Pre-confirmation Bankruptcy Sale: When Can You Hurry up and Sell?

In re MCSGlobal Inc., 562 B.R. 648 (Bankr. E.D. Va. 2017)

A chapter 11 trustee sought court approval of a sale of substantially all of the debtor’s assets prior to confirmation of a plan of reorganization. The purchase agreement terms included release of claims against the buyer and a bar order precluding creditors from bringing similar claims. A creditor objected.

The debtor (MCS) was in the business of providing IT staffing using IT employees in the United States on H-1B Visas. Ownership of the debtor had changed hands a couple of times prior to bankruptcy. Along the way a company (ProLink) obtained a judgment for ~$750,000 against several companies, including the then parent company of MCS (CGS). After obtaining the judgment, ProLink served a garnishment summons on MCS as an alleged account debtor. This eventually resulted in a judgment against MCS for ~$775,000.

In the meantime CGS sold MCS. The purchaser (Kellton) was unhappy about the ProLink judgment and demanded indemnification from CGS’ owner (Mr. Doki). Mr. Doki agreed to repurchase MCS in settlement of the indemnification claim. There was an initial down payment and a secured promissory note for the balance.

At the time MCS filed bankruptcy, the note was in default. Although the bankruptcy court denied a ProLink motion to convert the case to chapter 7 liquidation, the court sua
sponte ordered appointment of a chapter 11 trustee due to Mr. Doki’s conflicts of interest.

The trustee sought court approval to sell substantially all of the assets of MCS to Mr. Doki for $200,000, with a release of the trustee’s claims against Mr. Doki. Although ProLink did not object, Kellton did. Notwithstanding the objection, the court approved the sale to Mr. Doki.

However, almost immediately Mr. Doki defaulted. After the default the trustee terminated the Doki purchase agreement and filed a motion to sell substantially all of the MCS assets to Kellton instead. This time ProLink objected.

Under the new purchase agreement the purchase price remained $200,000, and once again the trustee released claims against the buyer (this time Kellton). In addition (1) the trustee retained all claims against Mr. Doki, (2) the bankruptcy estate retained all pre-closing cash ($148,000), (3) the buyer agreed to pay up to ~$137,000 in deferred salaries, and (4) the buyer also agreed to pay an additional payroll for the employees if the sale closed by a certain date.

ProLink objected that (1) the trustee was selling too cheap and Kellton was liable for a transfer of ~$1.1 million from MCS to Kellton, and (2) the related bar order would preclude ProLink from suing Kellton for claims arising from the alleged $1.1 million transfer.

The court noted that approval of a sale of substantially all of a Chapter 11 debtor’s assets prior to confirmation of a plan must have a sound business purpose – which required showing that (1) there was a sound business reason or emergency justification for the pre-confirmation sale, (2) the sale was proposed in good faith, (3) proper notice was given to interested parties, and (4) the purchase price was fair and reasonable.

In addition to the terms of the sale, the court considered the trustee’s testimony that the debtor’s operating liabilities exceeded its cash, MCS had no line of credit, and the bankruptcy estate was administratively insolvent with accrued administrative expenses of $400,000 (so a creditor such as ProLink could not expect any distribution). The trustee also testified that he tried to engage a business broker to market the assets, but was told that he could not do better than the Kellton deal. Further, if the trustee terminated the debtor’s operations, the debtor would be obligated to repatriate all of the H-1B Visa employees – giving rise to further administrative expense.

Given these facts, the court concluded that the trustee met his burden and the sale should be approved.

With respect to the purported $1.1 million transfer, the only indication that the funds ever existed was a MCS balance sheet that was questionable. Bank statements did not show that MCS had anything close to $1.1 million. The court concluded that the trustee was reasonable in discounting the claim and declining to pursue fraudulent transfer litigation. Given the complexities and expense of litigation and the uncertainty of winning, the court agreed with the trustee and approved the purchase agreement with release as a reasonable settlement of the claims against Kellton.

That left the issue of the bar order. ProLink argued that it should be allowed to sue Kellton under state law for breach of fiduciary duty and a fraudulent transfer based on the purported $1.1 million transfer.

The court began by noting the distinction between this case and a case involving forced release of third party claims. Generally courts draw a distinction between claims that are particular to a creditor versus claims that are derivative of the trustee’s rights.

If claims are derivative, the trustee has the right to control how they are handled. This includes settlement and release of the claims, with a corresponding injunction against creditors pursuing those or related claims. Here the bankruptcy court found that both the fiduciary duty and the fraudulent transfer claims asserted by ProLink were derivative and could be barred by the trustee’s settlement.

Accordingly the court approved the sale to Kellton, including the release of claims and the bar order.

It can be difficult to justify sale of substantially all of a Chapter 11 debtor’s assets outside the confirmation process. The procedures and substantive requirements for confirmation provide substantial protections to creditors and other interested parties. As a practical matter a court is more likely to go along with a pre-confirmation proposed sale if (1) it will provide a demonstrably better result – often because a business is failing and rapidly losing any value, and (2) the court is able to adequately address all objections of interested parties in the context of the sale.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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