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Collateral Attacks on Sale Orders, Due Diligence, and the Barton Doctrine

By James E. Bailey III and Paul S. Murphy – December 10, 2012


He who sells what isn’t his’n,
Must buy it back or go to pris’n.


— Daniel Drew (1797–1879)

 

Assets are sold by bankruptcy trustees and debtors-in-possession every day across the country. The overwhelming majority of these sales are concluded successfully and without incident. But what happens when a trustee sells an asset that the estate did not own? Consider the following hypothetical situation:


XYZ, Inc., is a subcontractor in the construction business generally performing earthmoving and site preparation work. XYZ owns a number of pieces of heavy earthmoving equipment and leases others. XYZ “borrows” other pieces of equipment from time to time from companies with which it subcontracts. Due to the downturn in the economy, XYZ files a voluntary Chapter 11 case. A Chapter 11 trustee is appointed and meets with the owner of the business to define the universe of assets that might be available for liquidation. The owner of the business carefully walks through the yard and identifies hundreds of pieces of equipment, some of which he credibly states belong to other persons. The trustee employs an auction company to sell the equipment not identified as being owned by third parties. The trustee also files a motion to approve the sale of the estate’s assets through the auction. ABC, LLC, receives notice of the sale motion, the order, and the upcoming auction.


Unbeknownst to the trustee, ABC owns a trailer located on the yard, an “All-Haul 10×5×40” that XYZ “borrowed.” Prior to the sale motion, the owner of XYZ identified several pieces of equipment owned by ABC and pointed these out to the trustee. The trustee allows ABC to retrieve its equipment prior to the sale. While ABC is on the yard, it has access to the trailer and never makes a claim of ownership to it.


The auction company produces a brochure and Internet marketing materials listing the trailer as one of several hundred lots that are to be sold at the upcoming auction. The auction materials describe the trailer as a “Haul-All Trailer 12×6×42.” The trailer is clearly not an “All-Haul” trailer,” and this is obvious to anyone familiar with trailers. Interested persons are invited to inspect the auction lots on the yard prior to the auction. A representative of ABC inspects the items and shows up on the day of the auction. Before bidding begins on the trailer, the auctioneer advises the bidders that there is a mistake in the description and that this is an “All-Haul” trailer, not a “Haul-All” trailer. ABC’s representative is present at the auction and bids on the trailer to purchase it but is outbid by LMNOP, L.P.


Thirteen months after the sale, ABC files suit against LMNOP for recovery of the trailer in question, asserting that it owns the trailer. LMNOP answers and files a third-party complaint against the auction company. The auction company then makes a demand on the trustee under the auction contract to indemnify it from and against any losses.


This scenario sets up a pretty clear case of a collateral attack on a bankruptcy court’s sale order. What about the fact that the debtor did not actually own the trailer? Does that matter? What is the trustee to do?


Sale Orders
A Question of Consent
Bankruptcy courts have consistently held that an interest holder’s consent to a section 363 sale may be implied. See S. Motor Co. v. Carter-Pritchett-Hodges, Inc. (In re MMH Auto. Grp., LLC), 385 B.R. 347 (Bankr. S.D. Fla. 2008) (upholding section 363 sale of property free and clear in the face of unsecured creditor’s post-sale claims to same); see also Canzano v. Ragosa (In re Colarusso), 382 F.3d 51 (1st Cir. 2004); FutureSource LLC v. Reuters Ltd., 312 F.3d 281 (7th Cir. 2002); In re Porras, 2001 WL 871286 (Bankr. W.D. Tex. 2001); In re Gabel,61 B.R. 661, 667 (Bankr. W.D. La. 1985)(holding creditor is estopped from denying its implied consent to a section 363 sale after sale is ordered and conducted).


