Appeal of Unstayed Order Approving Bankruptcy Sale of Real Property Free and Clear of Lease and Related Settlement Agreement Dismissed as Moot

To promote the finality of bankruptcy asset sales, section 363(m) of the Bankruptcy Code "moots" an appeal of an order approving a sale to a good-faith purchaser unless the party challenging the sale obtains a stay pending appeal. Courts, however, sometimes disagree over the scope of section 363(m) and whether it also bars appeals of orders approving transactions that are related to a sale, such as settlements.

The U.S. District Court for the Eastern District of Louisiana recently addressed this question in In re Royal Street Bistro LLC, 2022 WL 6308294 (E.D. La. Sept. 23, 2022) ("Royal Street II"), appeal filed, No. 22-30629 (5th Cir. Oct. 5, 2022). The district court affirmed bankruptcy court orders approving an auction sale of properties free and clear of a tenant's leasehold interest as well as a related settlement agreement because both appeals were mooted by section 363(m)—the sale, by the express terms of section 363(m), and the settlement, because it was an integral part of the sale.

The ruling reinforces the principle that property can be sold free and clear of a tenant's leasehold interest, despite protections of such interests elsewhere in the Bankruptcy Code. It is also emblematic of the broad interpretation in the Fifth Circuit of statutory mootness under section 363(m).

Dismissal of Appeals Under the Doctrine of Mootness

"Mootness" is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. An appeal can be either constitutionally, equitably, or statutorily moot. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.

The court-fashioned remedy of "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan that has been "substantially consummated." See Collier ¶ 1129.09 (16th ed. 2022).

An appeal can also be rendered moot (or otherwise foreclosed) by statute. For example, section 363(m) of the Bankruptcy Code provides that, absent a stay pending appeal, "[t]he reversal or modification on appeal of an authorization … 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."

Section 363(m) is a powerful protection for good-faith purchasers because it limits appellate review of a consummated sale irrespective of the legal merits of the appeal. See Made in Detroit, Inc. v. Official Comm. of Unsecured Creditors of Made in Detroit, Inc. (In re Made in Detroit, Inc.), 414 F.3d 576 (6th Cir. 2005); see also In re Palmer Equip., LLC, 623 B.R. 804, 808 (Bankr. D. Utah 2020) (section 363(m)'s protection is vital to encouraging buyers to purchase the debtor's property and thus ensuring that adequate sources of financing are available).

The circuits are split regarding whether section 363(m) automatically moots an appeal of an order approving an unstayed sale under all circumstances. Some circuits, including the First, Second, Fifth, Eleventh, and D.C. Circuits, have held that, in the absence of a stay of the sale order, the court must dismiss a pending appeal as moot unless the purchaser did not act in good faith. See Mission Product Holdings, Inc. v. Old Cold, LLC (In re Old Cold, LLC), 879 F.3d 376, 383 (1st Cir. 2018); U.S. v. Salerno, 932 F.2d 117, 123 (2d Cir. 1991); In re Walker County Hospital Corp., 3 F.4th 229, 236 (5th Cir. 2021); In re Steffen, 552 F. App'x 946, 949-50 (11th Cir. 2014); In re Magwood, 785 F.2d 1077, 1081 (D.C. Cir. 1986); see also Reynolds v. ServisFirst Bank (In re Stanford), 17 F.4th 116, 122 (11th Cir. 2021) (although statutory mootness precludes review of an unstayed order approving a sale to a good-faith purchaser, mootness under section 363(m) is not jurisdictional, but acts as a defense); In re Ern, LLC, 124 F. App'x 151, 152 (4th Cir. 2005) (dismissing an appeal of a sale order as moot because the assets had been transferred and the party challenging the sale failed to obtain a stay pending appeal); In re Rimoldi, 172 F.3d 876, 1999 WL 132260, *1 (9th Cir. 1999) ("This court has recognized only two exceptions to section 363(m)'s rule of mootness. The first applies where real property is sold subject to a statutory right of redemption; the second applies where state law otherwise would permit the transaction to be set aside.").

