Jason Binford, Collusion Confusion: Where Do Courts Draw the Lines in Applying Bankruptcy Code Section 363(n)?

• Publication year: 2011

COLLUSION CONFUSION: WHERE DO COURTS DRAW THE LINES IN APPLYING BANKRUPTCY CODE SECTION 363(N)?

Jason Binford^*

INTRODUCTION ................................................................................................ 42

I. THE LEGISLATIVE HISTORY OF Sec. 363(N) .............................................. 45

II. THE ELEMENTS AND APPLICATION OF Sec. 363(N) ................................... 49

A. Jurisdiction and Standing ............................................................. 49

B. The Application of Sec. 363(n) .......................................................... 54

1. The Relationship Between Sec. 363(n) and Sec. 363(m) ................. 55

2. The Elements of a Sec. 363(n) Cause of Action .......................... 56

a. Evidence of an Agreement to Collude ............................. 57

i. Circumstantial Evidence of an Agreement to

Collude ...................................................................... 57 ii. Disclosure of an Agreement....................................... 61 iii. Collusion Versus Collaboration ............................... 64

b. Among Potential Bidders ................................................. 66

c. Controlling the Sale Price ............................................... 68

3. Remedies Under Sec. 363(n) ....................................................... 70

4. Criminal Penalties .................................................................. 71

III. THE FINALITY OF SALE ORDERS ........................................................... 72

A. The Statute of Limitations on a Sec. 363(n) Claim-Does

Sec. 363(n) Trump Rule 60(b)? ......................................................... 72

B. Fraud on the Court Claims ........................................................... 76

CONCLUSION .................................................................................................... 82

INTRODUCTION

Recent changes, statutory and otherwise, have caused fundamental shifts in the practice of corporate bankruptcy law. Until recently, an unprecedented amount of liquidity permitted financially distressed companies to prop themselves up with infusions of capital. While the credit markets have tightened,¹the effects of the era of "easy money" will continue to be felt for quite some time. Moreover, when companies do file for bankruptcy, debtors often find that they must deal with hedge funds, as opposed to traditional banks, because such funds have replaced banks as the principal lenders to many distressed companies.²The participation of these funds can greatly complicate a bankruptcy case. For example, hedge funds often take aggressive positions and are much less reluctant than a bank to attempt to wrestle control of the company away from the debtor.³The financial industry, already in flux as a result of these market changes, was further affected by the passage of the

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA").⁴Much of the initial commentary surrounding BAPCPA concerned its effects on consumer bankruptcy filings,⁵but the act also made substantial changes to the Bankruptcy Code that have reverberated in the corporate bankruptcy world. While the influx of easy capital and the complication of the bankruptcy process have contributed to the low number of corporate bankruptcy filings, the changes in the bankruptcy law have also played a part.⁶These changes have made reorganization via the bankruptcy courts more expensive and otherwise generally less attractive.⁷As a result, large corporate bankruptcy filings are at a ten-year low.⁸

None of this is to say, however, that the practice of corporate bankruptcy has come to an end. The Bankruptcy Code continues to offer solutions that are simply unavailable in other workout scenarios. Rather than avoid the bankruptcy courts altogether, bankruptcy practioners and commentators predict that companies will make more frequent use of remedies that are short of a traditional reorganization. One example is the sale of a business (or portion of a business) pursuant to Sec. 363 of the Bankruptcy Code⁹.

Section 363 allows a debtor¹⁰to sell assets outside the ordinary course of business. The section can be used for the sale of any of the debtor's assets, but the term "363 sale" (also known as a "going concern sale") usually refers to a sale of the debtor's entire business via a public or private auction process. A common procedure¹¹involves a debtor seeking an initial bid on the assets from a "stalking horse bidder." The debtor will then request that the court approve bid procedures and marketing efforts. When using a stalking horse bidder, such bid procedures will often involve a "breakup fee" paid to the stalking horse bidder, if it is outbid, to compensate for the expense of conducting the due diligence necessary to set the first bid. Once the auction is completed, the debtor will take the highest and best bid and will seek court authorization to sell the assets to the winning bidder. At this point, the court will hear any objections to the sale made by other parties in interest. Once the court issues an order approving the sale, Sec. 363(m) provides that the sale can be overturned only upon a showing that the purchaser lacked "good faith."¹²

