The finality of asset sales in bankruptcy is an indispensable feature of U.S. bankruptcy law designed to maximize the value of a bankruptcy estate as expeditiously as possible for the benefit of all stakeholders. To promote the finality of bankruptcy sales, section 363(m) of the Bankruptcy Code prohibits reversal or modification on appeal of an order approving a sale to a good-faith purchaser unless the party challenging the sale obtains a stay pending appeal. Section 363(m) has also been read broadly to protect the interests of any good-faith purchaser in the purchased assets.
The U.S. Court of Appeals for the Seventh Circuit recently examined the scope of 363(m) in Archer-Daniels-Midland Co. v. Country Visions Cooperative, 29 F.4th 956 (7th Cir. 2022). The court of appeals affirmed lower court rulings denying a motion to bar an entity holding a right of first refusal on property purchased from a debtor "free and clear" of all interests pursuant to section 363(f) from continuing state court litigation seeking to enforce its right. In doing so, the Seventh Circuit appears to have placed an affirmative obligation on asset purchasers to notify the bankruptcy court of any notice deficiencies discovered during the sale process. According to the Seventh Circuit, because the buyer had actual and constructive knowledge of a right of first refusal held by a party who had not received notice of the bankruptcy, yet never informed the bankruptcy court, the buyer had not acted in good faith and was not entitled to the protections of section 363(m).
The Breadth of Section 363(m)
Section 363(m) of the Bankruptcy Code 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).
Section 363(m) has also been read to go further than simply limiting appellate review— broadly protecting 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 (7th Cir. 1992) (holding that a collateral attack on 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 (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)).
The Bankruptcy Code does not define "good faith." Courts have adopted various definitions, many of which are substantially similar. See generally Collier on Bankruptcy ("Collier") ¶ 363.11 (16th ed. 2022). For example, the U.S. Court of Appeals for the Fifth Circuit has defined a "good faith purchaser" for purposes of section 363(m) as "'one who purchases the assets for value, in good faith, and without notice of adverse claims.'" Hsin Chi Su v. C Whale Corp. (In re C Whale Corp.), 2022 WL 135125, *3 (5th Cir. Jan. 13, 2022) (quoting In re TMT Procurement Corp., 764 F.3d 512, 521 (5th Cir. 2014)); accord In re Mark Bell Furniture Warehouse, Inc., 992 F.2d 7, 8 (1st Cir. 1993). Lack of good faith is commonly manifested by "fraud, collusion between the purchaser and other bidders or the trustee, or an attempt to take grossly unfair advantage of the other bidders." TMT Procurement, 764 F.3d at 521; accord In re Ewell, 958 F.2d 276, 279 (9th Cir. 1992); In re Abbotts Dairies, Inc., 788 F.2d 143, 147 (3d Cir. 1986); Hoese Corp. v. Vetter Corp. (In re Vetter Corp.), 724 F.2d 52, 56 (7th Cir. 1983); Badami v. Burgess (In re Burgess), 246 B.R. 352, 356 (B.A.P. 8th Cir. 2000); In re General Motors Corp., 407 B.R. 463, 494 (Bankr. S.D.N.Y. 2009).
Some courts—principally in the Third Circuit—require a finding of good faith at the time the bankruptcy court approves a sale or lease of property under section 363. See Abbotts Dairies, Inc., 788 F.2d at 149–50; In re Perona Bros., Inc., 186 B.R. 833, 839 (D.N.J. 1995); In re Primel, 629 B.R. 790, 799 (Bankr. W.D. Pa. 2021); In re Hereford Biofuels, L.P., 466 B.R. 841, 860 (Bankr. N.D. Tex. 2012). Other courts do not. See, e.g., In re Zinke, 97 B.R. 155, 156 (E.D.N.Y. 1989) (declining to adopt the Abbotts Dairies rule); In re M Cap. Corp., 290 B.R. 743, 748 (B.A.P. 9th Cir. 2003) ("Because findings of 'good faith' made at the time of the sale may be premature because they are made before the really interesting facts emerge, the Ninth Circuit does not require that a finding of 'good faith' be made at the time of sale and has rejected the Third Circuit's contrary rule.").
Courts also disagree as to whether any entity asserting a lien on, or other interest in, property to be sold free and clear under section 363(f) of the Bankruptcy Code must be provided with advance notice of the sale for the purchaser of the property to be entitled to the protection of section 363(m). See generally Collier at ¶ 363.11 ("The protection afforded by section 363(m) has been held not to protect even an otherwise good faith purchaser when no notice was given to the lienholder, resulting in the purchaser taking the property subject to the lien."). Compare United States v. Moberg Trucking, Inc. (In re Moberg Trucking, Inc.), 112 B.R. 362 (B.A.P. 9th Cir. 1990) (section 363(m) requires that a sale be authorized under section 363(b), which specifically requires notice and a hearing; thus, section 363(m) mootness is not applicable when the appellant seeks to attack the section 363 sale of estate property on the grounds of improper notice) with In re Edwards, 962 F.2d 641 (7th Cir. 1992) (a purchaser at a section 363(b) sale took clear title even though the lienholder did not receive notice at the time of the sale); In re Motors Liquidation Co., 529 B.R. 510 (Bankr. S.D.N.Y. 2015) (lack of notice will not invalidate a sale, unless party can show prejudice).
