New York Bankruptcy Court Adopts "Realistic Possibility" Standard for Free and Clear Sales Under 11 U.S.C § 363(f)(5)
Section 363(f)(5) of the Bankruptcy Code allows a bankruptcy trustee to sell estate property free and clear of any competing interest in the property (such as a lien or other security interest) if the interest holder "could be compelled, in a legal or equitable proceeding, to accept" a money satisfaction in exchange for its interest. However, courts disagree regarding what circumstances trigger this section. For example, is it enough that such an interest could be eliminated in state foreclosure sale? In In re Urban Commons 2 West LLC, 668 B.R. 42 (Bankr. S.D.N.Y. 2025), the U.S. Bankruptcy Court for the Southern District of New York weighed in on this question. It rejected the narrow view adopted a decade earlier in the same district by the district court in Dishi & Sons v. Bay Condos LLC, 510 B.R. 696 (S.D.N.Y. 2014), but cabined the potentially broader view espoused by some courts (and of concern to the Dishi court) by adopting what it termed a "realistic possibility" standard.
Free-and-Clear Bankruptcy Asset Sales
Section 363(b)(1) of the Bankruptcy Code provides in relevant part that a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP"), "after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate." Section 363(f) of the Bankruptcy Code authorizes a trustee or DIP to sell estate property "free and clear of any interest in such property of an entity other than the estate," but only if one of the following is true:
- applicable nonbankruptcy law permits sale of such property free and clear of such interest;
(2) such entity consents;
(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.
11 U.S.C. § 363(f).
A bankruptcy court's power to order sales free and clear of a competing interest without the consent of the party asserting the interest has been recognized for more than a century. See Ray v. Norseworthy, 90 U.S. 128, 131–32 (1875). It promotes the expeditious liquidation of estate assets by avoiding delay caused by sorting out disputes concerning the validity and extent of competing interests, which can later be resolved in a centralized forum. It also facilitates the estate's realization of the maximum value possible from an asset. A prospective buyer would discount its offer significantly if it faced the prospect of protracted litigation to obtain clear title to an asset. See In re WBQ P'ship, 189 B.R. 97, 108 (Bankr. E.D. Va. 1995); accord In re Realia, Inc., 2012 WL 833372, *10 (B.A.P. 9th Cir. Mar. 13, 2012) (noting that "the purpose of the 'free and clear' language is to allow the debtor to obtain a maximum recovery on its assets in the marketplace"), aff'd, 569 F. App'x 544 (9th Cir. 2014).
Under section 363(f)(5), estate property may be sold free and clear of a competing interest in the asset (such as a mortgage or a security interest) if the holder of the interest "could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest." For example, "[a]pplicable nonbankruptcy law may recognize a monetary satisfaction when the lienholder is to be paid in full out of the proceeds of the sale or otherwise." Collier on Bankruptcy ¶ 363.06[6] (16th ed. 2025).
Most courts agree that section 363(f)(5) applies if any third party could compel the interest holder to accept money in exchange for their interest under state law, such as through a foreclosure or sale under the Uniform Commercial Code ("UCC"). See, e.g., In re Boston Generating, LLC, 440 B.R. 302, 333 (Bankr. S.D.N.Y. 2010) (approving the sale of debtors' assets free and clear of certain liens under section 363(f)(5) "because the [lenders] could be compelled under state law to accept general unsecured claims to the extent the sale proceeds are not sufficient to pay their claims"); In re Jolan, Inc., 403 B.R. 866, 870 (Bankr. W.D. Wash. 2009) (approving a sale free and clear of liens "[b]ecause there are Washington legal and equitable proceedings by which lienholders may be compelled to accept money satisfactions"); see also In re Stephens, 402 B.R. 1, 5 (B.A.P. 10th Cir. 2009) ("It is well-established that property rights in bankruptcy are created and defined by state law. As such, every bankruptcy case necessarily involves the bankruptcy court's consideration and application of state law.").
A minority of courts, however, have held that section 363(f)(5) applies only when the debtor itself, rather than a third party, could compel the interest holder to exchange its interest for money. See Dishi, 510 B.R. at 711. Because a debtor cannot initiate a foreclosure or UCC sale, for example, this approach substantially narrows the scope of section 363(f)(5), especially where the proceeds are insufficient to pay underwater liens (as were at issue in Urban Commons).