In MMH Automotive, a purchaser of real property from a Chapter 7 trustee at a section 363 sale filed an adversary complaint seeking a determination that an unrecorded billboard lease, of which the purchaser did not have actual notice, was eliminated as an interest upon entry of the order approving the bankruptcy sale free and clear of all claims, liens, and encumbrances. The billboard lessee countered by asserting an enforceable right in the real property, claiming it had no notice of the sale of the property, and requested that the sale order be invalidated due to the trustee’s failure to provide notice of the sale. 385 B.R. at 352. The bankruptcy court held, inter alia, that (1) it retained jurisdiction to determine the validity and enforceability of the sale order; (2) because the trustee had actual notice of the billboard lease, the lessee was entitled to receive notice of the proposed sale; and (3) the appropriate remedy for the lack of proper notice to the lessee was not to void the entire sale, but to afford the lessee treatment to which it would have been entitled had it received notice of the sale, that is to have the value of its interests paid from the proceeds of the sale. Id. at 347. It is important to note that the court held that the lessee was entitled to receive notice of the proposed sale because the trustee had actual knowledge of the defendant/third parties’ interest in the billboard and the billboard lease through express deposition testimony, deposition exhibits, discovery documents that included the billboard lease, and a purchase agreement that specifically recited that the billboard on the property is not owned by the seller, but rather by a third party. Id. at 347, 354.


In this regard, the MMH Automotive court held: “However, a party whose interest is hidden, whether by design or failure to do what is necessary to protect or disclose such interest cannot later complain that its interest has been compromised without notice, because, logically, the trustee cannot be expected to know that a ‘hidden’ interest exists.” Id. at 357, citing Wood v. CLC Corp. (In re CLC Corp.), 110 B.R. 335 (Bankr. M.D. Tenn. 1990) (creditor who did not file a claim or provide any notice to debtor of its interest in a property was not entitled to receive notice of a sale in accordance with 11 U.S.C. § 363 or Fed. R. Bankr. P. 6004(a) or 2002(a)).


Similarly, in Colarusso,the First Circuit held that by participating as an unsuccessful bidder in a section 363 sale of estate property free and clear of all competing interests, without ever asserting claim to property and without ever objecting to the sale or seeking adequate protection of purported interest, the claimant was equitably estopped from later asserting any interest in the property. 382 F.3d at 62.


These cases indicate that consent to a sale may be implied and that even if the property is not owned by the debtor (and, therefore, not property of the section 541(a) bankruptcy estate), a trustee can convey title to a good faith purchaser.


Good Faith Purchaser
Under 11 U.S.C. § 363(m), a sale to a third-party purchaser acting in good faith may not be reversed unless the aggrieved party obtains a stay of the sale pending appeal of the sale order. See Colarusso, 382 F.3d at 61–62 (citing In re Stadium Mgmt. Corp., 895 F.2d 845 (1st Cir. 1990)).


Section 363(m) does not say that the sale must be proper under 363(b); it says that the sale must be authorized under § 363(b). There is no doubt that when a bankruptcy court authorized the sale . . . it was acting under § 363(b). It matters not whether the authorization was correct or incorrect. The point is that the proper procedures must be followed to challenge an authorization under §363(b).


Id. at 62 (quoting In re Sax, 796 F.2d 994, 97–98 (7th Cir. 1986)) (emphasis in original); accord In re Cont’l Airlines, 91 F.3d 553, 570 (3d Cir. 1996) (“Unless the sale is stayed pending appeal, the transaction survives even if it should not have been authorized in the first place.”).


Moreover, if the time for appeal has passed, the sale may be challenged, if at all, in accordance with the provisions of Rule 60(b) of the Federal Rules of Civil Procedure, incorporated into the Bankruptcy Code through Federal Rule of Bankruptcy Procedure 9024. Colarusso, 382 F.3d at 62; see also FutureSource LLC v. Reuters Ltd., 312 F.3d 281 (7th Cir. 2002) (holding that an order approving a bankruptcy sale is a judicial order and can be attacked only collaterally within the tight limits that Federal Rule 60(b) imposes on collateral attacks on civil judgments). In the hypothetical above, ABC’s action occurred 13 months after the sale.


Bankruptcy Court Relief
The bankruptcy court has the authority to interpret, clarify, apply, and enforce its own orders, especially where its jurisdiction to enter the original order was not and is not at issue. This precept is in the fabric of the Bankruptcy Code. See 11 U.S.C. § 105(a) (“No provision of [the Bankruptcy Code] providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.”). See also Brown v. Ramsay (In re Ragar), 3 F.3d 1174, 1178 (8th Cir. 1993) (affirming action taken by bankruptcy court pursuant to section 105—and subsequently adopted by district court—to enforce and implement its own order).


