Collusion in Bankruptcy Sales
Written by: Jason Binford
Haynes and Boone, LLP;
Dallas
This article is the first in a series of articles discussing §363(n) and collusion in bankruptcy sales. Subsequent articles will discuss the fine line between collusion and collaboration, and will explore the application of the specific elements of a §363(n) action.
Since the enactment of the Bankruptcy Abuse and Consumer Protection Act of 2005 (BAPCPA) approximately two years ago, bankruptcy commentators have speculated on exactly how this legislation would change the administration of bankruptcy cases. It was clear from enactment that several changes in the law made chapter 11 reorganization cases more complicated and more costly. As a result, it appears that more and more debtors are avoiding a “full blown” reorganization under the Bankruptcy Code in favor of selling all or a portion of the business in bankruptcy. Such a sale is authorized under §363 of the Bankruptcy Code and is commonly referred to as a “§363 sale.”
A §363 sale is usually conducted via a public or private auction. The debtor frequently obtains court authorization for the bidding procedures. Parties bid on the assets for sale pursuant to the court approved procedures and the debtor sells the assets to the highest and best bidder, conditioned on court approval of the sale.
The debtor sets out the procedures for the auction process in its court-approved filing. These procedures are supplemented by the provisions of the Bankruptcy Code. One of the most important of such provisions is the prohibition on collusive bidding in Bankruptcy Code §363(n). Generally speaking, §363(n) prohibits potential bidders at a §363 sale from colluding, thereby stifling the bidding process and denying the debtor the true value for the assets.
The importance of complying with §363(n) is illustrated by the remedies that are available under the section for violating its provisions. The specific text of the section provides that the sale may be avoided, or that the debtor (or other party bringing the action) may recover consequential damages (i.e., the amount the assets should have sold for minus the amount they actually sold for), costs, attorneys’ fees, and punitive damages. However, the list of damages listed in §363(n) is not exclusive. Parties found liable for collusive bidding could also be prosecuted criminally under certain provisions of title 18 of the U.S. Code.
Given the significant liability that is at stake, it would be comforting to know that bankruptcy case law provides clear guidance on how to avoid liability under the section. Unfortunately, that is not the case. Very few courts have discussed the section at any length. However, the few cases that are on point provide some helpful broad guidelines.
First, the elements for liability under §363(n) are as follows: (1) there must be an agreement; (b) among potential bidders; (3) that controlled the price at bidding.
An “agreement” among potential bidders need not be in writing. The court may infer such an agreement from the conduct of the parties. However, if the circumstantial evidence of the allegedly collusive behavior could just as easily be construed as resulting from innocent behavior, then a court likely will not infer that a collusive agreement existed. A common example of such innocent behavior involves joint bidding. Potential bidders may submit a joint bid if, for example, each party is unable to afford a competitive bid on its own. In other words, collaboration is permitted, but collusion is not.
In addition, disclosure of any agreement between potential bidders will weigh heavily against a finding of collusion. But, note that if an agreement truly is collusive (i.e., it seeks to control the ultimate sales price), disclosure will not relieve the parties of liability.
The second element of liability under §363(n) relates to whether the agreement is among “potential bidders.” This element has been interpreted very broadly. The general rule for parties considering bidding at a bankruptcy sale is that this consideration alone likely makes you a “potential bidder” for the purposes of §363(n).
The last element of liability under §363(n) is whether the agreement controlled the sale price. The leading case on this issue has held that an agreement does not run afoul of §363(n) if it affects the sales prices, as long as it does not control the sales price. Like the issue of collusion versus collaboration, the court will scrutinize the motivation of the parties. If the parties are entering into the agreement for the purpose of stopping the bidding or of keeping the sales price low, then the court likely will hold that the agreement violates §363(n). Any other motivation that has a secondary effect on the sales price is permissible.
Therefore, the best bet for avoiding liability under §363(n) is to disclose the agreement and to make it clear that the agreement is motivated by something other than a desire to control the sales price.