8th Circuit Affirms Dismissal of Lawsuit Attacking Approved Bankruptcy Sale

The Bankruptcy Court dismissed the complaint for failure to state a claim. The Bankruptcy Court ruled the trustee did not plead a plausible claim of fraud on the court, collusive bidding, or request for post-judgment relief. The Bankruptcy Court ruled the remaining claims were barred by the finality of the sale order. The trustee also moved the Bankruptcy Court for leave to amend the complaint. The Bankruptcy Court denied this as well because the Bankruptcy Court determined such amendment would have been futile. The bankruptcy appellate panel for the Eighth Circuit affirmed the Bankruptcy Court's ruling, and the trustee appealed to the U.S. Court of Appeals for the Eighth Circuit.

Property Rights Are Good Against the World

The court began its analysis by describing that bankruptcy sales' nature as in rem proceedings protect them from collateral attack. Quoting another circuit court opinion, the court wrote, "Property rights are rights good against the world, not just parties to a judgment or persons with notice of the proceeding." The plaintiffs would not be allowed to attack the validity of the sale. The court then considered whether the trustee's claims constituted a collateral attack on the bankruptcy sale. The court noted that, "At bottom, [the trustee's] complaint is that Sager Creek won the auction for the Allens' assets with an overvalued bid that was supported by an undisclosed agreement between an unsecured creditor and the second lienholders who formed Sager Creek." The sale order included the Bankruptcy Court's determination that all of the purchased assets were subject to a "competitive and good faith bidding process" and Sager Creek's bid was the "highest or otherwise best bid." The Bankruptcy Court also found that the consideration provided by Sager Creek was the "highest and otherwise best offer" for the assets. The appellate court reasoned that in order for the trustee's claims to succeed, a court would have to contradict those determinations. The court found the trustee's arguments to the contrary were without merit.

The trustee argued he was not attacking the finality of the sale order because the defendants were not parties to the order and he did not seek reversion of title to the assets sold. The court rejected that argument by reiterating the rule that a bankruptcy sale "is a judgment that is good as against the world, not merely as against the parties to the proceedings." Further, a claim not need seek reversion of title to assets sold in a bankruptcy sale. Rather, a suit that seeks "heavy damages" from parties involved in a bankruptcy sale is a "thinly disguised collateral attack on the judgment confirming the sale."

Next, the trustee argued that his claims did not conflict with "integral" provisions of the sale order. Section 363(m) of the Bankruptcy Code provides that a bankruptcy sale may be reversed or modified on direct appeal if it was stayed pending appeal. A prior Eighth Circuit decision held an appeal only affects the validity of the sale if it challenges a provision in a sale order that was integral to the sale. The court noted that prior discussions did not address whether a collateral attack on a sale order was subject to the limitation that the claims not challenge "integral" provisions of a sale order. However, the court noted it need not address that issue because here the trustee's claims did in fact attempt to challenge integral provisions of the Allens' sale order because the claims adversely altered the parties' "bargained for-exchange."

The court also rejected the argument that the sale order was obtained by fraud on the Bankruptcy Court based on the failure to disclose the side agreement and the financial advisers' knowledge of the agreement. The court stated that fraud on the court requires a finding of "the most egregious misconduct directed to the court itself, such as bribery of a judge or jury or fabrication of evidence by counsel." It does not include fraud between the parties or even false statements or perjury. The court concluded that the trustee's allegations related to the side agreement, and failure to disclose the same to the Bankruptcy Court, did not satisfy that standard.

Finally, the trustee argued that the sale order was void under the U.S. Supreme Court's ruling in Czyzewski v. Jevic Holding, 137 S. Ct. 973 (2017), which held that structured dismissals that distribute assets in violation of the priority scheme of the Bankruptcy Code are not permitted. The trustee argued that the sale in Allens distributed more assets to some unsecured creditors than others. The court rejected this argument as well. First, the court noted Jevic involved structured dismissals, not bankruptcy sales and the Supreme Court stated in its opinion that some bankruptcy matters permit distributions of estate assets outside of the Bankruptcy Code distribution scheme. Next, the court reasoned that even if the Allens sale violated the rule in Jevic, the sale order would not be rendered void as a result. The court ultimately dismissed the trustee's appeal of dismissal of the complaint.

The court also dismissed the trustee's appeal of the decision that amending the complaint would be futile. The trustee sought to amend the complaint to assert that interested parties were denied due process because they were not aware of the defendants' conduct related to the sale. The trustee argued that because interested parties were not aware of the undisclosed side agreement, they were denied due process notice of the bankruptcy sale. The court reasoned the terms of the Sager Creek bid were stated on the record at the auction hearing. Over 5,000 creditors received notice of the auction and sale hearing. The court found that interested parties were afforded proper notice and opportunity to be heard, and therefore due process was satisfied.

Collateral Attacks Are Not Permitted

This decision serves as a reminder to what extent courts respect the finality of court-approved bankruptcy sales that have closed and funded, and the power of Section 363(m) of the Bankruptcy Code to promote finality that a good faith purchaser — as determined by the Bankruptcy Court — will receive the benefit of its bargain if no stay pending appeal is obtained.

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Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at [email protected] or 215-988-2554. Joseph N. Argentina Jr. is an associate in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, DE, offices. He can be reached at [email protected] or 215-988-2541. This article also appeared in The Legal Intelligencer, an ALM sibling of The Bankruptcy Strategist.