PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

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No. 14-2709

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In re: ICL HOLDING COMPANY, INC., et al.

Debtors

United States of America,

Appellant

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Appeal from the United States District Court

for the District of Delaware

(D.C. Civil Action No. 1-13-cv-00924)

District Judge: Honorable Sue L. Robinson

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Argued January 14, 2015

Before: AMBRO, FUENTES, and ROTH, Circuit Judges

(Opinion filed: September 14, 2015)

Tamara W. Ashford

 Acting Assistant Attorney General

David A. Hubbert

 Deputy Assistant Attorney General
2

Thomas J. Clark, Esquire (Argued)

Bethany B. Hauser, Esquire

Christopher Williamson, Esquire

United States Department of Justice

Tax Division

950 Pennsylvania Avenue, N.W.

P.O. Box 502

Washington, DC 20044

Charles M. Oberly, III

 United States Attorney 

Ellen W. Slights, Esquire

Office of the United States Attorney

1007 North Orange Street, Suite 700

P.O. Box 2046

Wilmington, DE 19899

Counsel for Appellant

Anthony W. Clark, Esquire (Argued)

Kristhy M. Peguero, Esquire

Skadden, Arps, Slate, Meagher & Flom

One Rodney Square

P.O. Box 636

Wilmington, DE 19801

Felicia G. Perlman, Esquire

Matthew N. Kriegel, Esquire

Candice Korkis, Esquire

Skadden, Arps, Slate, Meagher & Flom

155 North Wacker Drive, Suite 2700

Chicago, IL 60606
3

Kenneth S. Ziman, Esquire

Skadden, Arps, Slate, Meagher & Flom

4 Times Square

New York, NY 10036

Counsel for Appellees

ICL Holding Co., Inc., 

Boise Intensive Care Hospital Inc.,

CareRehab Services LLC, 

Crescent City Hospitals LLC,

LifeCare Healthcare Holdings Inc., 

LifeCare HoldCo LLC, 

Lifecare Ambulatory Surgery Center Inc.,

Lifecare Holding Co. of Texas LLC, 

Lifecare Holdings Inc,,

Lifecare Hospital at Tenaya LLC, 

Lifecare Hospitals LLC,

Lifecare Hospitals of Chester County Inc., 

Lifecare Hospitals of Dayton Inc.,

Lifecare Hospitals of Fort Worth LP,

Lifecare Hospitals of Mechanicsburg LLC, 

Lifecare Hospitals of Milwaukee Inc.,

Lifecare Hospitals of Ne Orleans LLC,

Lifecare Hospitals of North Carolina LLC,

Lifecare Hospitals of North Texas LP,

Lifecare Hospitals of Northern Nevada Inc.,

Lifecare Hospitals of Pittsburgh LLC,

Lifecare Hospitals of San Antonio LLC,

Lifecare Hospitals of Sarasota LLC,

Lifecare Hospitals of south Texas Inc.,

Lifecare Investments LLC, 

Lifecare Investments 2 LLC,

Lifecare Management Services LLC, 
4

Lifecare Reit 1 Inc., Lifecare Reit 2 Inc., 

Lifecare Specialty Hospital of North Louisiana LLC,

Nextcare Specialty Hospital Of Denver Inc.,

Nextcare Hospitals Muskegon Inc.,

Pittsburgh Specialty Hospital LLC,

San Antonio Specialty Hospital Ltd.,

LifeCare Holding Co. Inc., 

LifeCare Intermediate HoldCo Inc.,

Laura D. Jones, Esquire

Peter J. Keane, Esquire

James E. O’Neill, III, Esquire

Bradford J. Sandler, Esquire

Pachulski Stang Ziehl & Jones

919 North Market Street, Suite 1600

P.O. Box 8705, 17th Street

Wilmington, DE 19801

Counsel for Appellee

Official Committee of Unsecured Creditors

Stanley B. Tarr, Esquire

Michael D. DeBaecke, Esquire

Blank Rome

1201 Market Street, Suite 800

Wilmington, DE 19801

Ira S. Dizengoff, Esquire

Abid Quershi, Esquire

Akin Gump Strauss Hauer & Feld LLP

One Bryant Park

New York, NY 10036
5

Scott Alberino, Esquire

Ashleigh L. Blaylock, Esquire

Akin Gump Strauss Hauer & Feld LLP

1333 New Hampshire Avenue, NW

Washington, DC 20036-4000

Counsel for Appellees

Steering Committee, Hospital Acquisition LLC

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OPINION OF THE COURT

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AMBRO, Circuit Judge

11 U.S.C. § 363 allows a debtor to sell substantially all 

of its assets outside a plan of reorganization. In modern 

bankruptcy practice, it is the tool of choice to put a quick 

close to a bankruptcy case. It avoids time, expense, and, 

some would say, the Bankruptcy Code’s unbending rules. 

