- Second Circuit Moots Appeal of 363 Sale in WestPoint Stevens
- September 1, 2010
- Law Firm: Cadwalader Wickersham Taft LLP - New York Office
In a recent decision in the chapter 11 case of WestPoint Stevens, Inc.,1 the United States Court of Appeals for the Second Circuit interpreted section 363(m) of the Bankruptcy Code to render an appeal of sale under section 363 of the Bankruptcy Code statutorily moot. The Second Circuit held that because the Bankruptcy Court had not stayed the order authorizing the sale, a stay of only one aspect of the sale rendered moot of the sale in its entirety. The decision further emphasizes the finality of any sale under section 363 of the Bankruptcy Code, and the necessity of obtaining a stay pending appeal.
In March of 2005, the Debtors filed a motion seeking to sell substantially all of their assets. In the ensuing months, a group of secured lenders led by Wilbur Ross, which controlled approximately 54% of the first lien debt but none of the second lien debt, battled for control of the reorganized company with a lender group led by Carl Icahn, which held approximately 40% of the first lien debt and approximately 51% of the second lien debt.
The Debtors held an auction in June 2005. After several rounds of bidding between the Icahn and Ross groups, the Icahn group submitted the winning bid. The Icahn bid contemplated that (i) WestPoint International, a new entity to be formed by the Icahn group, would acquire the assets subject to the auction; (ii) the Icahn group would purchase a $187 million equity stake in WestPoint International; and (iii) prepetition first and second liens would be released in exchange for $489 million in equity to be distributed to first lien lenders and $95 million in equity to be distributed second lien lenders.
On July 8, 2005, the Bankruptcy Court approved the sale. The Ross group appealed the order and filed a motion with the Bankruptcy Court seeking a stay pending appeal. The Bankruptcy Court denied this motion and the Ross group filed a motion with the District Court seeking a stay of the sale order pending appeal. However, before the District Court considered the stay motion, the parties entered into a stipulation (the "Stay Stipulation"), pursuant to which the Ross group withdrew the stay motion and the Debtors placed in escrow the equity interests earmarked for distribution to the second lien lenders, pending judicial determination of the correct allocation of those interests. The Debtors and the buyer subsequently closed the sale and the Icahn group took control of the business.
On appeal of the remaining components of the sale order, the District Court overturned the portions of the order relating to the release of the liens of the first lien lenders and the satisfaction of their claims. The District Court found that any distribution of equity in WestPoint International to the second lien lenders violated an intercreditor agreement that required the first lien lenders to be paid in full in cash before any exercise of the second lien lenders' rights. Accordingly, the District Court remanded the case to the Bankruptcy Court.
The Bankruptcy Court ordered the escrowed equity interests to be distributed to the first lien lenders. The Icahn group would still maintain its 17.5% interest in WestPoint International (because this interest had been bought with cash and was not subject to liens of the first or second lien lenders) and would be entitled to its share of the distribution as a first lien lender and second lien lender.
The District Court affirmed the Bankruptcy Court's order, and an appeal to the Second Circuit followed.
The Second Circuit's Decision
The Second Circuit construed section 363(m) to render statutorily moot key aspects of the Ross group's appeal of the sale order. Section 363(m) provides that:
The reversal 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.
As the Second Circuit noted, section 363(m) "creates a rule of 'statutory mootness'"2 and "moots a broader range of cases than are barred under traditional doctrines of mootness."3 The Second Circuit observed that section 363(m) operates as a jurisdictional limit on its review of a bankruptcy court's sale order, so that the Second Circuit has jurisdiction only to consider the good faith aspects of an unstayed sale under section 363.
The Bankruptcy Court denied the Ross group's motion for a stay under section 363(m) of the Bankruptcy Code. The Ross group subsequently withdrew its stay motion at the District Court level, pursuant to the Stay Stipulation. The Second Circuit thus faced a situation in which the sale order had not been stayed, but certain narrow components of the sale arguably had been stayed by the agreement of the parties.
The Second Circuit resolved this dilemma in two ways. First, the Second Circuit held that the integral aspects of a sale were subject to the statutory mootness provided by section 363(m) of the Bankruptcy Code and were thus not subject to review unless the sale itself is stayed. Commenting on the scope of the Stay Stipulation, the Second Circuit noted that "given the centrality of the lien release and claim-satisfaction provisions to the sale, it is implausible that the Stay Stipulation would stay those portions of the sale without any explicit mention of them."4 Accordingly, the Second Circuit held that the lien release and claim satisfaction provisions of the sale order were statutorily moot and not subject to review.5
The Second Circuit then considered the issue that indisputably had been stayed - the correct allocation of the escrowed equity interests among the first lien lenders and the second lien lenders. The Second Circuit found that the sale order had violated the intercreditor agreement by giving the second lien lenders a recovery without providing payment in full in cash for the first lien lenders. However, the Second Circuit refused to allocate the escrowed equity interests in such a way as to disrupt the Icahn group's control of the business, on the grounds that any challenge to the Ichan group's control of the reorganized business was moot under section 363(m) of the Bankruptcy Code.
The Second Circuit remanded the appeal to the Bankruptcy Court, instructing it to allocate the Icahn group sufficient securities to maintain its 51% interest in WestPoint International. The escrowed securities were then allocated in the original proportion to the minority members of the second lien lenders who did not consent to the Stat Stipulation, and the remaining securities were allocated to the first lien lenders (other than the Icahn group).
By putting all integral aspects of an unstayed, good-faith sale beyond appellate review, the Second Circuit adopted a broad reading of section 363(m) that will protect the finality of sales under section 363. In doing so, the Second Circuit adopted a very different approach from that taken by the 9th Circuit Bankruptcy Appellate Panel in Clear Channel.6 In that case, the court held that section 363(m) of the Bankruptcy Code protected the proposed sale, but not certain narrow portions of the sale order stripping liens from the transferred property, with the result that the buyer took the property subject to the liens that had originally been stripped off at the time of the sale.
The Second Circuit's decision also highlights that the finality provided by section 363(m) of the Bankruptcy Code can impose a heavy burden. The Second Circuit found that the first lien lenders were entitled to be paid in full in cash under the intercreditor agreement. However, the Second Circuit did not allocate all of the escrowed securities to the first lien lenders because they "withdrew their appeal with respect to their right to be paid in cash" under the intercreditor agreement.7
The first lien lenders may have been able to vindicate their rights under the intercreditor agreement and the Bankruptcy Code (which protects intercreditor agreements through section 510(a)) in a different setting. However, the finality imposed by section 363(m) of the Bankruptcy Code foreclosed that possibility here. Creditors and other parties who seek to vindicate their rights on appeal must pay close attention to the scope of section 363(m) of the Bankruptcy Code and seek a stay pending any needed appeal.
The decision also highlights the difficulties that can arise when parties wish to stay some aspects of a sale but not others. Parties in this situation must consider whether a stipulated stay will achieve its purpose when it potentially interferes with an otherwise unstayed sale.
1 Contrarian Funds LLC v. Aretex LLC (In re WestPoint Stevens, Inc.), 600 F.3d 231 (2d Cir. 2010).
2 Id. at 247 (citations omitted).
4 Id. at 252-53.
5 The extent to which the lien release and claim satisfaction provisions were entered into in good faith was reviewable under section 363(m) but not raised on appeal by the Ross group.
6 Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (BAP 9th Cir. 2008).
7 In re WestPoint Stevens, 600 F.3d at 254.