The Fifth Circuit recently held that a debtor-in-possession (DIP) lender did not qualify as a “good faith” lender, overturning orders of the United States District Court and Bankruptcy Court for the Southern District of Texas, including a final order approving DIP financing.  In re TMT Procurement Corp., 764 F.3d 512 (5th Cir. 2014).   Notably, the court held that because the DIP lender knew that collateral securing its loan was subject to adverse claims by a third-party in an unrelated proceeding, the DIP lender was not a “good faith” lender.  As a result, challenges to the lower courts’ orders were not moot under sections 363(m) and 364(e) of the Bankruptcy Code (as the lender and debtor had asserted), and the court proceeded to hear the merits of the appeal and ultimately vacated the lower courts’ orders. The decision underscores the importance of the “good faith” requirement, particularly for DIP lenders relying on collateral that is not property of the estate.


Vantage Drilling Company (“Vantage”), an offshore drilling company, entered agreements with companies owned by Hsin-Chi Su (“Su”) for the acquisition of offshore drilling rigs and ships.  As part of the arrangement, Vantage issued 100 million shares of its stock to F3 Capital, an entity solely owned and controlled by Su.  After business disputes arose, in 2012, Vantage sued Su in Texas on several theories, fraud, negligent misrepresentation and unjust enrichment (the “Vantage Litigation”).  Vantage sought a constructive trust on all profits or benefits obtained by Su — including the Vantage stock issued to F3 Capital.

Meanwhile, in 2013, 23 foreign marine shipping companies Su owned (the “Debtors”) filed for chapter 11 bankruptcy in the United States Bankruptcy Court for the Southern District of Texas.  The Bankruptcy Court granted several creditors’ motion to dismiss as to two of the companies, and denied the motions as to the remaining 21, but required those companies to pledge certain non-estate “Good Faith” property to ensure compliance with court orders, pay sanctions, serve as collateral for capital loans and satisfy any amounts arising under section 507 of the Bankruptcy Code.  Ultimately, the Debtors agreed to an escrow agreement pursuant to which it would pledge more than 25 million shares of F3’s Vantage stock (the “Vantage Shares”) to the Bankruptcy Court to be held in custodia legis for the benefit of the debtors.  In doing so, both F3 Capital and Su represented and warranted that they could deliver the collateral “without violating any requirements of, or injunctive relief in, the [Vantage Litigation].”  Id. at 517.

Vantage was not so confident and sought a preliminary injunction in the Vantage Litigation. The district court determined that Su could not otherwise sell, transfer, pledge or encumber his Vantage stock without court permission, but directed Vantage to raise in the bankruptcy court its complaints about encumbrances on the Vantage stock to the bankruptcy court that issued the order.

In the bankruptcy court, Vantage challenged the escrow agreement as a “party in interest.”  The bankruptcy court rejected Vantage’s challenge and upheld the escrow agreement, noting that F3 Capital was not a party in the Vantage Litigation and had received the Vantage Shares prior to the commencement of that lawsuit.  Vantage filed an interlocutory appeal with the district court.

At the same time, the Debtors filed an emergency motion in the district court to borrow up to $20 million in DIP financing.  The district court approved a DIP lending facility that gave the DIP Lender a first priority lien and security interest in the deposited shares of Vantage stock (the “DIP Order”).  The DIP Order provided that the DIP Lender’s interest in the shares could not be modified by any subsequent order of the bankruptcy court or district court.  The DIP Order also found that the DIP Lender had 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, shielding the DIP Lender from subsequent reversals that might discourage DIP lending.  Accordingly, unless the DIP Order were to be stayed pending appeal a reversal or modified, the debts incurred or liens granted would be valid.

Fifth Circuit Ruling

Vantage appealed the DIP Order and several related decisions of the district court and bankruptcy court to the Fifth Circuit.  In response, the Debtors asserted that Vantage’s appeal was moot under sections 363(m) and 364(e).  Vantage’s assertion was based on the settled legal principle that a failure to obtain a stay of an authorization under sections 363 and 364 moots an appeal when the transaction was conducted in good faith, and Vantage had not sought or obtained a stay of any orders.  Vantage countered by arguing that the DIP Lender did not act in “good faith.”  The Debtors in turn argued that Vantage had waived its “lack of good faith” argument by raising it for the first time on appeal.

First, the Fifth Circuit concluded that Vantage had sufficiently raised the issue of good faith below.  Vantage had asserted both that F3 Capital had fraudulently obtained the Vantage Shares and that Vantage’s constructive trust over the shares would survive any attempt to pledge the shares to another party who was on notice of Vantage’s adverse claim, including the DIP Lender.

Next, the Fifth Circuit addressed the good faith question directly.  In the context of section 363(m), the court had previously defined “good faith” in several ways, including instances where a purchaser acts without notice of adverse claims.  The Fifth Circuit distinguished between (i) knowledge of an objection to a transaction — as would be the case whenever a creditor objections to a transaction and seeks to have it reversed on appeal — from (ii) knowledge of an adverse claim with respect to the property being purchased or pledged.  Only the latter precluded a finding of good faith.  Here, the DIP Lender knew and had adequate notice that Vantage, a third-party entirely unrelated to the bankruptcy proceedings, had an adverse claim on the Vantage Shares.  On this basis, the Fifth Circuit concluded that the DIP Lender did not come within the meaning of “good faith” as envisioned by sections 363(m) and 364(e), and therefore, Vantage’s appeal of the lower courts’ orders were not moot.

The Fifth Circuit next addressed Vantage’s arguments that the lower courts lacked subject matter jurisdiction over the Vantage Shares and the Vantage Litigation.  First, Vantage had argued that the Vantage Shares were never “property of the estate,” and did not become so pursuant to section 541(a)(7) of the Bankruptcy Code simply by virtue of being pledged to the Bankruptcy Court in custodia legis.  The Fifth Circuit agreed, noting that the Vantage Shares “were not created with or by property of the estate, they were not acquired in the estate’s normal course of business, and they were not traceable to or arise out of any prepetition interest included in the bankruptcy estate.”  Id. at 525.  The Fifth Circuit also held that the lower courts lacked jurisdiction to adjudicate matters subject to the Vantage Litigation because that litigation was not “related to” the bankruptcy proceeding.  That F3 Capital and the Debtors had a common owner — Su — was immaterial for the purpose of establishing “related to” jurisdiction; the outcome of the Vantage Litigation would have no conceivable effect on the Debtors’ estate.  For this reason, the lower courts lacked subject matter jurisdiction.

In sum, after determining that the appeals were not moot, that the Vantage Shares were not “property of the estate” and that the Vantage Litigation was not “related to” the bankruptcy proceedings, the Fifth Circuit concluded that the lower courts lacked the authority to encumber the Vantage Shares.  The Fifth Circuit vacated the orders and remanded the case to the bankruptcy court.