In 2007, Olsen Brothers Enterprises, LLP ("OBC") granted a 10-year right of first refusal on a Wisconsin grain facility to the predecessors in interest of Country Visions Cooperative (collectively, "CVC"). CVC duly recorded the right in the local real estate records. OBC dissolved shortly afterward and distributed its assets to its partners (brothers Paul and David Olsen), an event that neither triggered nor dissolved the right of first refusal according to its terms.
In 2010, the Olsen brothers and their spouses filed for chapter 11 protection in the Eastern District of Wisconsin. Their chapter 11 plan provided for the sale of the grain-facility property to Archer-Daniels-Midland Co. ("Archer") free and clear of all liens under section 363(f). In performing its due diligence, Archer acquired a copy of a title report for the property that disclosed CVC's right of first refusal. Archer was also aware that CVC was not a party to the bankruptcy case, and Archer had in fact been contacted by CVC's counsel about protecting its interest in the property. Archer never brought any of this to the attention of the bankruptcy court. In 2011, the bankruptcy court confirmed the plan and authorized the sale. CVC was never notified of the bankruptcy filing, the chapter 11 plan, or the sale.
In 2015, after Archer arranged to sell the property to another entity, CVC sued Archer in state court demanding compensation for the abrogation of its right of first refusal. Archer then asked the bankruptcy court to reopen the case and, relying on section 363(m), to issue an order enforcing the free and clear sale of the property and barring CVC from seeking any remedy in state court.
The bankruptcy court reopened the case, but declined to grant the relief requested by Archer. The district court affirmed on appeal. Both courts ruled that Archer had not acquired the property in good faith because it knew of the existence of CVC's right of first refusal, yet failed to alert the bankruptcy court. Given the failure of the debtors and Archer to disclose what they knew about CVC's right of first refusal, the bankruptcy court considered vacating the sale as a fraud on the court, but instead merely denied Archer's motion for an order enjoining the state court litigation. Archer appealed to the Seventh Circuit.
The Seventh Circuit's Ruling
A three-judge panel of the Seventh Circuit affirmed. According to U.S. Circuit Judge Frank H. Easterbrook, "it seem[ed] clear" that the Olsen brothers proceeded in bad faith because: (i) they knew of CVC's right of first refusal, yet failed to notify CVC of their bankruptcy filing and the proposed sale of the property, for which they were obligated to give CVC at least 21 days' notice under Rule 2002(f) of the Federal Rules of Bankruptcy Procedure; and (ii) they failed to inform the bankruptcy court of CVC's interest.
However, Judge Easterbrook explained, the dispute at issue was between CVC and Archer, and "[t]he question is whether [Archer] bought the parcel in good faith, not whether the Olsens sold it in bad faith." "[O]n that score," he wrote, "it is impossible to disagree with the bankruptcy and district judges that someone who has both actual and constructive knowledge of a competing interest, yet permits the sale to proceed without seeking the judge's assurance that the competing interest-holder may be excluded from the proceedings, is not acting in good faith." Archer-Daniels, 29 F.4th at 959.
Had CVC been made a party to the proceedings, Judge Easterbrook noted, it would have been in a position to appeal an order approving the sale over its objection. But it was not, he wrote, "and a non-party cannot be expected to appeal." Id.
The Seventh Circuit accordingly ruled that Archer was not a good-faith purchaser and that it was therefore obligated to defend the state court litigation.
The finality of bankruptcy asset sales is an essential aspect of the American bankruptcy system. It is designed to promote the expeditious administration of bankruptcy estate assets and bring an element of certainty to purchasers, without which they might be either disinclined to participate in the sale process or unwilling to offer a fair price. Section 363(m) essentially cuts off most challenges to a court-approved sale, but Archer-Daniels illustrates that the provision has limitations. One of them is that the purchaser—as distinguished from the debtor or the trustee—must have acted in good faith to qualify for its protections.
In many respects, the facts in Archer-Daniels presented an easy case because it was clear that both the purchaser and the debtor purposefully concealed information from the bankruptcy court. In addition to the direct inquiry from counsel to CVC, the purchaser had actual and constructive knowledge based upon the fact that the title report for the property listed the right of first refusal. Potential bankruptcy asset purchasers should heed Archer-Daniels's warning: In order to protect one's status as a "good-faith purchaser," a buyer must act as if it has an affirmative obligation to fully diligence the marketed asset and inform the court of any notice deficiencies that may exist.