Other circuits, including the Third, Sixth, and Tenth Circuits, have rejected the view that section 363(m) automatically moots an appeal. Instead, those courts have held that an appeal is not moot as long as it is possible to grant effective relief without impacting the validity of the sale. See In re ICL Holding Co., Inc., 802 F.3d 547, 554 (3d Cir. 2015) (section 363(m) did not moot the government's appeal of the terms for the ordered distribution of escrowed funds for administrative expenses and settlement proceeds from the sale of substantially all of the debtors' assets since the court could order redistribution of the sale proceeds without disturbing the sale); Brown v. Ellmann (In re Brown), 851 F.3d 619 (6th Cir. 2017) (holding that parties alleging statutory mootness under section 363(m) must prove that the reviewing court is unable to grant effective relief); Osborn v. Duran Bank & Trust Co. (In re Osborn), 24 F.3d 1199 (10th Cir. 1994) (holding that an appeal of a sale order was not mooted by section 363(m) when under Texas state law a constructive trust could be imposed on the sale proceeds), abrogated in part on other grounds by Eastman v. Union Pac. R.R., 493 F.3d 1151 (10th Cir. 2007); In re C.W. Min. Co., 740 F.3d 548, 555 (10th Cir. 2014) (section 363(m) will moot appeals in cases where the only remedies available are those that affect the validity of the sale); see also In re 388 Route 22 Readington Holdings, LLC, 2021 WL 4811409, *2 (3d Cir. Oct. 15, 2021) ("Put simply, § 363(m) moots a challenge to a sale when '(1) the underlying sale or lease was not stayed pending the appeal, and (2) the court, if reversing or modifying the authorization to sell or lease, would be affecting the validity of such a sale or lease.'") (citations omitted), cert. denied, 142 S. Ct. 1674 (U.S. 2022); In re K & D Indus. Servs. Holding Co., Inc., 850 F. App'x 966, 968-69 (6th Cir. 2021) ("Because § 363(m) 'limits appellate review of a consummated sale … regardless of the merits of legal arguments raised against it,' and because we cannot grant effective relief without disturbing the sales, the appeals to the district court are moot.") (citation omitted).

In Trinity 83 Dev., LLC v. ColFin Midwest Funding, LLC, 917 F.3d 599 (7th Cir. 2019), the Seventh Circuit held that section 363(m) did not moot an appeal involving a dispute over the proceeds of a sale of assets in bankruptcy. In concluding that section 363(m) merely provided the purchaser with a defense in litigation challenging the sale, the Seventh Circuit overruled its prior decision construing the scope of section 363(m) in In re River West Plaza-Chicago, LLC, 664 F.3d 668, 671-72 (7th Cir. 2011). According to the Seventh Circuit in Trinity 83, "We now hold that § 363(m) does not make any dispute moot or prevent a bankruptcy court from deciding what shall be done with the proceeds of a sale or lease." Trinity 83, 917 F.3d at 602.

Statutory mootness under section 363(m) can preclude appellate review not only of an unstayed sale order but also orders approving transactions that are an integral part of the sale. See, e.g., MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 2021 WL 5986997, *3 (2d Cir. Dec. 17, 2021) (in a nonprecedential summary order, affirming a district court order dismissing an appeal of an order approving an assignment of a lease that was "integral" to a sale transaction and noting that "[w]e have held in no ambiguous terms that section 363(m) is a limit on our jurisdiction and that, absent an entry of a stay of the Sale Order, we only retain authority to review challenges to the 'good faith' aspect of the sale" (internal quotation marks and citations omitted)), cert. granted, 142 S. Ct. 2867 (2022); In re Pursuit Holdings (NY), LLC, 845 Fed. App'x 60 (2d Cir. 2021) (the statutory mootness rule indisputably applies to challenges to any integral provision of an order approving a sale, such as a settlement); In re Trism, Inc., 328 F.3d 1003, 1007 (8th Cir. 2003) (mooting under section 363(m) "a challenge to a related provision of an order authorizing the sale of the debtor's assets" because the related provision was integral to the sale of the assets and reversing the provision would alter the parties' bargained-for exchange); see also Matter of Alabama-Mississippi Farm, Inc., 791 F. App'x 466, 470 (5th Cir. 2019) (section 363(m) does not preclude an appeal asserting a security interest in sale proceeds because, "nothing in the record suggests that the sale … was dependent on how the proceeds of that sale were to be distributed"). 

