A recent district court opinion emphasizes that court orders establishing bidding procedures and requirements under Bankruptcy Code section 363(e) mean what they say.
In K&B Capital, LLC v. Official Unsecured Creditor’s Comm. (In re LWD, Inc.), 340 B.R. 363 (W.D.Ky. 2006), the district court affirmed a bankruptcy court ruling that a successful bidder’s failure to follow court-established bidding processes—coupled with that bidder’s failure to disclose all assets that were to be acquired and the value thereof—resulted in the bidder being required to disgorge undisclosed payments that it had received from the debtors. The bidder also was required to surrender the value of prepaid insurance policies that the bidder knew about because of its status as a secured creditor, but failed to disclose to the court.
The bankruptcy court and district court decisions were based upon stipulated facts, such that the material circumstances of the transaction were not in dispute, and the courts therefore were able to focus upon the legal effect of the (rather unusual) facts.
K&B Capital, LLC ("K&B") was the successful bidder of all of the assets of several chapter 11 debtors at a court-supervised auction sale (authorized under 11 U.S.C. § 363(e)), following the administrative consolidation of the debtors’ cases. K&B’s successful bid totaled $2.55 million, including a "credit bid" of $1.75 million, and a pledge to contribute net cash of $805,000.
Shortly after the sale, however, the committee of the debtors’ unsecured creditors (the "Committee") filed a motion seeking to require K&B to return certain cash payments that K&B had received from the debtors prior to the auction sale and, in addition, the cash value of certain insurance policies, the value of which the Committee contended was not properly disclosed by K&B.
The genesis of the Committee’s motion was K&B’s status as a secured creditor and as a bidder (ultimately, the successful bidder) for the debtors’ assets. K&B had acquired certain indebtedness owed by the debtors, and a security interest in "most of the debtors’ assets" by having purchased those interests from Bank One.
While the district court opinion does not specify the basis for valuing K&B’s secured claim (and therefore the value of its credit bid) as $1.75 million, the amount of such a credit bid would ordinarily equal the amount of the indebtedness owed by the debtors, less any payments received following the valuation date of those obligations. Furthermore, all assets to be sold pursuant to Bankruptcy Code section 363(e) must be fully disclosed and fairly valued, in accordance with procedures established by the court after notice and a hearing.
In this case, the court observed that "K&B and the Debtors, as insiders, were in a position of superior knowledge," such that "the burden of disclosure" of the nature and valuation of the assets to be sold "was on their shoulders . . . ." While the court’s identification of K&B as an "insider" of the debtors is not fully explained, that designation appears to arise from the Committee’s assertion, accepted by the bankruptcy court and the district court, that "‘Bank One had essentially seized the assets of [the debtors] when K&B acquired the position of Bank One in January 2003.’"
Both courts therefore concluded that K&B had a duty to disclose the nature and valuation of all assets that were to be sold, as well as all payments that K&B received from the debtors after the value of K&B’s credit bid was fixed at $1.75 million.
The bankruptcy court and the district court each ruled that K&B failed to meet its duty of disclosure by (i) having failed to report the payments that K&B continued to receive from the debtors after the court had established the applicable bidding procedures, but before the actual date of the auction sale of the Debtors’ assets; and (ii) having failed to present a fair valuation (according to the Committee, at least) of the surrender value of certain prepaid insurance policies held by the debtors.
With respect to the post-petition payments received by K&B, after the debtors’ indebtedness to K&B had been fixed and established by the court, the court had little difficulty in rejecting K&B’s explanation that additional payments received by K&B were permitted under prior court orders that had permitted the debtors to utilize cash collateral in exchange for adequate protection payments.
While the Bankruptcy Code permits debtors to utilize cash collateral in exchange for payments made to one or more secured creditors having an interest therein, the issue raised by the Committee was not whether K&B should have received payments from the Debtors, but rather why K&B failed to disclose and to account for those payments. As such, the court could have ruled that such nondisclosure is at least an implicit violation of the requirement under Bankruptcy Code sections 363(c)(2) and 363(e) that a debtor use "cash collateral" only if "adequate protection" is received by a secured creditor for the debtor’s use thereof.
While the court did not base its holding on Code section 363, it did rule that K&B’s continuing receipt of "adequate protection" payments (after the value of K&B’s credit bid was established by the court) violated Bankruptcy Code section 549(a)(1), which prohibits a debtor from making "a transfer of property of the estate . . . after the commencement of the case," unless the transfer (including any one or more payments) is "authorized under [the Bankruptcy Code] or by the court." 11 U.S.C. § 549(a)(1).
With regard to the insurance policies at issue held by the debtors, the court accepted the Committee’s assertion that there was a specific and ascertainable "refund value" of those policies if cancelled. The court rejected K&B’s assertion that the insurance policies were of no value because they were "’not convertible,’" finding that the insurer would owe money to the holder thereof (in this case, to K&B) if the policies were cancelled, as opposed to being assigned to K&B. As such, the court required K&B to pay that "refund value" in addition to the total amount of its winning bid for the debtors’ assets.
This article is presented for informational purposes only and is not intended to constitute legal advice.