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Debtors’ Funds Purchased in Section 363 Sale Permitted to be Disbursed to Debtors’ Administrative and Unsecured Creditors Over IRS Objections

United States v. LCI Holding Co., Inc., Nos. 13-924 (SLR), 13-1188 (SLR), 2014 WL 975145 (D. Del. March 10, 2014)

On March 10, 2014, Judge Sue L. Robinson of the District Court denied the request of the United States, on behalf of the Internal Revenue Service (the “IRS”), to stay disbursement of funds placed into escrow by a purchaser of debtor-assets intended to satisfy some but not all administrative and unsecured claims asserted against the debtors.  During the chapter 11 bankruptcy cases of LCI Holding Company, Inc. and its affiliated debtors (the “Debtors”), the Debtors’ prepetition senior secured lenders (the “Lenders”) formed an entity (the “Purchaser”) that purchased the debtors’ assets (including their cash) through a credit bid.  Pursuant to the asset purchase agreement and a related settlement agreement reached with the Official Committee of Unsecured Creditors (the “Committee”), the Purchaser created and funded certain escrows from cash it purchased from the Debtors in the sale.  The escrows were intended to, among other things, (i) satisfy certain fees and expenses of professionals and certain expenses expected to be incurred by the Debtors in connection with the winding down of their estates and (ii) provide a distribution to allowed general unsecured claims and noteholders claims.  Excluded from those entitled to share in the escrowed funds was the IRS, who asserted that it was entitled to an administrative claim for tax liability that resulted from the Debtors’ sale of its assets to the Purchaser.

The IRS objected to the sale and the settlement agreement, arguing, among other things, that the relief requested by the Debtors violated sections 1123 and 1129 of the Bankruptcy Code because payments were to be made to some but not all administrative claimants and payments were to be made to general unsecured claimants prior to the satisfaction of the IRS’s administrative claim.  The Bankruptcy Court overruled the IRS’s objections, approved the sale and settlement agreement, and ultimately, denied the IRS’s requests for a stay.  The Court held that the sale was grounded in a sound business purpose, proposed in good faith, and in the best interest of the estates. Accordingly, the proposed sale satisfied the standards for approval under section 363 of the Bankruptcy Code. Importantly, because confirmation of a plan was not before the Court, it was not required to analyze the sale under the rubric of sections 1123, 1129, or otherwise.  Moreover, the Court approved the settlement, finding that the escrows at issue were funded by settlement proceeds that were not property of the Debtors’ estates.

The IRS appealed and sought to stay disbursement of the escrowed funds.  The District Court determined that the Bankruptcy Court did not err when approving the sale and settlement.  Simply put, the record, argument, and testimony supported the Bankruptcy Court’s determination that the sale was appropriate and that the escrowed funds were not property of the estate.  Thus, the Bankruptcy Court’s orders were upheld, a stay was denied, and the appeals were dismissed.

The decision of LCI Holdings is not surprising given the applicable precedent in Delaware.  Although the District Court cited only one case in support of its decision, In re TSIC, Inc., 393 B.R. 71 (Bankr. D. Del. 2008), in which funds paid by a purchaser of debtor-assets to unsecured creditors were held to be non-debtor assets and thus not subject to the confirmation requirements of the Bankruptcy Code, additional case law exists in support, including In re World Health Alternatives, 344 B.R. 291 (Bankr. D. Del. 2006), Czyzewski v. Jevic Holding Corp. (In re Jevic Holding Corp.), No. 13-104, 2014 WL 268613 (D. Del. Jan 24, 2014), and In re Kainos Partners Holding Co., LLC, No. 10-560, 2012 WL 6028927 (D. Del. Nov. 30, 2012).