Section 363(m) has also been read to go further than simply limiting appellate review and to protect broadly the interests of any good-faith purchaser by subjecting any collateral attack made against a section 363 sale to a good-faith purchaser to the requirements of Rule 60(b) of the Federal Rules of Civil Procedure, which governs motions for reconsideration of or relief from prior court judgments or orders. See In re Edwards, 962 F.2d 641, 643 (7th Cir. 1992) (holding that a collateral attack on a sale to a good-faith purchaser must be made pursuant to Fed. R. Civ. Proc. 60(b)); In re Veg Liquidation, Inc., 572 B.R. 725, 737 (Bankr. W.D. Ark. 2017) ("To the extent the trustee is alleging that fraud was involved, his remedy is under Rule 60, not [section] 363(m)."), aff'd, 583 B.R. 203 (B.A.P. 8th Cir. 2018), aff'd, 931 F.3d 730 (8th Cir. 2019); see also In re Alan Gable Oil Dev. Co., 978 F.2d 1254, 1992 WL 329419, *4 (4th Cir. 1992) ("[T]hough section 363(m) does not in the strictest sense apply to [a movant's] 60(b) motion, the policy favoring protection of good faith purchasers of estate property does. Not only does [the movant] bear the burden of establishing that the district court abused its discretion, he must do so in light of the strong policy favoring good faith purchasers of bankruptcy assets."); In re Nilhan Devs., LLC, 631 B.R. 507, 534 (Bankr. N.D. Ga. 2021) ("Sale orders in bankruptcy cases are accorded a high level of finality and, accordingly 'collateral attacks on sale orders should generally be prohibited.'") (quoting In re CHC Indus., Inc., 389 B.R. 767, 774 (Bankr. M.D. Fla. 2007)).

Scope of Free-and-Clear Sales

The ability of a trustee or chapter 11 debtor-in-possession ("DIP") to sell bankruptcy estate assets "free and clear" of competing interests in the property has long been recognized as one of the most important advantages of a bankruptcy filing as a vehicle for restructuring a debtor's balance sheet and generating value. Still, section 363(f) of the Bankruptcy Code, which delineates the circumstances under which an asset can be sold free and clear of "any interest in such property," has generated a fair amount of controversy. This is so in part because the statute itself does not define "interest." 

Although section 363(f) is generally acknowledged to encompass liens and security interests, some courts, taking into account both the language of the provision and its underlying purpose, have interpreted it much more broadly to encompass other obligations that may flow from ownership of property, including, for example, successor liability claims. See, e.g., In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003); In re Norrenberns Foods, Inc., 642 B.R. 825 (Bankr. S.D. Ill. 2022). Broadly applied, however, section 363(f) arguably conflicts with certain other provisions of the Bankruptcy Code.

One of those provisions is section 365(h)(1), which specifically protects the interests of lessees and sublessees under unexpired real property leases. It provides that, if the trustee or DIP rejects an unexpired real property lease under which the debtor is the lessor, the non-debtor lessee (and any permitted successor or assign), pursuant to subsection (h)(1)(D)) has the option to either: (i) treat the lease as terminated and file a claim for breach; or (ii) retain its rights under the lease for the balance of the lease term (including any renewal or extension periods) "to the extent that such rights are enforceable under applicable non-bankruptcy law." 

Courts disagree whether the rights of a lessee (or sublessee) under section 365(h)(1) are effectively extinguished where the debtor does not reject the lease, but the leased real property is sold free and clear under section 363(f). See generally Collier at ¶¶ 363.06[1] and 365.11[5] (noting that efforts to sell real property free and clear of leasehold interests protected by section 365(h)(1) "have met with mixed results," but that "[t]he apparent majority view is that section 365(h) trumps section 363(f)").

Until 2022, only two federal courts of appeals had weighed in on this question, both staking out what was considered to be the minority view. In Precision Industries, Inc. v. Qualitech Steel SBQ, 327 F.3d 537 (7th Cir. 2003), the Seventh Circuit disagreed with several lower courts and held that a real property lease can be extinguished in a free-and-clear sale of the property under section 363(f), at least where the lease has not been formally rejected. In Pinnacle Rest. at Big Sky, LLC v. CH SP Acquisitions, LLC (In re Spanish Peaks Holding II, LLC), 872 F.3d 892 (9th Cir. 2017), the Ninth Circuit essentially endorsed this position, with certain caveats.