The issue at the core of this appeal, which arises from such a 

sale, is whether certain payments by a § 363 purchaser (here 

an entity formed by the secured lenders of the debtors) in 

connection with acquiring the debtors’ assets should be 

distributed according to the Code’s creditor-payment 

hierarchy. 

To give some color to this issue, the secured lenders 

here were owed more than the value of the debtors’ assets, 

making them undersecured. They acquired the assets by 

crediting approximately 90% of the secured debt they were 

owed. No cash changed hands. (This purchase mechanism is 

known in bankruptcy parlance as a “credit bid.”) The only 

cash payments made in connection with the deal were those 
6

the secured lenders deposited in escrow for professional fees 

and paid directly to the unsecured creditors. We conclude, as 

we explain more fully below, that neither of the two payments 

went into or came out of the bankruptcy estate. Thus the cash 

was not subject to the Code’s distribution priority. 

I. BACKGROUND

A. LifeCare’s Business Troubles

At the start of 2012, LifeCare Holdings, Inc. 

(“LifeCare”),1 once a leading operator of long-term acute care 

hospitals, was struggling financially. Management blamed its 

condition on Hurricane Katrina’s destruction of three of the 

company’s facilities and growth-stunting federal regulations 

that followed the 2005 natural disaster. Because of the 

weight of its debt load ($484 million, of which approximately 

$355 million was secured), new capital was hard to find. As 

a result, management considered two transactions that would 

salvage it as a going concern: a sale or a restructuring of its 

balance sheet. 

The sale didn’t happen initially because none of 

LifeCare’s suitors (there were at least seven of them) offered 

an amount that exceeded its debt obligations. The best 

offer—submitted by one of LifeCare’s biggest competitors—

reflected a recovery to the secured lenders of only 80-85%. 

Management considered that option inadequate and thus was 

left with the restructuring alternative. To go that route, 

however, it needed the support of its secured lenders. But 

they had another idea. Rather than support a restructuring of 

 

1

 LifeCare while in Chapter 11 was referred to as “LCI.” Per 

its plan of reorganization it became “ICL.” Hence we simply 

use the term “LifeCare.”
7

LifeCare’s balance sheet, the secured lenders wanted to 

purchase the company outright—that is, all of its cash and 

assets. To that end, they offered to credit $320 million of the 

$355 million debt they were then owed. 

Because their credit bid was LifeCare’s best (and only) 

alternative to liquidation under Chapter 7, the company 

agreed to part with all of its assets, including cash. To 

memorialize the proposed sale, the secured lender group 

(through an acquisition vehicle called Hospital Acquisition, 

LLC2) entered into an Asset Purchase Agreement with 

LifeCare in December 2012. 

In addition to its credit bid, the purchaser agreed to 

pay the legal and accounting fees of LifeCare and the 

Committee of Unsecured Creditors (the “Committee”) and to 

pick up the tab for the company’s wind-down costs. Because 

the professionals hadn’t completed their work, the agreement 

directed the purchaser to deposit cash funds into separate 

escrow accounts. Any money that went unspent had to be 

returned to it. 

B. LifeCare Files for Bankruptcy

LifeCare and its 34 subsidiaries, which together 

operated 27 long-term acute care hospitals in 10 states and 

had about 4,500 employees, filed for bankruptcy one day after 

entering into the Asset Purchase Agreement.

3

 Among the 

 

2

 For convenience, we refer to the buyer interchangeably as 

the secured lender group, the secured lenders, or simply the 

purchaser. 

