A recent decision from the Bankruptcy Court for the District of Montana highlights the limits of the term “interests” under section 363(f) of the Bankruptcy Code, and the limits of “good faith” under section 363(m).

In In re Mountain Divide, LLC, Case No. 16-61015-11 (Bankr. D. Mont. 2016), the debtor filed a Chapter 11 petition, and shortly thereafter, filed a motion to sell substantially all of its assets to Deep River Operating, LLC (“Deep River”) and Future Acquisition North Dakota, LLC (“FAC”).  Deep River and FAC were considered a joint stalking horse bidder.  Deep River, however, failed to provide the debtor with the financial information necessary to demonstrate its ability to close the sale.  As a result, FAC stepped into Deep River’s position in accordance with the bidding procedures order, and was ultimately determined to be the successful bidder at the auction.

The bankruptcy court entered a sale order (the “Sale Order”) that, among other things, found that (i) the debtor and FAC negotiated and entered into the purchase and sale agreement at arm’s length without collusion or fraud, (ii) FAC was a good faith purchaser in accordance with section 363(m), and (iii) the debtor’s assets would be sold to FAC free and clear of all liens, claims, and interests (collectively, the “Interests”) under sections 363(b) and (f).  The Sale Order also enjoined essentially all persons and entities from asserting the Interests against FAC.  The sale to FAC closed on January 20, 2017, and the debtor’s Chapter 11 plan was confirmed on November 30, 2017.

After closing, FAC filed a complaint against Deep River in the United States District Court for the Southern District of Texas, alleging that Deep River breached the provisions of the bid agreement (the “Bid Agreement”) executed between FAC and Deep River, which governed their own agreement to submit a joint bid to purchase the debtor’s assets.  Under the Bid Agreement, FAC and Deep River agreed to, among other things, jointly purchase the debtor’s assets (30% to FAC and 70% to Deep River).  Deep River asserted counterclaims against FAC, alleging that FAC breached the Bid Agreement and tortuously interfered with Deep River’s existing and prospective contracts.  Interestingly, neither FAC nor Deep River had ever disclosed the Bid Agreement to the bankruptcy court during the sale proceedings.

Even though it sued Deep River in Texas District Court, FAC also brought proceedings before the Montana Bankruptcy Court alleging that Deep River’s counterclaims in the District Court action constituted a collateral attack on the Sale Order.  Specifically, FAC argued that the counterclaims were “Interests” that had been sold free and clear under section 363(f), and that the Sale Order enjoined persons (presumably, including Deep River) from pursuing such Interests against FAC.  The bankruptcy court, however, ruled that the Deep River’s counterclaims arising under the Bid Agreement were not the type of interests that section 363 or the Sale Order sought to preclude after the sale, because the counterclaims were not attacking the validity of the sale, nor were they the type of successor-liability claims that are commonly thought of as “interests” under the Bankruptcy Code.  In fact, Deep River’s counterclaims against FAC were not dependent on FAC’s ownership of the property sold and not dependent on the outcome of the sale itself.  The counterclaims also did not allege that the sale was improper or the result of conspiracy; instead, they were based on the Bid Agreement and FAC’s alleged breach of the Bid Agreement.  The bankruptcy court further concluded that Deep River’s counterclaims did not conflict with any provision of the Sale Order.   Interestingly, the bankruptcy court noted that the tortious interference claims could ultimately constitute a collateral attack on the Sale Order, but that it could not reach a conclusion on this issue based on the record before the court.

Although FAC did not argue the point, the bankruptcy court analyzed whether the Sale Order’s good-faith finding under section 363(m) precluded Deep River’s counterclaims.  The bankruptcy court found that the protections afforded by section 363(m) apply “only if the court, upon reversing or modifying the order authorizing the sale, would affect the validity of the sale.”  Quoting the Ninth Circuit Bankruptcy Appellate Panel’s decision in Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25, 35-6 (9th Cir. B.A.P. 2008), the bankruptcy court concluded that section 363(m) “addresses only changes of title or other essential attributes of a sale . . . [and that] the terms of those sales, including the free and clear term at issue here, are not protected.”  In short, section 363(m) does not apply when there is no risk of reversal or modification of the sale following an appeal.  The bankruptcy court could not conclude that would happen based on the record before it.  As such, the bankruptcy court held that Deep River’s counterclaims against FAC did not amount to an impermissible collateral attack on the Sale Order or its provisions, nor were they precluded by section 363(m).

This decision reminds bankruptcy practitioners that “interests” under section 363(f) has its limits.  Here, “interests” did not include claims against a purchaser that were based on an undisclosed contract governing a joint bid for the debtor’s assets.  Moreover, even though the bankruptcy court found that the purchaser was entitled to good-faith protections under section 363(m), those protections did not preclude certain claims against the purchaser related to the sale.  It is unclear from the decision why FAC and Deep River did not disclose the Bid Agreement during the sale proceedings.  While that may have been a proper and justifiable decision of FAC and Deep River at the time of the sale proceedings, query whether disclosure of the Bid Agreement during the sale proceedings, and/or reference to it in the Sale Order, would have helped FAC’s post-sale proceedings against Deep River in the bankruptcy court.