The Dishi court adopted this narrow view to avoid what it perceived would be a statutory redundancy—namely, if section 363(f)(5) encompasses actions that any party could bring, then it also encompasses the situations already covered elsewhere in subsections (1)–(4) of section 363(f). See id. at 710–11 (citing In re Smith, 2014 WL 738784, at *2 (Bankr. D. Or. Feb. 26, 2014) (listing various hypothetical proceedings that purportedly satisfy section 363(f)(5)); see also In re Ricco, Inc., 2014 WL 1329292, at **9–10 (Bankr. N.D. W. Va. Apr. 1, 2014) (noting that "the statute requires that the trustee or debtor be the party able to compel monetary satisfaction for the interest which is the subject of the sale," eliminating concerns of redundancy) (quoting In re Haskell L.P., 321 B.R. 1, 9 (Bankr. D. Mass. 2005)).
In addition, according to Dishi, a broad interpretation of section 363(f)(5) could allow virtually any interest to be wiped away in a free-and-clear sale. Dishi, 510 B.R. at 710–11. ("[I]t is difficult to see when paragraph (5) will not permit a free and clear sale."). As an example of the concern for overbreadth, the Dishi court identified the hypothetical availability of eminent domain or tax lien foreclosures as proceedings that could be used to compel an entity to accept a money satisfaction of its interest. Because these hypothetical proceedings could be available in almost any situation, section 363(f)(5) could strip away virtually any interest, a result the Dishi court found to be inappropriately unchecked.
In Dishi, the district court's decision also was influenced by section 363(f)(5)'s interaction with section 363(e) of the Bankruptcy Code. There, the DIP wanted to sell a lease free and clear of a leasehold intertest, but the leaseholder wanted to remain in possession under section 363(e), which requires a bankruptcy court, upon the request of any party holding an "interest" in property being used, sold, or leased during a bankruptcy case, to provide "adequate protection" of that interest. Dishi, 510 B.R. at 699–700. The court agreed that section 363(f) applied to the sale of a lease because a leasehold interest is an "interest" under section 363(e). Id. at 701. Because section 363(e) obligated the court to provide adequate protection of the leaseholder's interest, the court allowed the lessee to remain in possession of the premises for the duration of the lease. Id. at 711–12. The court accordingly concluded that a foreclosure proceeding by a third-party mortgagee could not compel the leaseholder to accept money in exchange for its leasehold interest. Id. at 711.
Urban Commons
Urban Commons 2 West LLC and four affiliated companies (collectively, the "debtors") filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code in the Southern District of New York in November 2022 with the intent to liquidate their assets, which included long-term leasehold interests in a New York City hotel (the "Lease Interests"). The debtors proposed a liquidating chapter 11 plan and sought court approval to sell the Lease Interests free and clear of all liens, claims, interests, and encumbrances under sections 363(b) (governing sales of estate property outside the ordinary course of a debtor's business) and 363(f)(5) of the Bankruptcy Code in a credit bid transaction with the debtors' secured lender, for amounts less than the lender's $114 million loan balance. A contractor with a junior (and highly underwater) mechanic's lien on the hotel property (securing a claim for $189,000 in unpaid prepetition services) objected to the free-and-clear sale, arguing that neither section 363(f)(5) nor any other subsection of section 363(f) authorized such a sale free of its interests.
The Bankruptcy Court's Ruling
In a September 26, 2024, bench ruling, the bankruptcy court approved the sale of the Lease Interests under section 363(f)(5) free and clear of the contractor's mechanic's lien. The court issued a written opinion explaining and expanding upon its ruling on March 4, 2025.
At the outset of his opinion, U.S. Bankruptcy Judge Philip Bentley noted that, although the district court's decision in Dishi has "significant precedential weight," a bankruptcy court is not bound to follow that precedent (at least in the Second Circuit). See Urban Commons, 668 B.R. at 44 n.1. After reviewing various court interpretations of section 365(f)(5), the bankruptcy court rejected the rationale articulated in Dishi and instead adopted a broader interpretation of the provision.
Judge Bentley explained that when property of a bankruptcy estate is sold for less than the face amount of liens encumbering it (an "underwater" asset), section 363(f)(5) is frequently the only available basis for a free-and-clear sale because: (i) in such cases, if a secured creditor whose lien is not in bona fide dispute refuses to consent to the sale, subsections (2), (3), and (4) of section 363(f) do not apply by their terms; and (ii) many courts interpret section 363(f)(1) narrowly to apply only to a limited number of non-bankruptcy laws permitting non-judicial sales free and clear of liens. Id. at 46. The court also noted that, for decades after the enactment of the Bankruptcy Code in 1978, courts and legal commentators have recognized as indisputable that free-and-clear sales under section 363(f)(5) were "widely available because foreclosure sales and UCC sales satisfied that [provision]." Id. (citations omitted).