3

 The cases were subsequently consolidated for procedural 

purposes. The separate corporate identities of LifeCare’s 

subsidiaries are irrelevant to this appeal. 
8

company’s first requests was permission to sell substantially 

all of its assets through a Court-supervised auction under 11 

U.S.C. § 363(b)(1). After receiving the go-ahead from the 

Bankruptcy Court, LifeCare marketed its assets to over 106 

potential strategic and financial counterparties. In the end, 

however, the secured lender group’s $320 million credit bid 

remained the most attractive offer. According to the 

testimony of LifeCare’s advisor from Rothschild, Inc., many 

of the putative bidders were concerned with “reimbursement 

issues and the challenging regulatory environment facing the 

long-term acute care industry.” Hence they were unwilling to 

offer LifeCare an amount commensurate with the debt relief 

put forward by the secured lenders. 

Though the secured lender group was selected by 

default as the successful bidder, the sale was not yet a done 

deal. Two important players in the bankruptcy case, the 

Committee and United States Government—neither of which 

would recover anything if the Court approved the sale—

objected to the asset transfer. The former criticized it as a 

“veiled foreclosure” that would leave the bankruptcy estate so 

insolvent even administrative expenses would not be paid. 

The Government, for its part, argued that the sale would 

result in capital-gains tax liability estimated at $24 million, 

giving it an administrative claim that would go unpaid. This 

was unfair, it maintained, because under the proposed sale 

arrangement equally situated administrative claimants—

primarily the bankruptcy professionals—would get paid if the 

sale went through. 

As is not uncommon, however, and before its 

objections to the sale reached resolution, the Committee 

struck a deal with the secured lender group. In exchange for 

the Committee’s promise to drop its objections and support 

the sale, the secured lenders agreed to deposit $3.5 million in 

trust for the benefit of the general unsecured creditors. The 
9

compromise was embodied in a Term Sheet (which we refer 

to as the “Settlement Agreement” or “Settlement”) that was 

submitted to the Bankruptcy Court together with the sale 

materials, but later resubmitted in a stand-alone motion for 

the Court’s approval. 

C. The Sale Hearing

On April 2, 2013 the Bankruptcy Court approved the 

proposed sale from the bench. Applying the “sound business 

purpose” test, which bankruptcy courts use to decide whether 

to approve a § 363 sale, see In re Montgomery Ward Holding 

Corp., 242 B.R. 147, 153–54 (Bankr. D. Del. 1999), the Court 

described LifeCare’s condition as getting progressively 

worse; in bankruptcy talk, it was a “melting ice cube.” The 

only way to avoid liquidation (a potential threat to LifeCare’s 

patients and a result that would leave the unsecured creditors 

and the Government with nothing) and allow the company to 

continue as a going concern was through a quick sale. The 

Court’s order approving the sale noted that (1) it was the only 

alternative to liquidation and best opportunity to realize the 

full value of LifeCare’s assets, (2) the offer accepted was “the 

best and only one,” and (3) a plan of reorganization would not 

have yielded as favorable an economic result. The Court also 

found that the parties gave proper notice of the sale and that 

the purchaser paid a fair and reasonable sum and acted in 

good faith. Finally, and important for our purposes, the Court 

addressed the Government’s Code-based fairness objection. 

Deeming the administrative fee monies put in escrow by the 

purchaser not to be estate property, those funds weren’t 

subject to distribution to LifeCare’s creditors, and thus the 

Government had no claim to any of it. 

The Court reserved judgment on the proposed 

settlement until a later date. 
10

D. The Settlement Hearing

A bankruptcy court’s approval of a settlement 

agreement is not a fait accompli. The settlement must be 

“fair and equitable.” Prospective Comm. for Indep. 

Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 

U.S. 414, 424 (1968). To determine if it is, courts in this 

Circuit apply the four-factor test set out in In re Martin, 91 

F.3d 389, 393 (3d Cir. 1996), which balances the “value of 

the claim that is being compromised against the value to the 

estate of the acceptance of the compromise proposal.” In re 

World Health Alternatives, Inc., 344 B.R. 291, 296 (Bankr. D. 

Del. 2006) (internal quotation marks omitted). The test 

requires a court to weigh (whether in response to a challenge 

or on its own): “(1) the probability of success in litigation; (2) 

the likely difficulties in collection; (3) the complexity of the 

litigation involved, and the expense, inconvenience and delay 

necessarily attending it; and (4) the paramount interest of the 

creditors.” In re Martin, 91 F.3d at 393. 

