The following is a case summary written by Kathleen A. Cashman-Kramer with edits by D. Edward Hays of Marshack Hays LLP analyzing In re Portland Injury Institute, LLC, 2022 WL 263490 (9th Cir. BAP 2022).
When Can An Avoidance Action Be Sold to a Creditor?
The debtor’s principal – also a potential target of the chapter 7 trustee’s avoiding powers action – lost his bid to stop a sale of the debtor’s remaining assets and the avoiding power action against him. The buyer was also one of the largest creditors of the debtor and had a pre-petition business arrangement with the debtor that had fallen apart, resulting in hard feelings. In Portland Injury Institute,the Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”) affirmed the Bankruptcy Court’s approval of the sale, including the avoidance claims, and debtor’s principal appealed.
To review the published opinion, click here.
In December 2018, Dr. Do formed Debtor Portland Injury Institute LLC (“Debtor”) as a single member LLC to perform chiropractic services. After forming Debtor, he entered into an agreement with Platinum[A1] Management Inc. (“Platinum”), under which Platinum would provide management and other services to Debtor.
From the very beginning everything was in dispute between Dr. Do and Platinum, primary of which was that Platinum asserted that the agreement made its principal, Mr. Golovan, a minority owner of Debtor with a right to purchase Dr. Do’s remaining interest in Debtor if he left the practice. Dr. Do denied both of these contentions. As a result of the dispute, Debtor informed its patients in October 2019 that it would no longer provide services, and it ceased operations by November 2019. Platinum asserted that Dr. Do continued to collect payments and insurance reimbursements on behalf of Debtor after it ceased operating and failed to account for over $200,000 of Debtor’s funds. The fights continued, with Dr. Do claiming that after Debtor ceased operations, Mr. Golovan attempted to initiate an improper purchase of Dr. Do’s ownership in Debtor, filed documents with state authorities indicating that he was the sole owner of Debtor, and took possession of all Debtor’s property, including patient records.
Fast forward to January 2021, when Debtor filed a chapter 7 petition, listing as its only scheduled assets office equipment—repossessed prepetition and having an unknown value—and accounts receivable – valued at $0. Debtor included Platinum and Mr. Golovan as unsecured creditors but listed their claims at $0. Debtor also scheduled Mr. Golovan as owner of a 49% interest in Debtor but indicated that the interest was disputed.
The Trustee filed a motion for authority to sell property to Platinum pursuant to Section 363; the property consisted of all Debtor’s personal and intangible property and all causes of action against third parties, including Trustee’s avoidance powers under the Bankruptcy Code including “the right to pursue the debtor’s former principal for any avoidable transfers made while that principal controlled the debtor . . .” The sale specifically excluded from assets to be sold the unused retainer held by Debtor’s bankruptcy counsel and Debtor’s medical records. The purchase price was $15,000, and the sale was subject to overbid.
Dr. Do objected to the sale on various grounds, including that the Trustee could not sell the avoidance actions to Platinum unless it was pursuing interests common to all creditors and would exercise those powers for the benefit of the remaining creditors; he also sought to extend the deadline for overbids until seven days after the court ruled on his objection and contended that if his objections were overruled, he anticipated overbidding for the assets. Platinum responded to Dr. Do’s objection, confirmed its intent to comply with HIPAA under the terms of the proposed sale, and submitted Ninth Circuit precedent that it claimed permitted Trustee to sell his avoidance actions “to one who would not exercise the powers for the benefit of all creditors,” citing Duckor Spradling & Metzger v. Baum Trust (In re P.R.T.C., Inc.), 177 F.3d 774, 781 (9th Cir. 1999).