According to Judge Bentley, this understanding was "briefly threatened" by a Ninth Circuit Bankruptcy Appellate Panel's decision in Clear Channel Outdoor, Inc. v. Knuppfer (In re PW, LLC), 391 B.R. 25 (B.A.P. 9th Cir. 2008), where the court reversed a bankruptcy court's approval of a free-and-clear sale under section 363(f)(5), concluding that the parties failed to identify any "legal or equitable proceeding" permitting such a sale under applicable bankruptcy or non-bankruptcy law. However, subsequent court rulings blunted the impact of Clear Channel, noting that the panel did not rule that no qualifying proceedings existed under applicable non-bankruptcy law, but merely that the parties had not identified any, and reaffirming that the availability of state law foreclosure or other enforcement remedies satisfies section 363(f)(5). Id. at 47 (citing In re Boston Generating, 440 B.R. 302, 333 (Bankr. S.D.N.Y. 2010); In re Jolan, Inc., 403 B.R. 866, 969-70 (Bankr. W.D. Wash. 2009)). Although the decade-old Dishi opinion "has attracted little attention," Judge Bentley explained, the decision represents a "renewed threat to the widespread availability of free-and-clear sales for underwater assets." Id.
The bankruptcy court was not persuaded by the rationale and concerns articulated in Dishi. It rejected the district court's overly restrictive approach, arguing that its "construction [was] so narrow as to virtually nullify section 363(f)(5)." Id. at 48. Instead, the court posited an alternative "middle ground construction" of the provision "more consistent with the text and purposes of section 363(f)(5)." Specifically, Judge Bentley explained, a free-and-clear sale should be permitted under section 363(f)(5), not in cases where "any conceivable hypothetical proceeding" exists "that might compel interest holders to accept a money satisfaction, but only proceedings that might realistically be brought in the case if the automatic stay were lifted or did not apply." Id. In most cases, he noted, state law foreclosure proceedings or UCC sales would satisfy section 363(f)(5) under that formulation.
According to the bankruptcy court, this interpretation would remedy the Dishi court's concerns about the potential overbreadth of section 363(f) because many hypothetical proceedings that could eliminate certain interests do not meet that "realistic possibility standard." For example, Judge Bentley noted, easements and covenants running with the land would survive foreclosure and therefore cannot be extinguished by section 363(f)(5). Therefore, a debtor seeking to sell assets free and clear of such interests would have to satisfy one of the other subsections of section 363(f). Id. at 48-9. Likewise, eminent domain and tax lien foreclosures would have to be more that theoretical possibilities to be used as the basis for a free and clear sale under section 363(f)(5). As Judge Bentley explained, "eminent domain would be relevant only in the rare case where there was a realistic possibility that the government might use that power to take the debtor's property." Id. at 48
The bankruptcy court further explained that its middle-ground interpretation "conforms more closely" with section 363(f)(5)'s "text, statutory context, and purposes." According to Judge Bentley: (i) section 363(f)(5) is written in the "passive voice," indicating that the provision applies in circumstances where any creditor (and not merely the trustee or the debtor), could compel acceptance; (ii) because foreclosure and UCC sales are the main state law alternatives to bankruptcy asset sales, "it makes sense that Congress would have looked to such state law mechanisms to determine which property interests would be extinguished by a bankruptcy sale"; and (iii) this approach comports with the Bankruptcy Code's broader purpose "to balance the competing interests of secured creditors and the debtor." Id. at 49–50. By contrast, the bankruptcy court emphasized, the Dishi court's narrow construction of section 363(f)(5) "would undercut the purpose of the provision" by allowing junior lien holders to "retain their liens and potentially be able to enforce them against the buyer for full value, even though the value of their interest in the collateral is zero," lowering the price that a buyer would be willing to pay. Id. at 50.
Outlook
The mechanic's lien holder did not appeal the bankruptcy court's ruling in Urban Commons. Thus, we will not have the benefit in this case of a renewed examination of the issue by a district court in the Southern District of New York or the Second Circuit.
The bankruptcy court's decision in Urban Commons bridges the gap between the conflicting interpretations of section 363(f)(5). However, the ruling creates a division within the Southern District of New York, thereby causing uncertainty for debtors and potential debtors in that district with respect to such sales. Otherwise, the ruling is a positive development for debtors and bankruptcy trustees seeking to maximize the value of the bankruptcy estate by selling estate property free and clear of conflicting interests. It reinforces the long-standing (and majority) view that section 363(f)(5) permits free-and-clear sales in cases where the party asserting a competing interest in an underwater asset can be forced to accept a money judgment in a legal or equitable proceeding under applicable non-bankruptcy law, such as a state foreclosure or UCC sale.
This article was prepared with the assistance of Kelsey Moore, an associate in Jones Day's Cleveland Office.