At the settlement hearing the Bankruptcy Court 

addressed the Government’s argument that, assuming the 

settlement money was property of the estate (which the 

Government believed the money was), bypassing it and 

paying the unsecured creditors disturbed the Code’s priority 

scheme for the payment of creditors. Thus, regardless 

whether the Settlement satisfied the Martin factors, it was 

unlawful. As the Government’s lawyer put it, the “proposed 

[$3.5 million] settlement attempts to distribute estate property 

to junior creditors over the objection of a senior creditor in 

violation of the absolute priority rule[,]4and so therefore, it 

 

4 A prominent academic (and former Bankruptcy Judge) has 

aptly described the absolute priority rule as one of “vertical 

equity,” see Bruce A. Markell, A New Perspective on Unfair 
11

cannot be approved.” May 28, 2013 Hr’g Tr. 25:13–16. But 

the Court rejected this contention, maintaining that, because 

the Settlement Agreement “permits a distribution directly to 

the unsecured creditors” from the purchaser, it is “an 

indication that [the funds] are not property of [LifeCare’s] 

estate[,] and as such, the absolute priority rule . . . is not 

implicated.” Id. at 75:4–8. Addressing the Martin factors, 

the Court approved the Settlement, stating that the creditors’ 

objection had a very small chance of success and thus their 

$3.5 million payday was an excellent outcome. 

E. The Government’s Appeal and Stay Request

The Government appealed from both the sale order 

and the Court’s approval of the Settlement and sought to stay 

the effect of those decisions. At the stay hearing, the 

Government made clear its intent was not to stop the sale but 

to alter the part of the sale order that provides for the payment 

of professional fees and wind-down expenses. Likewise, it 

argued that the distributional terms of the Settlement 

Agreement should be modified to follow the Code’s paymentpriority scheme. But the Court again disagreed with the 

 

Discrimination in Chapter 11, 72 Am. Bankr. L.J. 227, 228-

29, 231 (1998)—junior creditors do not receive distributions 

under plans of reorganization until more senior creditors, 

unless they consent, are paid or allocated value in full. See 11 

U.S.C. § 1129(b). This is distinguished from “horizontal 

equity,” Markell, supra, at 227-28, 231, whereby creditors of 

the same priority rank receive proportionally equal 

distributions of estate property. See 11 U.S.C. §§ 1122(a), 

1123(a)(4), 1129(b)(1) (each to the extent they concern unfair 

discrimination); see also Ralph Brubaker & Charles Jordan 

Tabb, Bankruptcy Reorganizations and the Troubling Legacy 

of Chrysler and GM, 2010 U. Ill. L. Rev. 1375, 1403.
12

Government’s assessment and denied its stay request. See 

June 11, 2013 Hr’g Tr. at 34:9-12 (noting that there was 

nothing in the record on which to “base a finding that the 

funds being held, in effect, in trust for other creditors, for 

other parties and specifically pursuant to a contract, . . . are [] 

property of the estate”). 

The Government appealed the denial of its request for 

a stay to the District Court. But it too thought the 

Government had a weak case on the merits, agreeing with the 

Bankruptcy Court that the funds at issue were not property of 

the estate and thus not subject to the Code’s distribution rules. 

See App. at 11 (deferring to the Bankruptcy Court’s ruling, 

which was based on “a voluminous and uncontested record 

supplemented by the argument and testimony presented at 

several hearings . . . that the sale was warranted and the funds 

at issue belonged to the purchaser [and] not the estate”). 

Thus the District Court denied the stay request, concluding 

that the Government didn’t make the threshold showing of a 

sufficient likelihood of success on the merits. 

The Government appeals the approval of both the sale 

order and the Settlement. We have jurisdiction under 28 

U.S.C. § 158(d) and 28 U.S.C. § 1291. 

II. Analysis

The Government raises two issues. Did the 

Bankruptcy Court err in approving a provision of the sale of 

LifeCare’s assets under which the secured lender group 

agreed to pay some administrative claims but not others of 

equal priority? And did it err in approving the distributional 

terms of the Committee and secured lender group’s 

Settlement, which resulted in a $3.5 million payday for the 

unsecured creditors even though a senior creditor—namely 
13

the Government—received nothing? Before we can get to 

these issues, we must resolve the following questions:

(a) Is the Government’s appeal moot, be it 

constitutionally, statutorily or 

equitably?