The Fifth Circuit recently examined this issue, but in an oblique way. In In re Royal Street Bistro, L.L.C., 26 F.4th 326 (5th Cir. 2022) ("Royal Street I"), the court denied certain tenants' motion for a writ of mandamus directing a district court to issue a stay pending appeal of a bankruptcy court order approving the sale of leased real property free and clear of the tenants' leasehold interests. However, instead of issuing a summary order without explanation, the Fifth Circuit issued a brief per curiam opinion in which it agreed with the result reached by the lower courts but signaled disagreement with the holdings in Qualitech and Spanish Peaks, and cautioned courts against "blithely accepting Qualitech's reasoning and textual exegesis." 

Section 363(e) of the Bankruptcy Code provides protection to parties that have "interests" in property proposed to be sold free and clear under section 365(f). That subsection provides that, upon the request of an entity that has an "interest" in property proposed to be sold by the trustee or DIP, the court "shall prohibit or condition" the sale "as is necessary to provide adequate protection of such interest." See Qualitech, 327 F.3d at 547-48 ("Because a leasehold qualifies as an 'interest' in property for purposes of section 363(f), a lessee of property being sold pursuant to subsection (f) would have the right to insist that its interest be protected. 'Adequate protection' does not necessarily guarantee a lessee's continued possession of the property, but it does demand, in the alternative, that the lessee be compensated for the value of its leasehold—typically from the proceeds of the sale."); Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 698–99, 707–12 (S.D.N.Y. 2014) (real property may be sold pursuant to section 363(f) free and clear of a lessee's interest in the real property in limited circumstances, but that interest is entitled to adequate protection under section 363(e)).

Royal Street

Royal Alice Properties, LLC ("RAP") owned three properties in New Orleans. RAP's sole equity holder was Susan Hoffman ("Hoffman"). The properties were leased to Hoffman as her personal residence and to commercial tenants Royal Street Bistro, L.L.C. ("RSB") and Picture Pro, LLC ("Picture Pro" and, collectively with RSB and Hoffman, the "Tenants"). 

In August 2019, RAP filed for chapter 11 protection in the Eastern District of Louisiana. Shortly afterward, it commenced an adversary proceeding against AMAG Inc. ("AMAG"), the mortgagee of the properties, seeking a determination of the validity, extent, and priority of disputed liens AMAG had asserted against the properties.

While the adversary proceeding was pending, the court appointed a chapter 11 trustee. The court then granted summary judgment in favor of AMAG in the adversary proceeding. In July 2021, the trustee sought court approval of a settlement with AMAG and authority to sell the properties free and clear of AMAG's liens and the Tenants' leasehold interests 

The Tenants responded by filing a motion for adequate protection of their leasehold interests under section 363(e) in the form of retained possession of the leased premises through the end of their purported 20-year leases. They also asked the court to require the trustee to assume or reject the leases, arguing that rejection would trigger the protections set forth in section 365(h).

The bankruptcy court entered an order approving the settlement and the sale on November 30, 2021 (the "Nov. 30 order"), but denied the Tenants' motion for adequate protection and an order compelling the trustee to assume or reject the leases. According to the bankruptcy court: (i) because AMAG could have foreclosed on its mortgages under state law and thereby extinguished the tenants' leasehold interests, the properties could be sold free and clear of those interests under section 363(f)(1), which permits a sale free and clear if "applicable bankruptcy law permits sale of such property free and clear of such interest"; and (ii) because Picture Pro had not paid any rent for several months and was therefore in default of its lease, the property could be sold free and clear of the lease under section 363(f)(4), which permits a sale free and clear if "such interest is in bona fide dispute." See In re Royal Alice Props., 637 B.R. 465, 481-82 (Bankr. E.D. La. 2021).

The Tenants appealed the Nov. 30 order to the district court and simultaneously sought an emergency stay of the bankruptcy court's order pending the appeal. The district court denied the motion for a stay. Both the bankruptcy court and the district court relied on Qualitech and Spanish Peaks in denying the Tenants' requested relief.

The Tenants then filed a petition with the Fifth Circuit for a writ of mandamus compelling the district court to issue a stay pending appeal. In its summary opinion denial of the petition, the Fifth Circuit agreed with the result reached by the lower courts, but signaled disagreement with the holdings in Qualitech and Spanish Peaks, and cautioned courts against "blithely accepting Qualitech's reasoning and textual exegesis." See Royal Street I, 26 F.4th at 328.