Because Sec. 363 sales do not involve the lengthy and expensive process of, for example, soliciting votes in favor of a plan or reorganization, such sales are an attractive alternative to selling a business pursuant to the terms of a court- confirmed plan of reorganization.¹³Moreover, the use of such sales has increased in popularity in recent years.¹⁴Given this increased use of Sec. 363 sales, and given the increased number of participants in the bankruptcy process, it is more important than ever that the debtor and bidders alike know the rules of the game. No such rule is more important than the prohibition of collusive bidding as set forth in Bankruptcy Code Sec. 363(n). Section 363(n) is relatively short and straightforward. The section reads, in its entirety:

The trustee may avoid a sale under this section if the sale price was controlled by an agreement among potential bidders at such sale, or may recover from a party to such agreement any amount by which the value of the property sold exceeds the price at which such sale was consummated, and may recover any costs, attorneys' fees, or expenses incurred in avoiding such sale or recovering such amount. In addition to any recovery under the preceding sentence, the court may grant judgment for punitive damages in favor of the estate and against any such party that entered into such an agreement in willful disregard of this subsection.

Although the word "collusion" is never actually used, Sec. 363(n) is universally understood to prohibit collusion among potential bidders at a Sec. 363 sale. The text of Sec. 363(n) makes no effort to explain what is, and what is not, considered collusion. Congress left it to the courts to clarify this issue. The importance of understanding the boundaries set out in Sec. 363(n) is illustrated by the consequences of violating the section. These include the setting aside of the sale, monetary damages (including punitive damages), and criminal prosecution.¹⁵

Very little has been written about collusion in bankruptcy sales in general or Sec. 363(n) specifically.¹⁶Moreover, there is not a large body of Sec. 363(n) case law. This Article summarizes the issues raised in the case law in an attempt to provide some guidance to participants in Sec. 363 sales. Part I discusses the legislative history of Sec. 363(n). Part II analyzes the elements that must be shown for a party to be liable under Sec. 363(n) and the case law discussing its application. Part II also discusses the consequences of violating Sec. 363(n). Finally, Part III discusses the body of case law dealing with the finality of sale orders and whether Sec. 363(n) is an exception to otherwise applicable statutes of limitation. While a discussion of all these issues does not provide a crystal clear roadmap to avoiding liability, it should allow a party to recognize the principal signposts along the way.

I. THE LEGISLATIVE HISTORY OF Sec. 363(N)

There is not a great deal of legislative history for Sec. 363(n). In fact, the lack of discussion at the time of enactment, and the lack of amendments since enactment, is at least as significant as what Congress did say when it was enacted. Congress enacted Sec. 363(n) as part of the Bankruptcy Reform Act of

1978 (the "Reform Act"). Prior to the enactment of the Reform Act, bankruptcy law was governed by the Bankruptcy Act of 1898 (the "Act").¹⁷

Section 70(f) of the Act allowed for the sale of a debtor's real or personal property, conditioned on the bankruptcy court's approval. No mention was made of agreements among bidders or of the purchaser's good faith. While bankruptcy law did not yet provide these protections, section 70(f) did work to ensure that the property was not sold for an unreasonably low price by requiring that the property "shall not be sold otherwise than subject to the approval of the court for less than 75 per centum of its appraised value."¹⁸

Some courts have continued to apply this doctrine under the current

Bankruptcy Code.¹⁹

The Act was the first successful federal bankruptcy statute and governed the application of bankruptcy law for almost eighty years. A significant rise in bankruptcy filings in the 1960s, however, caught the attention of Congress.²⁰

It responded in 1970 by forming the Commission on the Bankruptcy Laws of the United States (the "Commission").²¹The Commission's mission was very broad: "to study, analyze, evaluate, and recommend changes in the substance and administration of the bankruptcy laws of the United States."²²The Commission issued its report in 1973, complete with substantive analysis of bankruptcy policy and a proposed new Bankruptcy Code.²³The report laid the foundation for the modern Sec. 363, but contained no reference...