(b) Were the funds paid to administrative 

claimants under the escrow 

arrangement approved by the Sale 

Order, or to the unsecured creditors per 

approval of the Settlement Agreement, 

property of LifeCare’s estate?

A. Mootness

LifeCare and the Committee contend that 

constitutional, statutory and equitable mootness bar our 

review of the Government’s challenge to the escrowed funds 

set up by the Asset Purchase Agreement as well as the $3.5 

million deposited in trust by the purchaser for the unsecured 

creditors. 

1. Constitutional Mootness

LifeCare’s constitutional mootness argument stems 

from the secured lender group retaining, after its credit bid is 

applied, a $35 million first priority lien on all property of the 

bankruptcy estate. Thus, LifeCare’s argument proceeds, the 

Government would be entitled to no relief (making its case 

moot) even if the escrowed funds were deemed estate 

property, as the funds would go to the secured lenders. We 

disagree. “[A] case ‘becomes moot [in the constitutional 

sense] only when it is impossible for a court to grant any 

effectual relief whatever to the prevailing party.’” Chafin v. 

Chafin, 133 S. Ct. 1017, 1023 (2013) (quoting Knox v. Serv. 
14

Employees, 132 S. Ct. 2277, 2287 (2012)). “‘As long as the

parties have a [concrete] interest, however small, in the 

outcome of the litigation, the case is not moot.’” Id. (quoting 

Knox, 132 S. Ct. at 2287). We have that here. The 

Government has a $24 million administrative claim that will 

go unpaid if the distributional terms of the escrowed funds are 

left undisturbed. Though the prospect of recovery might be 

remote, we cannot say it is impossible. Hence the 

Government’s appeal is not constitutionally moot, and we 

have jurisdiction to consider whether it is entitled to a piece 

of the pie. 

2. Statutory Mootness

Moving to statutory mootness, because the underlying 

asset sale was conducted under § 363(b) of the Bankruptcy 

Code, which authorizes the sale of estate property outside the 

ordinary course of business, it implicates 11 U.S.C. § 363(m). 

That provision moots any challenge to a § 363 sale that 

“affect[s] the validity of [the] sale” so long as “the purchaser 

acted in good faith and the appellant failed to obtain a stay of 

the sale.” 3 Collier on Bankruptcy ¶ 363.11 (16th ed. 2013). 

Subsection (m) reads in full (save for words not 

relevant here):

The reversal or modification on appeal of an 

authorization . . . of a sale or lease of property 

does not affect the validity of a sale or lease 

under such authorization to an entity that 

purchased or leased such property in good faith, 

whether or not such entity knew of the 

pendency of the appeal, unless such 

authorization and such sale or lease were stayed 

pending appeal. 
15

11 U.S.C. § 363(m). “[I]ts certainty attracts investors and 

helps effect[] debtor rehabilitation.” Cinicola v. 

Scharffenberg, 248 F.3d 110, 122 (3d Cir. 2001) (citing 

Collier at ¶ 363.11). Without it, the risk of litigation would 

chill prospective bidders or push them to “demand a steep 

discount.” In re River West Plaza-Chicago, LLC, 664 F.3d 

668, 671 (7th Cir. 2011) (quoting In re Sax, 796 F.2d 994, 

998 (7th Cir. 1986)).

To give effect to § 363(m)’s purpose, some courts 

“limit[] the appealability of a Section 363 sale order . . . to the 

issue of the purchaser’s good faith.” In re Motors Liquidation 

Co., 430 B.R. 65, 78 (S.D.N.Y. 2010). Under that view, if the 

objecting party fails to obtain a stay of the sale, appellate 

review “is statutorily limited to the narrow issue of whether 

the property was sold to a good faith purchaser.” Id. (quoting 

Licensing by Paolo, Inc. v. Sinatra (In re Gucci), 105 F.3d 

837, 839 (2d Cir. 1997)). By contrast, we interpret subsection 

363(m) more broadly and will review any sale-challenge that 

doesn’t “affect the validity of the sale.” Cinicola, 248 F.3d at 

128. Stated another way, so long as we can “grant effective 

relief,” § 363(m) doesn’t bar appellate review. Pittsburgh 

Food & Beverage, Inc. v. Ranallo, 112 F.3d 645, 651 (3d Cir. 

