Marguerite Lee De Voll, Neither "free" Nor "clear": the Real Costs of in Re Pw, Llc: a Look at Sec. 363(f)(3) and How to Protect Creditors

• Publication year: 2011

NEITHER "FREE" NOR "CLEAR": THE REAL COSTS OF IN RE PW, LLC: A LOOK AT Sec. 363(F)(3) AND HOW TO PROTECT CREDITORS

INTRODUCTION

Under a chapter 11 reorganization plan, Sec. 363(f)(3) allows a debtor to sell real estate collateral with senior and junior liens "free and clear" of other interests in the property.¹For the sale to be "free and clear," the sale amount must be greater than the "aggregate value of all liens on such property."²In its entirety, Sec. 363(f)(3) states:

The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if . . . (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.³

The federal bankruptcy courts have been inconsistent as to the interpretation of the phrase ". . . greater than the aggregate value of all liens on such property."⁴

The inconsistency affects the ability of a secured creditor to make a credit bid to purchase property free and clear of non-consenting junior creditors and the ability of a debtor to sell property at auction to satisfy the senior secured creditor's lien.⁵

Bankruptcy courts have interpreted Sec. 363(f)(3) mainly in two ways. Some courts have defined the "aggregate value of all liens" to mean the value of the collateral secured by the lien (the "Collateral Value" approach).⁶Under this approach, the aggregate value of the liens is determined by the best sale price of the collateral in a bankruptcy proceeding.⁷Other courts have defined "aggregate value of all liens" to be the total amount of all the liens on the collateral (the "Total Lien Amount" approach).⁸Under this approach, the aggregate value of the liens is based solely on the sum total of liens against the collateral, regardless of the actual value that the collateral would realize at sale.⁹The difference between these alternative interpretations becomes apparent when the amount of total liens on an asset exceeds the value of that asset. For example, a debtor owes a creditor $300,000 and has secured the loan with a lien on a piece of the debtor's real estate. However, there could be other creditors that have secured debt against that same real estate. Assume there is another $200,000 in debt secured by the same piece of real estate, totaling the amount of secured debt to $500,000 on the $300,000 piece of real estate. The debate within the courts centers on whether "aggregate value" should be based on the Total Lien Amount ($500,000) or the Collateral Value ($300,000). The approach chosen affects how senior and junior creditors are compensated when a debtor's real estate is sold during a bankruptcy proceeding.

This Comment seeks to clarify the issues surrounding the interpretation of

"aggregate value" under Sec. 363(f)(3) in four parts. Part I explores the history of

Sec. 363(f)(3) and, referencing the current inconsistency on how to interpret "aggregate value," explains how the statute arrived at its current language. Part II identifies and explains the two main judicial approaches to interpreting

Sec. 363(f)(3): the Collateral Value interpretation and the Total Lien Amount interpretation. Part III sets out an analysis of the most commonly given reasons for and against using the Collateral Value definition and proposes that the Collateral Value approach should be incorporated into the Bankruptcy Code. Part IV examines the recent Ninth Circuit Bankruptcy Appellate Panel case, In re PW, LLC. Relying on arguments for the Collateral Value approach, Part IV shows the adverse consequences of using the Total Lien Amount approach on both creditors and the estate and highlights the Ninth Circuit Bankruptcy Appellate Panel's error in using the Total Lien Amount approach.

There are ultimately three conclusions. First, in light of the two judicial interpretations of 11 U.S.C. Sec. 363(f)(3), the Ninth Circuit Bankruptcy Appellate Panel erred in its decision preventing the senior secured creditor's bid to be accepted free and clear of the junior creditors. Second, in order to prevent future misinterpretations of "aggregate value" with respect to senior and junior creditors, Sec. 363(f)(3) should be revised to incorporate the Sec. 506(a) definition of "value."¹⁰A revised Sec. 363(f)(3) is proposed that would read:

[S]uch interest is a lien and the price at which such property is to be sold is greater than the (i) value of the collateral if (a) the price is the best attainable price; and (b) it is in the interest of the estate; or (ii) the aggregate amount of all liens on such property.¹¹

Third, in lieu of a congressional revision, the underlying issue with Sec. 363(f)(3) could be resolved if a case came before the United States Supreme Court. If this were to occur, the Court should interpret Sec. 363(f)(3) to include the Collateral Value approach.

