ICL Holding Co., Inc. v.

PRECEDENTIAL

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
________________

No. 14-2709
________________

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

United States of America,
Appellant
________________

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
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

2
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,

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 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

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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

5
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.”

6
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.

7
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

8
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.

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 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[,]4 and 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

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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 payment-
priority 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.

11
 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

12
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.

13
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.

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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

15
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.

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 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.

17
 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

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.
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

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 wind-
down 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

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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
* * * * *

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.

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 As noted, the Bankruptcy Code’s creditor-payment
hierarchy only becomes an issue when distributing estate
property. Thus, even assuming the rules forbidding equal-
ranked creditors from receiving unequal payouts and lower-
ranked creditors from being paid before higher ranking
creditors apply in the § 363 context, neither was violated
here.

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