On January 10, 2022, the bankruptcy court entered a final order (the "Jan. 10 order") approving the settlement and bidding procedures for the sale of the properties at auction in February 2022.

The Tenants appealed the Jan. 10 order as well, and the district court consolidated that appeal with the appeal of the Nov. 30 order. 

At the auction, AMAG purchased one of the properties, and third parties bought the other two. The Tenants subsequently settled their dispute with AMAG and dismissed their consolidated appeal with respect to AMAG.

The trustee then moved to dismiss the appeal, arguing that any challenge to either the sale or the related settlement was rendered moot by section 363(m) because the purchasers acted in good faith and the sale was not stayed pending appeal. The trustee also argued that the appeal was moot due to the dismissal of AMAG from the litigation. According to the trustee, the Tenants could not overturn only the provisions of the settlement agreement that distributed the sales proceeds to the trustee, while leaving undisturbed the provisions awarding the remaining proceeds to AMAG.

The Tenants countered that they did not challenge the sale itself, but only the disposition of sale proceeds to the trustee under the settlement agreement. According to the Tenants, in the settlement agreement, they expressly relinquished any challenge to the sale or the distribution of sale proceeds to AMAG, but were seeking to reverse the settlement between the trustee and AMAG, but only as to the trustee, which was beyond the scope of section 363(m).

The District Court's Ruling

The district court ruled that the appeal was moot under section 363(m).

U.S. District Judge Sarah S. Vance explained that, in accordance with Fifth Circuit precedent, "'fatal means fatal: challenges to authorized bankruptcy sales are dismissed when the party challenging the sale' fails to obtain a stay." Royal Street II, 2022 WL 6308294, at *3 (quoting Walker County, 3 F.4th at 234). She rejected the Tenants' argument, based on out-of-circuit precedent, that challenges to settlement agreements are outside the scope of section 363(m), noting that those courts "construe section 363(m) more narrowly that the Fifth Circuit." Id. at *4 (citing In re X-Treme Bullets, Inc., 2020 WL 4455582, *7 (D. Nev. Aug. 3, 2020) (collecting cases and describing the Seventh and Ninth Circuits as adopting "the narrower view" of mootness under section 363(m)).

Instead, Judge Vance emphasized, the Fifth Circuit "considers how closely linked a challenged settlement provision is to a sale itself in order to determine the applicability of section 363(m) to an appeal." Id. She explained that, in this case, the terms of the settlement governing distribution of the sales proceeds "were part and parcel of the sale—they ensured that the sale would accomplish its purpose, the satisfaction of AMAG's claim, while allocating to the Trustee sufficient funds to effectuate the sale and to administer the estate." Id. at *5. The district court accordingly found that the terms of the settlement agreement governing the disposition of sales proceeds were "'necessary to facilitate the transaction' and are thus integrally linked to the underlying sale." Id. (quoting In re Sneed Shipbuilding Inc., 916 F.3d 405, 407 (5th Cir. 2019), and citing Alabama-Mississippi, 791 F. App'x at 470).

The district court was critical of the Tenants' effort to cherry-pick which provisions of the settlement agreement could be enforced and against whom. "Both [the trustee and AMAG] performed as agreed under the settlement agreement," Judge Vance wrote, "and the sales are final." The district court accordingly dismissed the appeal as moot under section 363(m).

Outlook

Royal Street II is consistent with the Fifth Circuit's broad interpretation of the scope of section 363(m) as applying not only to unstayed sale orders but also to orders approving transactions, such as settlements, that are integral to a sale. The decision also reinforces the importance of finality in bankruptcy sale transactions.

The Tenants appealed the district court's ruling to the Fifth Circuit on October 5, 2022. 

The Royal Street II district court was not asked to decide whether section 363(m) acts as a jurisdictional bar to any appeal, as distinguished from a limitation on remedies. This issue, however, is squarely before the U.S. Supreme Court in Sears Holdings. See MOAC Mall Holdings LLC v Transform Holdco LLC, No. 21-1270 (U.S.). The Court heard oral argument on December 5, 2022, and its decision may provide guidance on both the jurisdictional question as well as the proper scope of section 363(m).