In Gildea, the bankruptcy trustee claimed that a group of insiders colluded with the purchaser of the debtor’s assets at a Section 363 auction to control the sale price. Consequently it sought to recover the difference between the bid price and the true value of the assets from the defendants. In this opinion the court denied the defendants’ motions for summary judgment.
Section 363(n) of the Bankruptcy Code provides:
The trustee may void a sale under this section if the sale price was controlled by an agreement among potential bidders at such sale, or may recover from the party to such agreement any amount by which the value of 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.
The court noted that there must be an agreement between potential bidders that controls the price at bidding for the trustee’s claim to prevail. An agreement controls the price where the objective is to influence the price, and the price is actually controlled by the agreement. If an effect on the sale price is an unintended consequence of an agreement, it is not an agreement to control within the meaning of Section 363(n).
In this case a group of insiders, including the president and sole equity owner of the debtor and his wife, son and son’s wife, made attempts to obtain financing to buy the debtor’s assets from the summer of 2002 through sometime in early 2003.
On February 12, 2003, the debtor requested an order authorizing a Section 363 auction of its assets. The court approved and the auction was held on April 3, 2003. A third party, Arlington Capital, LLC, formed a company named GTA Acquisition, LLC to submit a bid of $2,725,000, which was the winning bid. The only other bid was a lower credit bid by Comerica, which was submitted as a partial credit against the ~$7.8 million owed to it.
A hearing was held on April 7, and the bankruptcy court approved the sale to GTA Acquisition on April 8 (with an amended sale order issued on April 16). A new entity that was formed and owned by insiders of the debtor bought GTA Acquisition pursuant to a buyout agreement with Arlington Capital dated April 7.
The defendants denied that any agreement to control the sale price existed; and even if there was an agreement, claimed that it could not have been intended to control the price since the insiders did not have the financing for a competitive bid. The defendants also challenged the collusion allegation based on the fact that Comerica effectively controlled the bidding as a significantly undersecured creditor entitled to credit bid (i.e. it could bid up to $7.8 million as a credit against the debt owed to it by the debtor if it thought that the Arlington Capital offer was too low).
In a 2006 opinion the court had concluded that because the insiders could not offer a competitive bid, “it is not reasonable to infer that Arlington and the [insiders] colluded to avoid bidding against each other.”
However, in 2007 the court reversed itself, explaining that additional facts “solidified the inference of collusion with evidence that the [insiders] discontinued their vigorous pursuit of financing to purchase the assets of the Debtor only after beginning to meet with Defendant Arlington Capital, and with evidence that the [insiders] had the possibility of obtaining financing sufficient to submit a competitive bid.”
In this opinion, the court did another detailed review of the facts and found that there was substantial evidence that a rational person could conclude showed an agreement to control the price at auction. In response to the argument that only Comerica could control the price through its credit bid, the court agreed that if an undersecured creditor has full information, its credit bid could dominate the price at auction. But if its belief about the collateral value is “clouded by deception,” then it is the colluding parties and not the misinformed creditor that dominates the price. In sum:
Making all reasonable inferences in favor of the Plaintiff, the Defendants formed a collusive agreement to control the price at auction by not bidding against each other, and by not revealing that the [insider] Defendants were part of the Defendant Arlington’s bid. The Court finds that such an agreement – if it existed – could have actually controlled the price at the auction by influencing Comerica’s credit bid.
Since the trustee was seeking damages (as opposed to rescinding the sale) he also had to show that the value of the assets was in excess of the bid. Again, the court found that there was enough potential evidence to support going to trial.
As evidenced by the court’s flip flop, the facts and inferences underlying the allegations were far from obvious. However, one clear lesson is that the parties must be transparent about their relationships. This case doesn’t say that it is per se wrong to do a joint bid, or to have an agreement to resell property after one party purchases it. But in the context of a bankruptcy sale, it is critical that any arrangements be disclosed to the court and all relevant parties. The failure to do so can lead to significant adverse consequences, ranging from liability for potential lost value or rescission of the sale to punitive damages.