BANKRUPTCY & GOOD FAITH: Possible Limits on Appellate Review

By Madeline Taylor on February 24, 2023

Bankruptcy can mean big business when it involves billions of dollars. Take retail juggernauts Mall of America (MOAC) and Sears, who entered into bankruptcy proceedings ultimately assigning assets amounting to over $5.2 billion — representing up to 600 leases of the super chain’s assets — to Transform, a retailer that assigns leases to its subsidiaries.

After the sale closed, Sears received court approval to also assign the MOAC lease to Transform however, MOAC in turn appealed the lease assignment to Transform. In turn, Transform objected to the appellate court’s jurisdiction to hear the appeal arguing that under Section 363(m), the court could not hear an appeal of a sale unless the appeal challenged the good faith aspect of the sale. MOAC argued that the Second Circuit should apply the majority interpretation of Section 363(m) and modify the terms of the sale so that the MOAC lease was not included in the sale, reasoning that this modification would not invalidate the sale. While Section 363(m) protects good faith purchases, there is currently a divide among the US Circuit Courts as to the extent of the rule that the Supreme Court set to resolve in MOAC Mall Holdings, LLC v. Transform Holdco, LLC & Sears Holding Corp.

Bankruptcy Code Section 363 Sales

The Supreme Court has granted certiorari to resolve a split among Circuit Courts as to whether Section 363(m) of the Bankruptcy Code limits appellate jurisdiction to address cases involving the sale of bankruptcy property. The Supreme Court will review the Second Circuit holding inMOAC Mall Holdings, LLC v. Transform Holdco, LLC & Sears Holdings Corp. and decide whether to limit to appellate review of bankruptcy sales.

A bankruptcy trustee may sell or lease property of the bankruptcy estate to raise money to pay the debtor’s obligations. These sales are authorized by Section 363 of the Bankruptcy Code and are referred to as “Section 363 sales.” The bankruptcy court will approve a Section 363 sale if the sale satisfies the requirements set forth in the statute. Most importantly, the sale must (1) be in the best interests of the estate and its creditors, (2) have legitimate business justifications, and (3) be negotiated in good faith and at arm’s length.

Section 363(m) Appeals

If an objecting party believes that the sale does not satisfy the Section 363 requirements, the opposition may appeal the court’s authorization of the sale. However, Section 363(m) says that even if the appellate court modifies or reverses the bankruptcy court’s approval of the sale, the validity of the sale is not affected if the sale was made in good faith. This means that even if the court finds that the sale should not have been approved, the sale cannot be reversed. This provision protects purchasers from losing the value of their bargain to an appeal by a creditor who is not involved in the transaction.

MOAC Mall Holdings, LLC v. Transform Holdco, LLC & Sears Holdings Corp

While Section 363(m) protects good faith purchases, there is currently a divide among the US Circuit Courts as to the extent of the rule. The Supreme Court is set to resolve this Circuit split in MOAC Mall Holdings, LLC v. Transform Holdco, LLC & Sears Holding Corp.

In 1991, Sears entered into a lease for a three-story anchor store in the Mall of America (MOAC). Sears filed for bankruptcy in 2018 and received court approval for a $5.2 billion sale of assets to Transform, a retailer who assigns leases to its subsidiaries. Under the terms of the sale, Sears sold the rights of up to 600 leases to Transform.

After the sale closed, Sears received court approval to assign the MOAC lease to Transform. MOAC appealed the bankruptcy court’s approval of the assignment, and the appellate court agreed with MOAC that the assignment was prohibited by the Bankruptcy Code. Transform objected to the appellate court’s jurisdiction to hear the appeal, arguing that under Section 363(m), the court could not hear an appeal of a sale unless the appeal challenged the good faith aspect of the sale. MOAC argued that the Second Circuit should apply the majority interpretation of Section 363(m) and modify the terms of the sale so that the MOAC lease is not included in the sale, reasoning that this modification would not invalidate the sale.

The district court and the Second Circuit maintained their stance that a Section 363(m) appeal may only be heard if the good faith aspect of the purchase is challenged, affirming the assignment to Transform. Citing the circuit split, MOAC petitioned to the Supreme Court, which granted certiorari on June 27th, 2022.

Moving Forward

If the Supreme Court sides with the Second and Fifth Circuits, any good faith purchase of bankruptcy property will have iron-clad protection from appellate review. If the Court holds with the majority of Circuits (Third, Sixth, Seventh, Ninth, Tenth, and Eleventh), Section 363(m) will, effectively, only limit available remedies, not jurisdiction, to an appeal of a Section 363 sale. In other words, if the Court adopts the majority rule, appellate courts will likely hear more cases in which they can review and modify Section 363 sales. Consequentially, purchasers of bankruptcy estate property will be at a higher risk of losing the property purchased because of the increased likelihood of judicial review. However, on the other hand, purchasers can potentially benefit from this risk by using it to negotiate a lower sales price and more favorable terms.

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BANKRUPTCY & GOOD FAITH: Possible Limits on Appellate Review

Bankruptcy can mean big business when it involves billions of dollars.

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