On September 14, 2015, the Third Circuit released a precedential opinion (the “Opinion”) which addressed payments from a buyer to non-debtor parties in a 363 sale.  The Third Circuit’s opinion is available here.  If you prefer the version of the Opinion published by Westlaw, it is ICL Holding Company, Inc., et al. v. United States, 2015 WL 5315604 (3d Cir. Sept. 14, 2015).

In this case, a creditor was purchasing all of the Debtor’s assets with a credit bid.  To insulate their bid from a Committee objection, the Purchaser agreed to pay the legal and accounting fees of the Debtor and the Committee by funding, outside of the bankruptcy estate, an escrow account.  The U.S. government objected to the payment to the Committee as was a “violation of the absolute priority rule”.  Opinion at *10.  The attorneys for the IRS objected to the sale and the payment to the Committee as its administrative (tax) claims would be unpaid.

Ruling from the bench, the Bankruptcy judge held that the settlement funds (deposited into escrow) were not part of the Debtor’s estate, and therefor not a consideration in its analysis of whether the absolute priority rule was violated.  Opinion at *10-11.  The District Court agreed with the Bankruptcy Court, holding that “the funds at issue were not property of the estate and thus not subject to the Code’s distribution rules.”  Opinion at *12.

The Third Circuit ultimately agreed with The Bankruptcy and District Courts, holding that they “cannot ignore the economic reality of what actually occurred” and that “as a matter of substance, we cannot conclude that the escrowed funds were estate property.”  Opinion at *20.

My $.02

In some situations, the economics are the most important aspect of a deal.  As the Third Circuit has now held, this is one such situation.  The funds used to pay the Committee were not part of the bankruptcy estate, and thus not subject to the absolute priority rule.  For any organizations looking to purchase assets out of a bankruptcy proceeding, this decision is a must read.