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Fifth Circuit Vacates DIP Financing Orders
The U.S. Court of Appeals for the Fifth Circuit, on Sept. 3, 2014, vacated five bankruptcy court and district court Chapter 11 debtor-in-possession (DIP) financing orders due to: 1) the lender's lack of good faith in relying on a third party's shares of stock as collateral; and 2) the bankruptcy court's lack of subject matter jurisdiction to authorize a lien on third party collateral subject to disputed ownership claims. In re TMT Procurement Corp., 2014 WL 4364894 (5th Cir. Sept. 3, 2014). To vacate the orders and hear the appeal, the Fifth Circuit had to reject the debtors' argument that the consolidated appeals were moot because of the lower courts' repeated findings “that the DIP Lender ' extended financing to the Debtors in good faith and was entitled to the full protections of sections 363(m) and 364(e) of the Bankruptcy Code ["Code"].” Id. at *3. Significantly, the court of appeals only found that the DIP lender lacked the statutory “good faith,” but not that it acted in bad faith. This distinction is meaningful due to the unusual facts of the case.
Relevance
The TMT decision is important to DIP lenders. Code sections 364(e) and 363(m) ordinarily will “moot ' an appeal” from a financing or a Section 363 sale order when “the purchaser or lender acted in good faith,” unless the appellant “obtain[s] a stay” pending appeal. Id. at *4. According to the U.S. Court of Appeals for the Third Circuit, however, an appeal from a DIP financing order, when “a stay is not granted,” can still be heard despite Code Section 364(e) if the “lender ' has not disbursed” funds on the DIP loan. In re Swedeland Dev. Group, Inc., 16 F.3d 552, 561 n.7, 562 (3d Cir. 1994) (en banc). Further, “[t]he purpose of [' 364(e)] is to encourage the extension of credit to debtors ' by eliminating the risk that any lien securing the loan will be modified on appeal.” In re Saybrook Mfg. Co., Inc., 963 F. 2d 1490, 1493 (11th Cir. 1992). Appellate courts, however, rarely find good faith lacking and rarely overturn DIP financing orders. The appellant in TMT had not obtained a stay, making the lender's good faith a threshold issue for the Fifth Circuit.
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