Should the trustee seek to enforce the terms of the sale order and, if so, how, where, and against whom?


How and Where?
This argument is best presented to the bankruptcy court that approved the sale. This could include the filing of a complaint seeking injunctive relief and damages for violation of the sale order. The typical complaint would seek relief under section 105(a) (cited above) as well as traditional notions of injunctive relief under Federal Rule of Bankruptcy Procedure 7065 and Federal Rule of Civil Procedure 65.


Injunctive Relief
The four traditional prerequisites to the issuance of a preliminary injunction are (1) a substantial likelihood that the movant will prevail on the merits; (2) a substantial threat that the movant will suffer irreparable injury if the injunction is not granted; (3) that the threatened injury to the movant outweighs the threatened harm an injunction may cause the party opposing the injunction; and (4) that the granting of the injunction will not disserve the public interest. See Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746 (5th Cir. 1995)(citing In re Commonwealth Oil Ref. Co., 805 F.2d 1175, 1189 (5th Cir. 1986)). In In re The Babcock & Wilcox Co., the district court made the following observation:


The Fifth Circuit employs a sliding scale when analyzing the degree of “success on the merits” a movant must demonstrate to justify injunctive relief. In re Hunt, 93 B.R. 484, 492 (N.D. Tex. 1988) (citing Canal Authority v. Callaway, 489 F.2d 567, 576 (5th Cir. 1974)). This involves “balancing the hardships associated with the issuance or denial of a preliminary injunction with the degree of likelihood of success on the merits.” Id. (quoting Florida Medical Ass’n v. U.S. Dep’t of Health, Education & Welfare, 601 F.2d 199, 203 n. 2 (5th Cir. 1979)).


2001 WL 536305, at *7 (E.D. La. May 18, 2001); see also Productos Carnic, S.A. v. Central Am. Beef & Seafood Trading Co., 621 F.2d 683, 686 (5th Cir. 1980) (“Where the other factors are strong, a showing of some likelihood of success on the merits will justify temporary injunctive relief.”).


In adapting the preliminary injunction standard to the bankruptcy context, some courts reformulate, relax, or even eliminate some of the traditional elements. Buke, LLC v. Eastburg (In re Eastburg), 440 B.R. 864, 872 (Bankr. D.N.M. 2010) (collecting cases). In particular, several courts have held that once a bankruptcy court is satisfied that certain proceedings would defeat or impair its jurisdiction, a bankruptcy court may issue an injunction under 11 U.S.C. § 105(a) without much, if any, further analysis. See Beck v. Fort James Corp. (In re Crown Vantage, Inc.), 421 F.3d 963, 975–76 (9th Cir. 2005); In re G.S.F. Corp., 938 F.2d 1467, 1475 (1st Cir. 1991); In re L&S Indus., Inc., 989 F.2d 929, 932 (7th Cir. 1993). However, a prudent practitioner should be prepared to demonstrate each of the requisite four elements.


1. Likelihood of Success. In the hypothetical above, the likelihood of success prong hinges on one core determination: whether the trailer that was sold to LMNOP is the same trailer that is the subject of ABC’s pending civil action. To demonstrate a likelihood of success on the merits, the trustee is not required to present sufficient evidence to “prove his entitlement to summary judgment.” Janvey v. Alguire, 628 F.3d 164, 175 (5th Cir. 2010). Although the trustee must present a prima facie case, the trustee “need not show that he is certain to win.” Id.


2. Irreparable Injury. With regard to irreparable injury, there are several concerns in the hypothetical case. First, if ABC is allowed to continue to litigate the merits of the non-bankruptcy action, the long-standing judicial policy prohibiting collateral attacks will be violated, seriously undercutting the orderly process of law. See Celotex Corp. v. Edwards, 514 U.S. 300, 313 (1995); Henkel v. Lickman (In re Lickman), 286 B.R. 821, 829–30 (Bankr. M.D. Fla. 2002) (collateral attack on the bankruptcy court’s jurisdiction and orders in the courts of another jurisdiction, if allowed to continue, would result in irreparable harm to the bankruptcy policy of the United States).


