Locke Lord QuickStudy: Third Circuit Provides Gifting Guidance in § 363 Sales

On appeal, the Government argued that the professional and settlement escrows were property of the bankruptcy estate and that the Code’s priority of payment scheme applies to § 363 sales, even if that paradigm textually applies only in the context of a plan of reorganization. The Third Circuit disagreed with the first point, concluding that the settlement monies—which the secured lender paid directly to the unsecured creditor body—did not constitute “estate property”. The Court of Appeals was persuaded by the fact that the settlement proceeds never became a part of the estate since they were to flow directly from the lender to the unsecured creditors. In contrast to the Armstrong World, decision, 432 F.3d 507 (3d Cir. 2005), the Third Circuit distinguished between the gifting of estate property from a senior to a junior creditor (relevant in that case), to the secured lender’s provision of its own “new money” property to a junior creditor, as was anticipated in ICL Holding.

Continuing, the Third Circuit found the question of whether the escrowed funds for the benefit of estate professionals was permissible under the Bankruptcy Code to be “more difficult,” though it ultimately came to the same conclusion. Under the Asset Purchase Agreement in ICL Holding, the escrowed funds were listed as part of the purchase price for the debtor’s assets. The objectors thus argued that those funds were property of the estate under 11 U.S.C. § 541(a)(6), which includes “proceeds . . . of or from property of the estate.” In considering the issue, the Court it focused on the “economic reality of what actually occurred.” Under the Asset Purchase Agreement, which memorialized the § 363 sale’s terms, the secured lenders purchase all of the debtor’s assets, including its cash, in exchange for its $320 million credit bid. Thus, because the secured lender bought all of the debtor’s cash, it also bought all residual cash from the asset sale—including the escrowed funds it was already paying for the benefit of the estate professionals. Therefore, “as a matter of substance,” the Third Circuit found that the escrowed funds had belonged to the lender (as successful buyer) and were not estate property and therefore not subject to the Bankruptcy Code’s rigid priority analysis.

The implications of the ICL Holdings decision are potentially substantial in providing to purchasers of a debtor’s estate assets under a § 363 sale a means to resolve objections outside of the rigid priority scheme of the Bankruptcy Code so long as the purchaser uses its own funds to do so and the transactions are otherwise disclosed to and approved by the Court. The extent to which this case becomes a common paradigm for future transactions remains to be seen.