1997). Thus the question we need to answer is whether we 

can give the Government the relief it seeks—“a 

redistribution” of the escrowed funds for administrative 

expenses and settlement proceeds to unsecured creditors, 

Reply Br. at 11—without disturbing the sale. 

LifeCare and the Committee both argue we cannot. 

LifeCare contends that, if we reallocate the escrowed funds, 

this will change a “fundamental term[] of the transaction” and 

deprive it of a key bargained-for benefit. LifeCare Br. at 5. 

Similarly, the Committee asserts that the settlement “cannot 

be reversed without affecting the validity of the sale,” 

Committee Br. at 12, and, like LifeCare, it will be deprived of 
16

a key deal term, as it “would not have withdrawn its objection 

to the sale without payment,” id. at 14. 

We disagree with both positions. The provision 

stamps out only those challenges that would claw back the 

sale from a good-faith purchaser. It does not moot “every 

term that might be included in a sale agreement,” even if each 

is technically “integral to that transaction.” Reply Br. at 10 

(emphasis in original). And, while § 363(m) aims to make 

sales of estate property final and inject predictability into the 

sale process, we don’t think it does so at all costs and 

certainly not for non-purchasers. Thus we fail to see how 

§ 363(m) bars our review. 

3. Equitable Mootness

Finally, the Committee contends the Government’s 

appeal is equitably moot because the Government was 

unsuccessful in obtaining a stay of the Settlement Order and 

it’s too late to undo the compromise because over $2 million 

has already been distributed. But, even if it is right about the 

consequences, the Committee’s reliance on the doctrine of 

equitable mootness misses the mark. In re SemCrude, L.P., 

728 F.3d 314 (3d Cir. 2013), makes clear that the doctrine 

“comes into play in bankruptcy (so far as we know, its only 

playground) after a plan of reorganization is approved.” Id. at 

317. Outside the plan context, we have yet to hold that 

equitable mootness would cut off our authority to hear an 

appeal, and do not do so here. And though we are 

sympathetic to the Committee’s position that it cannot 

recover its ability to object to a sale it viewed as unfair, we 

also note that without the Settlement Agreement it would 

have received nothing, thus cancelling (or at least mitigating) 

the claimed unfairness of considering the Government’s 

appeal. 
17

B. The Merits

On the merits the Government argues that the 

escrowed funds and settlement money were proceeds paid to 

obtain LifeCare’s assets, and thus qualify as estate property 

that should have been (but wasn’t) paid out according to the 

Code’s creditor-payment scheme. Included within that 

scheme, the argument proceeds, are that equally ranked 

creditors must receive equal payouts and lower ranked 

creditors can’t be paid a cent until higher ranking creditors 

are paid in full. The Government contends both principles 

were violated—the former because the similarly situated 

bankruptcy professionals were paid though the Government 

was not, the latter because it received none of the settlement 

money earmarked for the lower priority unsecured creditors. 

The Government’s argument relies on two key 

premises. The first is that the escrowed funds for 

professionals and settlement proceeds for unsecured creditors 

were property of the estate. (The Code’s distribution rules 

don’t apply to nonestate property.) The second is that the 

priority-enforcing Code rules apply here even if textually 

most (save for § 507) are limited to the plan context. We 

begin (and end) with the first issue. 

1. Are either the escrowed funds or settlement 

proceeds property of LifeCare’s estate?

11 U.S.C. § 541(a)(6) defines property of the estate as 

“proceeds . . . of or from property of the estate.” Thus, if 

either the escrowed funds or settlement sums are “proceeds of 

or from property of the estate,” they qualify as estate 

property. We go out of turn and start with the settlement 

monies, as this is the easier issue.
18

a. The Settlement Sums

The Bankruptcy Court held that, because the 

settlement monies were paid directly to the unsecured 

creditors from a trust funded by the purchaser and not given 

in exchange for any estate property, those funds were not 

property of LifeCare’s estate. The Government contends the 

Court erred because the secured lenders’ payment to the 

Committee was in substance an increased bid for LifeCare’s 

assets. In other words, the purchaser “agreed to a price it was 

willing to pay to acquire the debtors’ assets,” but “later had to 

increase its offer . . . to secure its successful bid.” Gov’t Br. 

at 36. Thus, the argument goes, the settlement sums should 

be treated as estate property. 

