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The Bankruptcy StrategistFeaturesBankruptcyLitigation

Sixth Circuit: Section 363 Sale Not 'Free and Clear' of Creditor's Claims

By Francis J. Lawall and Kenneth A. Listwak
September 01, 2021

The preferred method of acquiring distressed assets from an owner facing significant liabilities is often through a sale under Section 363 of the Bankruptcy Code. In fact, many practitioners today view Chapter 11 as more of a vehicle to convey assets rather than reorganizing around them. Buyers generally assume that the multi-page "free and clear" order, which typically follows the sale hearing, will insulate them from any of the seller's current (and often) future liabilities. However, that is not always the case.

In a recent U.S. Court of Appeals for the Sixth Circuit opinion, the court ruled that a Section 363 sale was not "free and clear" of a creditor's claims related to coal reserves sold by the debtor. The creditor, who held natural gas rights of record which ran with the land, received only publication notice of the proposed sale. Because the creditor was "known," the publication notice utilized failed to satisfy due process, thus leaving the creditor free to pursue claims against the buyer, notwithstanding the Section 363 sale order.

In 1998, well before the debtors' bankruptcies, Old Ben Coal Co. conveyed its rights to the methane gas in certain coal reserves it owned in Hamilton County to Illinois Methane, LLC. At the time, the simultaneous extraction of the natural gas and the coal itself was not technologically feasible. Under the terms of the deal, Old Ben conveyed the rights to all of the methane gas in its coal estates in exchange for $2.6 million. Old Ben retained the coal rights. This conveyance was made subject to several covenants that ran with ownership of the coal and methane gas. One such covenant was a delay rental obligation, which provided that:

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