A. Background
LifeCare Holdings, Inc., an operator of long-term acute care hospitals, and thirty-four of its subsidiaries entered into bankruptcy in December of 2012, following failed attempts to procure a sale of LifeCare’s assets or a restructuring of LifeCare’s balance sheet outside of bankruptcy. Prior to filing, LifeCare entered into an asset purchase agreement with its secured lender group which agreed to credit bid $320 million of the $355 million secured debt that LifeCare owed it. In addition to their credit bid, the lenders “agreed to pay the legal and accounting fees” for LifeCare and the committee of unsecured creditors and to pay the company’s wind-down costs. Id. at 550. The secured lenders deposited cash into separate escrow accounts for these purposes. As part of the agreement, the parties decided that “[a]ny money that went unspent had to be returned to [the secured lenders].” Id.
This proposal left two major constituents out of the money: the committee of unsecured creditors and the United States government, which stood to reap an administrative claim of approximately $24 million from the capital gains tax the sale was expected to generate. The secured lenders and the unsecured creditors subsequently reached a settlement agreement whereby the secured lenders agreed to place $3.5 million in a trust for the benefit of the general unsecured creditors and in exchange the committee agreed to abandon its objections and support the sale. The government’s objection remained unresolved.
The bankruptcy court approved both the sale and the settlement, declaring that the escrow and trust fund monies in question were not property of the estate and were therefore not subject to Code-regulated distribution.
The government appealed the bankruptcy court’s approval of both the sale and the settlement agreement to the district court which affirmed the bankruptcy court’s decisions, finding again that the funds in question were not property of the estate.
B. The Third Circuit’s Holding
The government appealed the district court decision, bringing the case before the Third Circuit to address whether the bankruptcy court erred in allowing some administrative creditors to take before other similarly situated administrative creditors and whether the bankruptcy court erred in allowing junior creditors to take before senior creditors.
The Third Circuit, however, did not reach either of these questions, focusing instead on two threshold inquiries. First the court determined that LifeCare and the Committee’s mootness arguments did not prevent it from hearing the appeal. Second, the court determined that the monies paid to the administrative claimants and the unsecured creditors did not constitute property of the estate such that “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.” Id. at 558.
In response to the government’s argument that the settlement funds were “in substance an increased bid for LifeCare’s estate,” the Third Circuit stated that