordered equitable distribution of the parties’ assets. Among other things, this included an order that the debtor and her husband cooperate in selling certain real estate, with proceeds to be divided evenly after satisfaction of all encumbrances.
• May 2013: The state court appointed the husband as receiver for the property based on the debtor’s failure to cooperate.
• July 2013: Final judgment was entered in the divorce case, reiterating that the property was to be equitably distributed.
• November 2013: The debtor found in contempt for obstructing the sale.
• April 2014: The husband signed a contract with a purchaser to sell the property for $1,325,000.
• April 2015: The state court replaced the husband with a third-party receiver, directing the new receiver to dispose of the property pursuant to its prior order.
• April to August l 2015: The state court issued a stay order and then vacated the stay, permitting the sale to move forward.
• September 2015: The court authorized the new receiver to retain professionals to sell the property in accordance with the April 2014 contract executed with the husband.
• November 2015: The debtor filed bankruptcy before the sale could close. Both the purchaser and the husband filed bankruptcy motions designed to allow the state court sale to proceed.

The bankruptcy court denied the purchaser’s motion for relief from the automatic stay to permit the state sale to go forward under the existing contract, but granted the husband’s motion to allow the state court receiver to proceed with a sale designed to maximize value. This was based on (1) the fact that the debtor had no viable plan to deal with the property and failed to comply with state court orders for a protracted period of time, in combination with (2) the bankruptcy court’s concern that the value had increased since the contract was signed.

Specifically, the bankruptcy court approved using the purchaser and sale contract modified to provide an increased bid of $1,425,000 as a stalking horse, with the property to be offered for sale at an auction. The auction was held in February 2016, and the purchaser was the winning bidder at a price of $1,865,000.

The purchaser continued to argue that she should have been allowed to purchase the property under the original contract terms, and that she was denied due process and was entitled to protection under certain Bankruptcy Code provisions. In attacking the new sale, the purchaser also contended that the debtor and receiver acted in bad faith during the auction process. Although the bad faith allegation caught the court’s attention, there was no evidence to support the claim that the process was tainted. Thus, the court approved the auction sale.

After more procedural maneuvering, the sale closed in March 2016. The debtor and purchaser continued their appeals – with the debtor focusing on the order that allowed the state court receiver to handle the sale, and the purchaser seeking to recover as damages the difference between the original contract price and the ultimate auction sale price.

Section 363(m) of the Bankruptcy Code was the focal point of the district court’s analysis. Under this section:

[R]eversal 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.

It was clear that neither the debtor nor the purchaser obtained a stay pending appeal. So the court’s decision turned on whether the orders subject to the appeals came within the scope of section 363(m).

The court began by emphasizing that this section creates the rule of “statutory mootness” which prevents challenges of sale authorizations except those addressing whether or not the purchaser was in “good faith.” This restriction is not limited to the sale itself, but extends to anything pertaining to the sale. There was no distinction between jurisdictional and non-jurisdictional challenges, and it did not matter whether there was no stay because the appellant failed to ask for one or because a request was denied.

The court made it clear that the failure to obtain a stay was fatal, using language such as: “a reviewing court may be powerless to undo or rewrite the terms of the consummated sale,” and failure to obtain a stay “divests the district court of jurisdiction” other than whether the purchaser acted in good faith.

In the case of the debtor’s appeal, the court noted that section 363(m) applies not only to the sale order itself but also to provisions that are “integral” to the sale. The order allowing the state court receiver to proceed was a necessary precursor to the sale. Reversing the order would negate the sale. So it was covered.

The same was true of the orders the purchaser appealed. They were necessary precursors to the eventual purchase or else approved the sale itself. In either case, reversing the orders would undo the sale. The purchaser argued that awarding damages equal to the difference between the contract price and the final sale price did not invalidate the sale, but the prevailing view is that section 363(m) divests jurisdiction of the entire sale order, not just the actual sale transaction.

The district court’s position can be summarized by the Sixth Circuit quote that a “majority of our sister circuits construe § 363(m) as creating a per se rule automatically mooting appeals for failure to obtain a stay of the sale at issue.” The short story according to the district court: in the case of a bankruptcy sale, no stay, no appeal – except as to whether the purchaser was a good faith purchaser.

Vicki R Harding, Esq.