Second, decisions rendered in the non-bankruptcy action could limit the bankruptcy court’s review of its own sale order. See Altman v. Davis & Dingle Family Dentistry (In re EZ Pay Servs.), 389 B.R. 751, 759–60 (Bankr. M.D. Fla. 2007) (finding potential collateral estoppel effect of parallel state court action on trustee suit amounted to a showing of irreparable injury meriting an injunction). In addition, ABC’s non-bankruptcy action contravenes the statutory and judicial policy favoring the finality of judgments approving sales in bankruptcy and thereby threatens to decrease the value of the assets sold in bankruptcy in general. See Tucker v. First Commercial Bank NA, 2000 WL 122408, at *2 (5th Cir. Jan. 4, 2000). Potential buyers will likely discount the value assigned to assets purchased at bankruptcy sales if they believe they could be subject to suit in a foreign jurisdiction long after the sale has occurred.


Finally, such a case could set a dangerous precedent for bankruptcy trustees. If the bankruptcy court’s sale orders are allowed to be challenged in foreign jurisdictions, trustees may be compelled to defend against such claims; consequently, it will be far more difficult and expensive for trustees to administer bankruptcy cases. See Crown Vantage, 421 F.3d at 974–75; In re Linton, 136 F.3d 544, 545 (7th Cir. 1998); Lickman, 286 B.R. at 830.


3. Injunction Will Not Cause Harm to the Defendant. In the hypothetical, ABC will not suffer harm if a preliminary injunction is entered prohibiting it from prosecuting its claim in the non-bankruptcy action for a limited time. Such an injunction does not foreclose ABC from bringing its arguments before this bankruptcy court in the context of an adversary proceeding. In addition, insofar as ABC’s actions constitute a collateral attack on the bankruptcy court’s sale order, ABC should not be able to claim it will be harmed by “a prohibition from doing that which [it] is not permitted to do in the first place.” Lickman, 286 B.R. at 831.


4. Injunction Will Not Disserve the Public Interest. This element requires a balancing of public interest with other competing social interests. As noted above, the policies underlying an orderly and effective judicial system would be well served by a preliminary injunction, and these interests should outweigh any competing concerns.


Against Whom?

One threshold question is to decide against whom the injunctive relief is to be sought. One option is to seek to enjoin the district court itself from proceeding with the action before it. This is fraught with several legal and practical problems. First, bankruptcy courts are generally loath to enjoin federal district judges. Second, if the action is pending in a state court, there are federalism concerns and the Younger doctrine. See Younger v. Harris, 401 U.S. 37 (1971). In light of these facts, the more effective course of action in the hypothetical would be to seek to enjoin ABC.


The Barton Doctrine
The Barton doctrine derives from the case of Barton v. Barbour, 104 U.S. 126, 26 L. Ed. 672 (1881). Under this doctrine, “a court appointed trustee cannot be sued for actions taken in the trustee’s official capacity unless leave is first obtained from the court that appointed the trustee.” In re WRT Energy Corp., 402 B.R. 717, 721–22 (Bankr. W.D. La. 2007) (setting out the history of the Barton doctrine and its applicability to bankruptcy trustees). Courts have held that the doctrine applies to suits against auctioneers and lawyers appointed by the trustee and approved by the court to represent the estate, reasoning that when auctioneers and lawyers act at the direction of the trustee for the purpose of administering the estate or protecting its assets, they are the “functional equivalent of a trustee.” Carter v. Rogers, 220 F.3d 1249, 1252 n.4 (11th Cir. 2000); In re DeLorean Motor Co., 991 F.2d 1236, 1241 (6th Cir. 1993).


