Gluckstadt Holdings, L.L.C. v. VCR I, L.L.C. (In re VCR I, L.L.C.), 922 F.3d 323 (5th Cir. 2019) –

The bankruptcy court granted a Chapter 7 trustee’s motion to approve holding a public auction and selling property of the debtor free and clear of claims and interests to the highest and best bidder. A prior prospective buyer that objected appealed to the district court, which affirmed the bankruptcy court, and then to the Fifth Circuit.

Originally the debtor and a prospective buyer (Gluckstadt) entered into a stipulated order agreeing to sell property of the debtor to Gluckstadt. Specifically, the order provided that the debtor “shall file and notice a motion for authority to sell the real property, free and clear of all liens, claims and interest, to [Gluckstadt], for $612,500, as soon as possible.”

The case was converted from Chapter 11 to Chapter 7 before the debtor filed the required motion. The trustee did not support selling the property without an open bid process. So, the trustee filed a motion that treated the proposed purchase by Gluckstadt as an opening bid at the auction, with the caveat that the sale would go to the highest and best bidder with no obligation to sell to Gluckstadt unless its bid was the highest and best bid.

Gluckstadt objected arguing that the stipulated order was a settlement agreement that was “fair and equitable” to the debtor and bound the trustee to seek authority to sell the property to Gluckstadt for $612,500 subject only to objections of creditors not participating in the settlement. In particular, the stipulated order did not contemplate a public auction. The bankruptcy court overruled the objection, and the district court affirmed. (As an aside, note that Gluckstadt’s appeal was not moot under section 363(m) despite the subsequent sale that was not stayed pending appeal because it was seeking damages for breach of its settlement agreement rather than challenging the sale.)

On appeal the Fifth Circuit noted that it had determined in a prior case that a settlement agreement involving sale of the debtor’s property was subject to section 363 of the Bankruptcy Code. The sale out of the ordinary course of business requires notice and hearing, is subject to bankruptcy court approval, and “must be supported by an articulated business justification, good business judgment, or sound business reasons.” Further:

“A trustee has a duty to maximize the value of the estate,” and he “must demonstrate that the proposed sale price is the highest and best offer, though a bankruptcy court may accept a lower bid in the presence of sound business reasons, such as substantial doubt that the higher bidder can raise the cash necessary to complete the deal.”

The court discussed another case where a Chapter 7 trustee negotiated a settlement with parties potentially subject to fraudulent transfer claims. A third party that offered to pay more for the claims man the settlement offer objected. The trustee argued for the settlement notwithstanding the higher offer because he believed it was in the best interests of the estate. The bankruptcy court approved the settlement over the objection of the third-party.

On appeal the bankruptcy court was reversed. The settlement was in effect a sale and the potential higher offer indicated that a competitive auction could yield a significantly higher price. The settling parties would be free to bid against any higher bidders. However, in the context of any agreement that is not unenforceable unless it is approved by the court, the duty to maximize assets trumps any contractual obligation.

The bottom line for the Fifth Circuit was that anyone who deals with a bankruptcy trustee in a transaction is charged with the knowledge that it may require court approval and that the trustee must present all facts to the court, including whether there is a more attractive alternative. In this case the agreement specifically required a motion for authority to sell, thus requiring court approval. In requesting authority, the trustee had a fiduciary duty to maximize the return for the bankruptcy estate. That duty trumps any contractual obligation arguably incurred in the context of an agreement not enforceable unless it is approved by the court.

The court concluded that Gluckstadt failed to address Fifth Circuit precedent, the requirements of section 363 for a sale outside the ordinary course of business, or the trustee’s duty to maximize assets of the bankruptcy estate. Accordingly, the court affirmed the lower court judgments.

Although it is possible to obtain court approval of a private sale in the face of objections by a potentially higher bidder, in the vast majority of cases a trustee or debtor in possession is going to insist on a public auction as a means to test whether the proposed sale is the best they can do. In this case the property ultimately sold at an auction for $2,325,000 instead of $612,500.

Vicki R Harding, Esq.