 We are not persuaded. Though it is true that the 

secured lenders paid cash to resolve objections to the sale of 

LifeCare’s assets, that money never made it into the estate. 

Nor was it paid at LifeCare’s direction. In this context, we 

cannot conclude here that when the secured lender group, 

using that group’s own funds, made payments to unsecured 

creditors, the monies paid qualified as estate property. For 

these points we find instructive In re TSIC, 393 B.R. 71 

(Bankr. D. Del. 2008). There, as here, the unsecured 

creditors launched objections to the winning bid at a § 363 

auction. See id. at 74. Before the sale closed, the purchaser 

and creditors’ committee agreed that the latter would drop its 

objection if the former funded a trust account for the benefit 

of unsecured creditors. See id. The United States trustee, 

relying principally on In re Armstrong World Indus., Inc., 432 

F.3d 507 (3d Cir. 2005), contended that the settlement 

violated the proscription against paying lower-statured 

creditors before higher ones. But the Bankruptcy Court 

disagreed. It held that, in contrast to Armstrong—which dealt 

with a gift of estate property from a senior creditor to a junior 

creditor over an intermediate creditor’s objection—the 
19

purchaser’s “funds [were] not proceeds from a secured 

creditor’s liens, do not belong to the estate, and will not 

become part of the estate even if the Court does not approve 

the Settlement.” In re TSIC, 393 B.R. at 77. And the trustee 

presented no evidence that the settlement funds “were 

otherwise intended for the Debtor’s estate.” Id. at 76. All are 

true here: the settlement sums paid by the purchaser were not 

proceeds from its liens, did not at any time belong to 

LifeCare’s estate, and will not become part of its estate even 

as a pass-through. 

 Moving to the Government’s next argument, we are 

similarly unpersuaded by its reliance on the Committee’s 

purported concession in its settlement-approval motion that 

the parties’ compromise “represents an agreement between 

the Buyer, the Lenders and the Committee to allocate 

proceeds derived from the sale.” App. at 519 (emphasis 

added). Like the Bankruptcy Court, we decline to elevate 

form over substance and give legal significance to the 

Committee’s description of the settlement funds. Our focus is 

on whether the settlement proceeds were given as 

consideration for the assets bought at the § 363 sale. The

evidence we have leads us to conclude they were not. 

b. The Escrowed Funds

Whether the professional fees and wind-down 

expenses (which make up the escrowed funds) qualify as 

property of the estate is a more difficult question. As noted, 

the Bankruptcy Court held that the funds did not so qualify 

because they “belong[ed] to the purchaser[] [and] not to the 

debtors’ estate.” June 11, 2013 Hr’g Tr. 34:1. The 

Government urges us to reverse that ruling because the funds 

were listed in subsections 3.1(a) and (b) of the Asset Purchase 

Agreement as part of the purchase price (indeed, they were 

called “[c]onsideration”) for LifeCare’s assets and thus 
20

qualify as estate property under Bankruptcy Code § 541(a)(6) 

(including as property of the estate “proceeds” from a

debtor’s asset sale). Though aspects of the Government’s 

argument are factually correct, we cannot ignore the 

economic reality of what actually occurred. 

Subsection 2.1(l) of the Asset Purchase Agreement 

makes clear that the secured lender group purchased all of 

LifeCare’s assets, including its cash, by crediting $320 

million owed by LifeCare to the secured lenders. Thus, once 

the sale closed, there technically was no more estate property. 

Put another way, getting $320 million of its secured debt 

forgiven resulted in the secured lender group getting all the 

property of LifeCare. This is an important point. The 

Government’s argument presumes that any residual cash from 

the sale—namely the monies earmarked for fees and winddown costs—would become property of LifeCare. See Reply 

Br. at 20–21 (arguing that “if [the value of LifeCare’s] cash is 

said to have been paid as part of the ‘purchase price,’ . . . it 

cannot be said to remain the property of the purchaser”) 

(emphases added). But that is impossible because LifeCare 

agreed to surrender all of its cash. And, per the sale order, 

whatever remains of the $1.8 million in escrow goes back to 

where it came from—the secured lenders’ account (as indeed 

happened by the time of oral argument to over $800,000 

placed into escrow). Thus, as a matter of substance, we 

cannot conclude that the escrowed funds were estate property. 

