Commercial Fraud Task Force Committee

ABI Committee News

Bankruptcy Sales Part IV: Factors To Consider When Bringing An Action Under §363(N)

This is the final article in a four-part series discussing collusion in bankruptcy sales. Part I discussed the prohibition of collusion in bankruptcy sales under §363(n) of the Bankruptcy Code. Part II discussed the difference between permissible collaboration and impermissible collusion. Part III explored the fine line between agreements that control a sales price at an auction versus agreements that only affect the sales price. Generally, parts I through III discussed the issue of collusion in bankruptcy in the context of how to avoid liability under Bankruptcy Code §363(n). Part IV will discuss the other side of the coin, i.e., how a §363(n) plaintiff (usually a losing party at an auction) should structure its case to maximize the chances that colluding parties are held liable.

The elements of the §363(n) action itself will not be discussed at length because these elements were covered in Parts I through III. As a quick review, to hold parties liable under §363(n), the colluding parties must have been potential bidders at the auction, as that term has been applied in §363(n) case law. This is not a high hurdle because the term “potential bidders” is interpreted very broadly by the courts. Second, the colluding parties must enter into a collusive agreement. Such an agreement need not be in writing and can be inferred from circumstantial evidence. Third, the agreement must control (rather than simply affect) the sales price.

Let’s say that the §363(n) plaintiff is confident that all three elements have been met. It would be incorrect to assume that the only issue remaining is to collect a judgment against the colluding parties. Section 363(n) plaintiffs should be aware of the limitations issues raised by the interaction between §363(n) and Federal Rule of Civil Procedure 60(b).

The text of §363(n) does not mention any statute of limitations. It therefore has fallen to the courts to analyze how (or whether) a time limitation on §363(n) actions applies. The statute cited for the proposition that §363(n) actions can be time-barred is Rule 60(b). Rule 60 is titled “Relief from Judgment or Order,” and subsection (b) is titled “Mistakes; Inadvertence; Excusable Neglect; Newly Discovered Evidence; Fraud.” The text of the rule provides that final orders can be set aside for several different reasons including newly discovered evidence, as well as “fraud (whether heretofore dominate d intrinsic or extrinsic), misrepresentation or other misconduct of an adverse party . . . .” If a final order qualifies under these two reasons, the rule further provides that a motion to set aside the order must be made within one year after the order was entered.

Because §363(n) actions are based on allegations of fraudulent behavior, some courts have applied a one-year statute of limitations to such actions under Rule 60(b). Other courts have noted that §363(n) does not explicitly provide a statute of limitations and that therefore the most closely analogous state statute of limitations should be “borrowed” for §363(n) limitation purposes. State statutes of limitations for fraud generally range from two to six years.

In addition, several courts have drawn a distinction between §363 actions that seek to set aside a sale and §363(n) actions that seek damages. Such an analysis is based on the text of Rule 60(b), which specifically refers to setting aside final orders. Therefore, if a §363(n) plaintiff is seeking to set aside the sale order based on allegations of collusion, these courts will apply a one-year statute of limitations on such an action under Rule 60(b). If, however, a §363(n) plaintiff is simply seeking damages (as specifically provided for in §363(n)), then these courts will analyze the action under state statutes of limitations for fraud. The lesson for any §363(n) plaintiff is to carefully consider the relief that is sought. If more than a year has passed since the entry of the sale order, the plaintiff should strongly consider seeking only damages, rather than seeking to set aside the sale order.

Structuring a §363(n) action as one for damages, however, is not the only basis that parties have used to bring what otherwise would be deemed a time-barred §363(n) action. Several cases have considered the §363(n) limitations issue in the context of “fraud on the court” claims. Fraud on the court is generally defined as (1) the defendant’s misrepresentation to the court, (2) the denial of the motion to confirm based on the misrepresentation, (3) the lack of an opportunity to discover the misrepresentation and either bring it to the court’s attention or bring a timely turnover proceeding against the garnishee, and (4) the benefit the defendant derived from inducing the erroneous decision. In other words, a party commits fraud on the court when, through its misrepresentations to the court, the party impedes the court’s ability to make an informed decision.

