Sale of a Claim or Compromise of an Asset?

Bankruptcy trustees are authorized to use, sell or lease estate property.[1] Trustees are also authorized to enter into compromises or settlements on behalf of the estate.[2] Both sales outside of the ordinary course of business under section 363 of the Bankruptcy Code and compromises of disputes under rule 9019 of the Federal Rules of Bankruptcy Procedure require bankruptcy court approval after notice and a hearing. In general, sales, on one hand, and compromises, on the other, each require the satisfaction of different legal standards. When considering a sale under section 363, the court’s obligation is “to assure that optimal value is realized by the estate under the circumstances.”[3] When considering the approval of a compromise, the court must determine whether the proposed compromise is “fair and equitable,” which requires the consideration of four factors: (1) probability of success in litigation, (2) collectability; (3) complexity, expense, inconvenience and delay attendant to continued litigation; and (4) the “paramount” interest of the creditors.[4]

While settlements of disputes and sales of assets might generally seem like two clearly distinct and distinguishable events, there are circumstances, blurring the line between the two. For example, what happens if the trustee settles claims against a defendant for cash, but a creditor contends that the claims are worth more than what the trustee is getting for them? On the other hand, what if a trustee seeks to sell a property interest in the estate’s claims to a third party or even one of the litigants? What standard applies?

In the case of In re Mickey Thompson Enter. Grp., the trustee originally sought to compromise a dispute of potential fraudulent transfer claims. A creditor objected because a third party was willing to pay more than the settlement amount for the settled claims. Although the trustee first replied that he would set overbidding procedures in order to obtain the best sale price for the claims, at the hearing the trustee reversed course asserting that the original settlement was in the best interest of the estate “when he entered it” and that he was contractually bound by the agreement. Although the bankruptcy court decided that it could not substitute its judgment for the trustee’s, the Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals (“BAP”) reversed. The BAP found that both the standards for compromises and sales were implicated by the transaction. The BAP opined that any purported contractual obligation of the trustee was trumped by the duty to maximize estate assets.[5]

The case of In re Lahijani involved a trustee’s efforts to sell claims against the debtor and others to the highest bidder. The trustee sought from the sale an all-cash offer as opposed to a combination of cash and a percentage of the recovery from the lawsuit. The successful bidder was a company set up by the debtor’s co-defendant, who had no intention of actually prosecuting the claims. The unsuccessful bidder appealed. The BAP reversed because the bankruptcy court wrongly ruled solely based on the sale price, when it should have examined each factor of the fair and equitable test in order to approve what fundamentally was also a compromise.[6]

In In re Fitzgerald, the trustee sought to sell the estate’s interest in a certain company and litigation claims consisting of a pending cross-complaint in a pending action. The only bidders were the plaintiff/cross-defendant and the life partner of the debtor/defendant/cross-complainant. The bankruptcy court approved the sale based on a dollar-to-dollar comparison of the bids. However, in light of the relationships between the parties and the constrained competition due to the nature of the asset, the BAP found that the transaction required stricter scrutiny. Indeed, the BAP again found that the bankruptcy court should have applied the fair and equitable standard applicable to compromises.[7]

The lesson from this line of cases is that, when in doubt as to which standard applies in a contested transaction, a trustee or purchaser should ensure that both the “optimal value” standard for sales and the “fair and equitable” standard for compromises are fully satisfied.


[1] 11 U.S.C § 363. With certain exceptions, chapter 11 debtors in possession are generally vested with the same rights and duties as trustees. See 11 U.S.C. § 1107.
[2] Fed. R. Bankr. P. 9019.
[3] In re Lahijani, 325 B.R. 282, 288 (B.A.P. 9th Cir. 2005).
[4] Id. at 290.
[5] In re Mickey Thompson Enter. Grp., 292 B.R. 415 (B.A.P. 9th Cir. 2003). The BAP suggested that the concern about a potential breach of contract by the trustee was misplaced since the agreement would only be enforceable after approval by the court. Id. at 421.
[6] Lahijani, 325 B.R. 282.
[7] In re Fitzgerald, 428 B.R. 872 (B.A.P. 9th Cir. 2010).

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