I. A HISTORY OF SECTION 363(f)(3)

In 1978, Congress passed the Bankruptcy Reform Act,¹²which codified and amended the previous Bankruptcy Act of 1898.¹³The stated purpose of the Bankruptcy Reform Act was "to modernize the bankruptcy law by codifying a new Title 11 that will embody the substantive law of bankruptcy."¹⁴Since its inclusion in the Bankruptcy Reform Act of 1978,

Sec. 363(f)(3) has undergone only one revision.¹⁵In 1984, Congress changed

"such interest" to "all liens on such property."¹⁶The current language of

Sec. 363(f)(3) states, in pertinent part:

The trustee may sell property . . . free and clear of any interest in such property of an entity other than the estate, only if . . . (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.¹⁷

The phrase "aggregate value of all liens of such property" has proved problematic, resulting in a division among the courts as to the meaning of aggregate value.¹⁸

The legislative history provides some guidance to courts regarding the interpretation of aggregate value: "The trustee may sell free and clear. . . [when] the interest is a lien and the sale price of the property is greater than the amount secured by the lien."¹⁹This suggests that it was Congress's intent to adopt an interpretation similar to the Collateral Value approach.

However, the legislative history is ambiguous enough to leave the issue in dispute among the bankruptcy courts. Last year, the Ninth Circuit Bankruptcy Appellate Panel became the first bankruptcy appellate panel ("BAP") to rule on the issue. The Ninth Circuit BAP ruled in favor of junior creditors, limiting the ability of a senior secured creditor to make a secured bid at auction on real estate collateral.²⁰In In re PW, LLC, the debtor filed for chapter 11 bankruptcy and, in conjunction with the senior secured creditor, developed a plan to sell at auction all of its real property, which was subject to the senior secured creditor's lien.²¹The property was also subject to a junior lien.²²At auction, the senior secured creditor made a credit bid in the amount of its lien, which was the highest bid received.²³The senior secured creditor purchased the property and pursuant to Sec. 363(f)(3) the lower court authorized the sale to be free and clear of the junior lien.²⁴However, the Ninth Circuit BAP reversed the lower court's ruling and held that "aggregate amount of all claims" meant the summed total "amount" of the liens on the collateral, without considering the value that the collateral would actually realize at sale.²⁵The PW, LLC case highlights the two competing definitions of aggregate value that have developed: the district court's Collateral Value definition and the BAP's Total Lien Amount definition.

II. TWO JUDICIAL APPROACHES

Courts have developed two approaches for interpreting the phrase "aggregate value of all liens" as it appears in Sec. 363(f)(3). The Collateral Value approach uses statutory construction as a tool to conclude that aggregate value means the value of the collateral secured by the lien.²⁶The Collateral Value approach has problems-the main one being that unbridled use of this approach could result in the sale of collateral for a price that is too low.²⁷

Thus, courts have limited the use of the Collateral Value approach to a case- by-case basis and have applied it only in particular circumstances, including when the sale price is the best attainable value or when the sale would be for the benefit of the estate.²⁸The Total Lien Amount approach uses a competing theory of statutory construction and also looks to legislative intent to conclude that aggregate value means the total amount of all the liens on the collateral, regardless of the value of the collateral itself.²⁹The subsections that follow will explain the rationales for and uses of the two different approaches.

A. Interpreting Aggregate Value to Mean the Value of the Collateral

Several courts have interpreted "aggregate value of all liens" to mean the value necessary for the purposes of a bankruptcy sale of the collateral, a determination that rests upon the value of the collateral upon which the liens exist.³⁰When interpreting aggregate value to mean the secured value of the collateral,³¹these courts have relied primarily on a theory of statutory construction.³²

Because the term aggregate value is ambiguous in Sec. 363(f)(3), these courts have argued that "[w]hen construing statutory language, [terms having particular meaning to the subject matter] are to be interpreted in line with that meaning, and in light of other provisions of the statute."³³This means the courts should look to the incorporation of "value" in other sections of the Bankruptcy Code to inform their interpretation of "aggregate value."³⁴These courts rely on the use of value under Sec. 506(a),³⁵which states in pertinent part:

An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value...