July 5, 2022

Volume XII, Number 186

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Creditor Not Entitled to Post-Sale Discovery to Attempt to Amend Sale Proceeds Distribution

In In re Squirrels Rsch. Labs, LLC, No. 21-61491, 2022 WL 1310173, at *1 (Bankr. N.D. Ohio Apr. 29, 2022), the United States Bankruptcy Court for the Northern District of Ohio recently addressed whether post-sale of the debtors’ assets, a creditor could conduct discovery to investigate the extent of a secured creditor’s liens in order to amend the distribution of the sale proceeds. Under the facts of this case, the bankruptcy court denied the creditor’s request.

In Squirrels, creditor Carl Forsell (“Forsell”) held a prepetition claim against the debtors in the amount of $744,373.60 for unfulfilled purchase orders. The debtors included Forsell in their creditor matrix and in their schedules as a creditor holding a contingent, unliquidated, disputed claim. In their schedules, the debtors also asserted that their senior secured lender held a “blanket lien” on “all physical assets” of the debtors.

As part of a prepackaged plan, the debtors filed a sale motion on the same day they filed their cases, seeking to sell substantially all of their assets to a stalking horse bidder for $3,010,000. Under the proposed sale, the senior secured lender agreed to set its secured claim at $3,000,000. The debtors served Forsell with the sale motion and with a motion to expedite the sale motion. Forsell did not object to the sale motion. When the bankruptcy court approved the sale motion, the debtors served Forsell with the order approving the sale motion, which contained deadlines for objecting to consummation of the sale transaction. Ultimately, the debtors received no competing bids for their assets, and the sale to the stalking horse bidder was approved, with the senior secured lender being entitled to $3,000,000 of the $3,010,000 sale proceeds. Again, Forsell did not object to consummation of the sale transaction. However, one month after the bankruptcy court approved the sale, Forsell filed a motion for relief from the sale order, asserting that the senior secured lender’s lien was a purchase money security interest, not a blanket lien, and sought discovery as to whether the senior secured lender had an interest in the property sold.

Initially, the bankruptcy court noted that prior to entry of the sale order, Forsell had broad discovery rights under Federal Rule of Bankruptcy Procedure 7026 and could have obtained all of the information he sought through normal pretrial discovery. However, the entitlement to post-judgment discovery is much murkier, but Forsell argued that he was entitled to post-judgment discovery under Rule 60(b) of the Federal Rules of Civil Procedure, which provides a party for relief from a final judgment or order. However, the bankruptcy court determined that Forsell was not entitled to relief under Rule 60.

First, the bankruptcy court held that Forsell was not diligent in obtaining information about the nature of the senior secured lender’s lien because he made no efforts to pursue information prior to the sale, filed no objection to the sale, and because the senior secured lender’s UCC was publicly available to Forsell prior to the sale. Further, the debtors did not commit fraud by calling the lien a “blanket lien” rather than a “purchase money security interest” because no unified definition of what constitutes a “blanket lien” exists, and therefore, parties must exercise their own due diligence to determine what assets serve as collateral for the lien.

Ultimately, the bankruptcy court held that no clear right to post-judgment discovery exists, but if it is available, the movant must make a prima facie showing that there is a basis for allowing post-judgment discovery in order to overcome the important need for finality in the context of chapter 11 sales. Without finality, bidders and purchasers will not be inclined to offer maximum value for assets.

For guidance, this case reiterates that during a bankruptcy sale process, parties must exercise diligence and “speak up now, or forever hold their peace.” 

Copyright ©2022 Nelson Mullins Riley & Scarborough LLPNational Law Review, Volume XII, Number 129
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About this Author

Keith Poston SC Attorney Financial Bankruptcy Law Nelson Mullins Riley & Scarborough LLP
Partner

Keith practices in the areas of bankruptcy and creditors' rights, consumer financial services litigation and financial institutions. He regularly represents committees of unsecured creditors, indenture trustees, chapter 7 trustees, secured creditors, unsecured creditors, bondholders, noteholders, liquidation trustees, plan administrators, disbursing agents, and other entities in bankruptcy reorganizations, liquidation proceedings, and bankruptcy related litigation.

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