Opinion ID: 2929108
Heading Depth: 3
Heading Rank: 1

Heading: Are either the escrowed funds or settlement

Text: 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. 17
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 18 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.
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 19 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 20 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)). 21 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