After the court considered whether to hold an evidentiary hearing and determined that the amended purchase agreement made clear that no protected health information would be included in the sale absent patient consent, it observed that its only role was to decide whether Trustee properly exercised his business judgment in the sale. The court then notified the parties that it followed the decision in Simantob v. Claims Prosecutor, LLC (In re Lahijani), 325 B.R. 282, 288 (9th Cir. BAP 2005), that an avoidance action could be sold to a creditor because the purchase price would benefit all remaining creditors. And because the court found that the overbid provision was not required and was included by Trustee for his convenience, it determined that it “cannot remake Trustee’s deal and must defer to Trustee’s reasonable business judgment.” Id. At *2. Dr. Do appealed the order approving the sale
The BAP found that all three grounds Dr. Do argued on appeal had no merit. In doing so, the BAP specifically affirmed existing Ninth Circuit law regarding the right of a bankruptcy trustee to sell or transfer a bankruptcy-specific avoiding power, citing Lahijani and other cases, finding that the bankruptcy court’s obligation in approving a motion under section 363(b), “is to assure that optimal value is realized by the estate under the circumstance,” and that it should defer to the Trustee’s position “where business judgment is entailed in the analysis or where there is no objection.” Id. at *2, citing to Lahijani at 288-89.
The BAP also agreed with the bankruptcy court on the HIPAA issues raised by Dr. Do, including the finding that an evidentiary hearing was unnecessary because there was no factual question about whether the proposed sale involved protected health information, and found no abuse of discretion.
On the subject of the bankruptcy court’s authorization of a sale under Section 363(b), the BAP swiftly disposed of Dr. Do’s assertion that the bankruptcy court was required to conduct a good faith and fair dealing analysis before approving the sale, when it found that the Trustee had not requested a Section 363(m) determination. Id. At *4. Next, the BAP noted that Dr. Do had not raised before the bankruptcy court whether it should have evaluated the sale under the “fair and equitable” settlement standard set forth in Goodwin v. Mickey Thompson Entertainment Group (In re Mickey Thompson Entertainment Group), 292 B.R. 415 (9th Cir. BAP 2003) and, as a result, waived it. The BAP, however, addressed the issue under applicable Ninth Circuit authority and found that because the potential avoidance actions at issue were against Dr. Do, not Platinum, “[t]here is no basis for the court to analyze the sale of claims against Dr. Do under the settlement standard when such claims are sold to a third party who is not a potential defendant.” Id. At *4.
The BAP rejected Dr. Do’s argument that the avoidance actions could be sold only to a third party who would pursue interests common to all creditors and would exercise the avoidance powers for the benefit of all creditors, finding that the BAP had specifically rejected this argument in Lahijani. Id. At *4-5.
Finally, the BAP found that the bankruptcy court did not err when it denied Dr. Do’s request to extend the overbid deadline, finding that a trustee’s selection of sales procedures is part and parcel of the trustee’s business judgment, entitled to deference. Id. At *5. As a result, it affirmed the bankruptcy court’s order authorizing the sale under section 363(b).
I believe that the decision is a correct one; it does not make new Ninth Circuit law but rather affirms the validity and application of existing law. If nothing else, it can and should serve as a reminder of certain “traps for the unwary” involving asset sales by a trustee, especially involving the sale of avoidance power actions. Whether supporting or opposing such a sale, the facts in this case should serve as reminders to all, among other things, that the amount of the sales price (here, $15,000) does not dictate the level of diligence with which such sales should be put before the court.
On May 26, 2022, the BAP published a different decision involving the competing considerations between a compromise and sale. See, Spark Factor Design, Inc. v. Hjelmeset (In re Open Med. Inst.), 639 B.R. 169 (B.A.P. 9th Cir. 2022). In Spark Factor, the BAP affirmed the bankruptcy court’s decision that a proposed compromise did not always have to be evaluated as a sale in the face of a proposed overbid especially where the settlement involved mutual releases.
In deciding whether to structure an agreement as a compromise or sale, trustees often consider several factors including whether a sale could generate overbids, whether closing an opposed sale could moot an appeal, or whether there are mutual claims that must be resolved via a compromise. Before documenting your next settlement and drafting the required motion to approve compromise, practitioners would be well-advised to review these two cases, educate the client so he or she may make an informed decision, and provide a sufficient record to satisfy both standards.
These materials were authored by Kathleen A. Cashman-Kramer, Of Counsel at Sullivan Hill Rez & Engel (Cashman-Kramer@Sullivanhill.com), with editorial contributions from ILC member D. Edward Hays of Marshack Hays LLP (firstname.lastname@example.org).