All that said, we recognize that, in the abstract, it may 

seem strange for a creditor to claim ownership of cash that it 

parted with in exchange for something. See Reply Br. at 21. 

But in this context it makes sense. Though the sale 

agreement gives the impression that the secured lender group 

agreed to pay the enumerated liabilities as partial 

consideration for LifeCare’s assets, it was really “to 

facilitate . . . a smooth . . . transfer of the assets from the 
21

debtors’ estates to [the secured lenders]” by resolving 

objections to that transfer. June 11, 2013 Hr’g Tr. 23:9–13. 

To assure that no funds reached LifeCare’s estate, the secured 

lenders agreed to pay cash for services and expenses through 

escrow arrangements. 

In this respect, an interesting argument the 

Government could have made, but didn’t, is that the escrowed 

funds resemble elements of an ordinary carve-out—best 

understood as “an arrangement under which secured creditors 

permit the use of a portion of their collateral [that is, estate 

property] to pay administrative costs, such as attorney fees,” 

and something the Bankruptcy Code allows debtors and 

secured lenders to agree to in the normal course.5 Harvey R. 

Miller & Ronit J. Berkovich, The Implications of the Third 

Circuit’s Armstrong Decision on Creative Corporate 

Restructuring: Will Strict Construction of the Absolute 

Priority Rule Make Chapter 11 Consensus Less Likely?, 

55 Am. U. L. Rev. 1345, 1390-1412 (2006); see also Richard 

B. Levin, Almost All You Ever Wanted to Know About Carve 

Out, 76 Am. Bankr. L.J. 445, 449 (2002) (maintaining that 

while “the carve out protects the professionals, [] it also may 

benefit the secured creditor, which might have concluded that 

an orderly liquidation or restructuring process is likely to 

result in the highest net recovery on its claim, even after 

 

5

 Typically a carve-out is established at the outset of a 

bankruptcy case in a cash-collateral order where “a specific 

amount of the cash collateral, either in existence or to be 

generated, is earmarked for the payment of counsel fees.” In 

re U.S. Flow Corp., 332 B.R. 792, 795 (Bankr. W.D. Mich. 

2005) (quoting Harvis Trien & Beck, P.C. v. Federal Loan 

Mortgage Corp. (In re Blackwood Assocs., L.P.), 187 B.R. 

856, 860 (Bankr. E.D.N.Y. 1995)).
22

payment of carve out expenses” (emphasis added)); Charles 

W. Mooney, Jr., The (Il)Legitimacy of Bankruptcies for the 

Benefit of Secured Creditors, 2015 U. Ill. L. Rev. 735, 750 

(noting that “[i]t is not unusual for a secured creditor to carve 

out from proceeds of its collateral funds to cover professional 

fees and other administrative expenses”). Thus, the argument 

would go, if the escrowed funds indeed resemble an ordinary 

carve-out, then for that reason alone they should be treated as 

estate property.

Ultimately the argument fails, for the difference 

between a carve-out and what we have here is the obvious. 

We are not dealing with collateral (if we were, this would 

suggest it was LifeCare’s property) but with the purchaser’s 

property because the payments by the purchaser were of its 

own funds and not LifeCare’s bankruptcy estate.6 

* * * * *

 

6

In re DBSD North America, Inc., 634 F.3d 79 (2d Cir. 

2011), a case the Government relies on heavily, is not to the 

contrary. The only question there was whether, in the context 

of a plan of reorganization, an “undersecured . . . [creditor] 

entitled to the full residual value of the debtor [was] free to 

‘gift’ some of that value” to a shareholder of the debtor. Id. at 

94. While the Second Circuit Court answered no—holding 

that “secured creditors could have demanded a plan in which 

they received all of the reorganized corporation, but, having 

chosen not to, they may not surrender part of the value of the 

estate for distribution to the stockholder as a gift,” id. at 99 

(internal quotation marks omitted)—the Court said nothing 

about whether a lender can distribute nonestate property to a 

lower-ranked creditor. 
23

 As noted, the Bankruptcy Code’s creditor-payment 

hierarchy only becomes an issue when distributing estate 

property. Thus, even assuming the rules forbidding equalranked creditors from receiving unequal payouts and lowerranked creditors from being paid before higher ranking 

creditors apply in the § 363 context, neither was violated 

here.