In Barton, the Supreme Court held that a party must first obtain leave of the appointing court before suing a railroad receiver in his official capacity. Barton, 104 U.S. at 126. The Court based its holding on the appointing court’s exclusive in rem jurisdiction over the property administered by the receiver. Id. Given the appointing court’s exclusive jurisdiction, the “non-appointing” court lacked jurisdiction over the suit against the receiver. Although the doctrine was conceived in the context of railroad receivers, courts have broadly applied the Barton doctrine to bankruptcy trustees. The extension of the doctrine to the bankruptcy arena reflects the fact that a “trustee in bankruptcy is a statutory successor to the equity receiver,” and “like an equity receiver, a trustee in bankruptcy is working in effect for the court that appointed or approved him, administering property that has come under the Court’s control by virtue of the Bankruptcy Code.” In re Linton, 136 F.3d 544, 545 (7th Cir. 1998).


With respect to bankruptcy trustees, courts have articulated the underlying policies and rationale for the Barton doctrine in different ways. Many courts focus on the bankruptcy court’s exclusive in rem jurisdiction over the estate. See, e.g., Beck v. Fort James Corp. (In re Crown Vantage, Inc.), 421 F.3d 963, 971 (9th Cir. 2005). Other courts have focused on a trustee’s quasi-judicial immunity derived from the appointing court. See, e.g., Barbee v. Price Waterhouse, LLP (In re Solar Fin. Servs.), 255 B.R. 801 (Bankr. S.D. Fla. 2000). Courts have also focused on the oversight and supervisory responsibilities of bankruptcy courts. See, e.g., Lowenbraun v. Canary (In re Lowenbraun), 453 F.3d 314, 321–22 (6th Cir. 2006) (stating that the purpose of the Barton doctrine is to enable “the Bankruptcy Court to maintain better control over the administration of the estate”); Crown Vantage, 421 F.3d at 974 (“[R]equiring that leave to sue be sought enables bankruptcy judges to monitor the work of trustees more effectively.”). The common thread running through these policy explanations is the bankruptcy court’s jurisdiction over the bankruptcy case and the powers that flow from that jurisdiction.


How to Prevent This Hypothetical from Becoming Reality
Conduct Due Diligence
Adequate due diligence is the first order of business for both the seller-trustee and a potential buyer. “Adequate” due diligence is, however, often difficult, if not impossible, to conduct. The debtor may be unwilling or unable to produce adequate records and, indeed, may intentionally withhold information or provide misleading information. The records to review depend on the type of assets being sold, but a non-exhaustive list generally includes the following:


  • the debtor’s books and records (preferably audited financials if available);
  • certificates of title;
  • title searches;
  • Uniform Commercial Code searches;
  • Department of Motor Vehicles records;
  • U.S. Patent and Trademark and state trademark office records; and
  • Internet domain name registries.

Provide Notice
As the cases bear out, notice is a key component to many courts’ analyses. For that reason, both the buyer and the seller-trustee should ensure at a minimum that notice is provided to all creditors, and the debtor may consider providing notice to all the world through publication.


Check the Accuracy of the Description of Assets to Be Sold
Both the seller-trustee and the buyer should check, double-check, and then check again the descriptions of the assets to be sold. Again, the nature of an asset will have a bearing on the precision with which that asset may be described, but generic descriptions such as “all the debtor’s assets” or “all personal property” should generally be avoided.


Conclusion
Bankruptcy sales can produce very favorable results and are and should be encouraged. The risk for both trustees and buyers of assets is limited by the good faith purchaser provisions of section 363(m); however, both parties to such transactions can further insulate a sale by considering, to the extent possible, appropriate due diligence, adequate notice, and asset descriptions. Problems do arise even when all reasonable steps are taken. In such instances, the trustee, and perhaps the trustee’s professionals, have the added protections (though limited) of the Barton doctrine to fall back on.


Keywords: bankruptcy and insolvency litigation, bankruptcy sales, Barton doctrine, injunction, Federal Rule of Bankruptcy Procedure 7065, Federal Rule of Bankruptcy Procedure 9024, Federal Rule of Civil Procedure 65, Federal Rule of Civil Procedure 60(b)


James E. Bailey III and Paul S. Murphy are attorneys with Butler, Snow, O'Mara, Stevens, and Cannada, PLLC, in Memphis, Tennessee, and Gulfport, Mississippi, respectively.



 
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