In the context of §363(n) actions, courts have considered the issue of whether a fraud-on-the-court claim will allow a party to set aside a sale under §363(n) when such a claim may otherwise have been time barred. The Bankruptcy Court for the District of Massachusetts discussed this issue in depth in Tri-Cran Inc. v. Fallon (In re Tri-Cran Inc.), 98 B.R. 609 (Bankr. D. Mass. 1989). In this case, the debtor sought to sell real estate to defendant John Fallon. The court approved the sale over the objections of several parties. The chapter 7 trustee investigated the circumstances surrounding the sale and determined that various parties colluded with the debtor. The investigation further determined that prospective asset purchaser Fallon learned of the sale from his close friend, Gargiulo, who was a stockholder of the debtor. But at the sale hearing, counsel for the debtor argued that Fallon learned of the sale through general knowledge of the debtor’s industry. The court specifically asked if Fallon had contacts with other stockholders and principals, and counsel for the debtor said no. Fallon, another attorney for the debtor, and Gargiulo were all present at this hearing and said nothing. The court later determined that one of the attorneys for the debtor knew these statements to be false.

The trustee filed an appeal seeking to set aside the order. In considering the trustee’s appeal, the court first noted that the trustee filed the action more than a year after the order was entered. The court concluded, however, that the Rule 60(b) limitation “does not apply when the basis of the motion is fraud upon the court.” Id. at 614. It was important in the court’s analysis, however, to specify the type of “fraud” that is required to demonstrate fraud on the court. The court provided that “[a]s it has been applied, fraud on the court refers to a subcategory of fraud, misrepresentation, or other misconduct in which the fraud, misrepresentation or other misconduct is committed by the court, its personnel or its officers.” Id. at 615. Applying this analysis, the court held that “the judgment in [Fallon’s] favor can be vacated for fraud on the court if it can be shown . . . that Fallon colluded with these officers of the court to obtain approval of the sale at the lowest price, and, to that end, colluded with them in perpetrating a fraud on the court.” Id. at 617. The court ultimately held that Fallon did not act in good faith because he colluded to keep the price low. The court vacated the sale and ordered Fallon to pay attorney’s fees, costs and expenses incurred by the trustee in litigating the matter.

The fraud on the court issue provides another avenue for avoiding the one-year statute of limitations under Rule 60(b). Specifically, if a §363(n) can frame the defendants’ actions as a fraud on the court, there is a chance that the court will hold that Rule 60(b) does not apply at all. It should be noted, however, that the fraud-on-the-court analysis cannot be described as “generally accepted.” In Landscape Props. v. Vogel, 46 F.3d 1416, 1422 (8th Cir. 1995), for example, the Eighth Circuit expressed serious doubt that framing an action as a “fraud-on-the-court” action has any substantive effect. While this case did not involve the issue of limitations, the court’s insistence that fraud on the court “adds nothing” to a §363(n) claim could prove troublesome to a tardy §363(n) litigant alleging that a special exception exists for fraud-on-the-court claims. Moreover, §363(n) litigants should be aware of a Seventh Circuit case that strictly applied the Rule 60(b) limitation period. In In re Met-L-Wood Corp., 861 F.2d 1012 (7th Cir. 1988), the court did not discuss fraud on the court, but applied the Rule 60(b) limitation period even though there was convincing evidence of bid rigging.

A §363(n) plaintiff therefore has several arrows in his quiver. If it has been less than a year since the sale order was entered, he should have no limitations problem. If more than a year has passed, he should only seek damages and should argue that Rule 60(b) does not apply. Moreover, if the defendants’ conduct fits within the definition of a fraud on the court (as collusive behavior likely does) then the plaintiff can argue that the Rule 60(b) limitations period does not factor into the analysis. If Rule 60(b) does not apply at all, the option of setting aside the order becomes available, even if it has been more than a year since the sale order was entered. Assuming, of course, that the plaintiff can also demonstrate the substantive elements to a §363(n) action, these different options provide a §363(n) plaintiff with the best chance of setting aside the order and/or recovering damages.

[1] Jason Binford is an associate in the bankruptcy section of Haynes and Boone, LLP. This article is adapted from a law review article to be published in vol. 21, issue 1 of the Emory Bankruptcy Developments Journal.