Section 363 Sale: Free and Clear of Claims That Are Backed By Strong Public Policies

Under Section 363(f) Free and Clear Means Free and Clear: A Case Study

Bankruptcy sales of assets under section 363(f) can bring more cash into the estate in part because the purchaser takes the assets “free and clear” of the liabilities of the debtor-seller. The Ormet[i] case illustrates that the “free and clear” quality of assets in the hands of the purchaser after a section 363 sale, trump claims against the seller that are supported by very strong Congressional policies.

Using union labor in Ohio, the Ormet Corporation and related companies produced aluminum. The companies then filed chapter 11 cases in the U.S. Bankruptcy Court for the District of Delaware. They sought and failed, to sell substantially all their assets as a going concern. The debtors stopped production but kept one facility on “hot idle” status in order to try to sell that asset as a going concern, with such sale being “free and clear” of claims against the seller, under section 363(f) of the Bankruptcy Code. An auction of the assets yielded a cash bid of $25.25 million.

The sole objection to the closing of the sale came from the Steelworkers Pension Trust, that sought to impose upon the buyer the liabilities of the debtor-seller arising from steelworkers’ rights to protection from pension plans left underfunded by the withdrawal of employers (like seller).  The court agreed with the Trust that Congress had “expressed a strong policy in favor of protecting multi-employer pension plans.”[ii] But was that enough to trump the free and clear nature of assets in a section 363 sale?

We discussed in an earlier article the legal mechanics of how, in a section 363 sale, a purchaser can take the assets free and clear of liens, claims, and encumbrances on the assets of the seller.  In short, section 363(f) provides that a debtor-in-possession (in a chapter 11 case) or trustee may sell property outside the ordinary course of business “free and clear of any interest in such property of an entity other than the estate” under certain conditions.

[Editor’s Note: For more information on 363 motions, please see The Nuts and Bolts of a 363 Motion.]

The “interest” in Ormet was the liability of the seller to steelworkers arising from its withdrawal from the pension plan.  The power to sell assets free and clear of such an interest is subject to conditions set forth in section 363(f)(1) – (5).[iii]  None of those conditions applied to limit the free and clear effect of the Ormet sale.

The Trust argued that the strong Congressional policy in favor of protecting the steelworkers should prevail over any order granting the assets to the purchaser “free and clear” of pension withdrawal liability.  In countering that argument, the Court posed the Bankruptcy Code’s policy “to maximize the value of the debtor’s assets for distribution to creditors in accordance with the priority scheme in the Code.”[iv]

In overruling the objection, the Court relied upon the holdings of Circuit Courts of Appeal that had applied section 363(f) to uphold orders approving section 363 sales to purchasers free and clear of claims premised on liabilities that embodied other strong Congressional policies: preventing sex and employment discrimination,[v] and protecting the medical benefits of coal workers.[vi]  Further, the court pointed out that a sale free and clear of all general unsecured claims except those of the Trust would violate the priorities scheme under section 507 of the Bankruptcy Code.[vii] Had the objection been sustained, the Trust may have gotten paid in full, while the other unsecured creditors would receive only their proportionate shares of the leftover assets.

[Editor’s Note: For more on priorities in bankruptcy, please see Absolute Priority Rule in Bankruptcy: Are You Atop the List?]

The strong policy advanced by the Trust could not defeat the express provisions of the Bankruptcy Code providing for free and clear sales and setting the scheme of priorities of payment – which in turn give authoritative form to the strong Congressional policies in favor of their application.

[Editor’s Note: This is an update of an article originally published in August 2014.]

[i] In re Ormet Corp., No. 13-10334 (MFW), 2014 WL 3542133 (Bankr. D. Del. July 17, 2014). All facts discussed herein are taken from this as yet unpublished memorandum opinion.
[ii] Id.at 6. As evidence of the policy, the court cited the Employee Retirement Income Security Act of 1974, codified at 29 U.S.C. § 1001 -1461, et seq. [ERISA] and the Multiemployer Pension Plan Amendments Act of1980, codified at 29 U.S.C. § 1381 – 1461 [MPPAA]. Id. at 6, n. 4.
[iii] Those subsections provide that the trustee or the debtor-in-possession may do so “only if” one of the following conditions is met:

1. applicable nonbankruptcy law permits sale of such property free and clear of such interest;
2. such entity consents;
3. such interest is a lien, and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
4. such interest is in bona fide dispute; or
5. such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

11 U.S.C. § 363(f)(1)-(5).
[iv] In re Ormet Corp. at 8 & 9.
[v] Id. at 5-8 (citing In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003)).
[vi] Id. (citing In re Leckie Smokeless Coal Co., 99 F.3d 573 (4th Cir. 1996)).
[vii] Id. at 9.