A U.S. Court of Appeals agreed on Tuesday to hear a challenge to Chrysler LLC's sale of most of its assets to a group led by Italian automaker Fiat , in a move that could potentially delay the deal.

The federal circuit court granted a request by a group of Indiana pension funds that hold a small portion of Chrysler's secured debt to stay the sale order to allow the circuit court to hear the expedited appeal.

A three-judge panel for the U.S. Court of Appeals for the Second Circuit will hear arguments in the appeal on Friday at 2 p.m. EDT (1800 GMT) in New York, according to a court order on Tuesday.

The judges on the panel will be the circuit court's Chief Judge Dennis Jacobs, Judge Amalya Kearse and Judge Robert Sack, according to the order.

The appeal is likely to be closely watched by General Motors Corp , which has filed its bankruptcy case this week in the same bankruptcy court as Chrysler and is pursuing a similar type of sale.

U.S. Bankruptcy Judge Arthur Gonzalez had ruled that the sale could become effective on Friday, bringing a New Chrysler out of bankruptcy, which will be owned by Fiat, the company's union, and the U.S. and Canadian governments, but that will now depend on the appeal.

The Indiana pension funds have objected to the sale, saying it violates traditional bankruptcy laws about the priority of repayment by favoring more junior creditors over senior secured creditors.

As we have stated from the beginning, Indiana retirees and Indiana taxpayers have suffered losses because of unprecedented and illegal acts of the federal government, Indiana State Treasurer Richard Murdoch said in a statement on Wednesday.

The pension funds argue that Chrysler's plan to distribute stock in the New Chrysler to the union and the U.S. government, while paying senior lenders only 29 cents on the dollar, is an illegal sub rosa reorganization plan, which ordinarily would not be permitted under the bankruptcy code.

Hoosier retirees and taxpayers are being deprived of millions of dollars in their funds while a foreign corporation receives a windfall at no cost, this is not equitable, Murdoch said.

Chrysler's lawyers argue that the company needs to complete the sale immediately to avoid liquidation. Fiat is allowed to walk away from the deal after June 15.

Judge Gonzalez had rejected the lenders' argument when he authorized Chrysler's sale late Sunday, saying that no one in the case was receiving a penny except for the secured lenders. More than 90 percent of Chrysler's secured lenders support the deal.

Gonzalez earlier on Tuesday ordered that the sale should be appealed to the Court of Appeals, bypassing the District Court.

Several other objectors to Chrysler's sales have joined the Indiana pension funds in the appeal, according to bankruptcy court documents.

The appeal is In re: Chrysler LLC, U.S. Court of Appeals for the Second Circuit, No. 09-2311. The bankruptcy case is In re: Chrysler LLC, U.S. Bankruptcy Court, Southern District of New York, No. 09-50002.

(Additional reporting by Tom Hals and Ajay Kamalakaran; Editing by Dhara Ranasinghe and Erica Billingham)

Chrysler Sale