Claim for Amount Owed in Bid Rigging Scheme Disallowed by Connecticut Bankruptcy Court

Rare is the decision finding that bid rigging occurred.  Recently, though, the United States Bankruptcy Court for the District of Connecticut uncovered a bid rigging scheme in connection with the sale of property in a Canadian arrangement proceeding.  In re Sagecrest II LLC, et al., Case No. 08-50754 (Bankr. D. Conn. Dec. 23, 2015).  In the context of the U.S. bankruptcy proceeding of one of the parties to the bid rigging, the bankruptcy court disallowed the claim of the other party to the scheme – finding that the contracts supporting the claim were unenforceable.  Through this decision on the disallowance of a proof of claim, In re Sagecrest provides a stern reminder of what not to do in connection with bidding for debtor assets.  
In March 2004, Sagecrest II, LLC (“SCII”) and Jean-Daniel Cohen (“Cohen”) arranged financing for two Canadian companies (the “Canadian Debtors”) to acquire real property in Canada.  A year later, the two Canadian Debtors filed petitions for arrangement under Canada’s Companies’ Creditors Arrangement Act.  During the Canadian arrangement proceedings, two former principals of the Canadian Debtors, SCII and Cohen each submitted bids for the property.  Following the hearing on the offers for the property, the former principals asked Cohen, and Cohen agreed, to provide financial backing for their offer.  With that agreement in hand, the former principals asked the Canadian court to re-open the period for parties to make offers for the property.  The Canadian court agreed, finding the possibility of higher and better offers in the best interest of creditors.
A few days before the revised bid deadline, SCII approached Cohen and asked that he withdraw his support for the former principals’ offer, support the SCII offer, and agree to not re-submit his offer for the property.  Cohen agreed and he and SCII entered into a “settlement” agreement.  The settlement agreement also provided that, following the transfer of the property to SCII, Cohen, or his designee, would be engaged as redevelopment consultant for the property in exchange for a fixed retainer and a commission on any future sale of the property.  Notably, the fees were to be paid to Cohen, or his designee, irrespective of the amount of services actually provided by Cohen.
The settlement agreement between SCII and Cohen was not disclosed to the Canadian monitor or the Canadian court.  Ultimately, the Canadian court approved SCII’s bid and SCII took title to the property.  Immediately thereafter, SCII and Equal Overseas Consulting (Cohen’s designee) entered into a consulting agreement mirroring the terms of the settlement agreement.  SCII made the first agreed payment to Equal, but did not pay the remaining amounts due under the consulting agreement.
In 2008, SCII filed a chapter 11 case in the United States Bankruptcy Court for the District of Connecticut.  The property was sold during SCII’s bankruptcy case.  Equal filed a proof of claim in SCII’s case for the unpaid retainer and commission on the court-approved sale of the property.  SCII objected to the claim arguing that the settlement and consulting agreements were unenforceable.
Settlement and Consulting Agreements Unenforceable
The bankruptcy court evaluated the settlement and consulting agreements under both Canadian and U.S. law.  Specifically, the court found the settlement and consulting agreements unenforceable under both Canadian and U.S. law (i) for lack of consideration, and (ii) under the doctrines of in pari delicto, Latin for “in equal fault,” and/or ex turpi causa non oritur actio, Latin for “from a dishonorable cause an action does not arise.”  Moreover, the bankruptcy court found the terms of the consulting agreement contrary to U.S. bankruptcy law governing the retention of professionals.
The bankruptcy court first evaluated the most basic of contract law principals – sufficiency of consideration – for the curiously titled “settlement” agreement. Though Cohen had claims against the Canadian Debtors, Cohen did not have claims against SCII.  Without claims against SCII to waive as consideration for the retainer fee and commission, there was nothing to warrant the settlement agreement and subsequent consulting agreement with Equal.  Accordingly, the bankruptcy court found that there was no consideration for the agreement to pay Cohen or Equal, and the lack of consideration rendered the agreements unenforceable.
Furthermore, the bankruptcy court found the consulting agreement unenforceable under the doctrines of in pari delicto and ex turpi causa non oritur actio.  The evidence at trial indicated that the settlement agreement and the consulting agreement constituted a side deal between SCII and Cohen under which Cohen would receive a payoff to withdraw his own bid, withdraw support for the former principal’s bid, and support SCII.  According to the bankruptcy court, this side deal had the effect of eviscerating the Canadian court’s order to re-open the bidding to potentially benefit the unsecured creditors of the Canadian Debtors.  Instead, the only unsecured creditor of the Canadian Debtors who received any benefit was Cohen, who, through the side deal, had arranged to be paid approximately the amount of his unsecured claims – far more than his pro rata share of distributions from the Canadian Debtors.
The bankruptcy court found this “collusive thwarting of a rival bid” was “offensive to the integrity of the Canadian legal system and/or a manifest interference with the administration of justice.”  Under the doctrines of in pari delicto and ex turpi causa non oritur actio, courts will leave the parties to their own devices and will not take steps to enforce agreements that are illegal or plainly offend public policy.  The bankruptcy court found these doctrines applicable to the settlement agreement and the consulting agreement and, again, found them unenforceable.
The Final Nail
Finally, in separately addressing Equal’s demand for a commission on the sale of the property, the bankruptcy court found that Equal was not entitled to a commission because it was not retained by SCII as a professional under section 327(a) of the Bankruptcy Code.  In addition, even if Equal had been properly retained, it provided no services and, thus, was not entitled to the commission on the sale of the property in SCII’s bankruptcy proceedings.
Because the settlement and consulting agreements were unenforceable and because Equal was not properly retained, the bankruptcy court sustained SCII’s objection and Equal’s claim was disallowed.  As the bankruptcy court found, Equal’s claims were tainted under applicable non-bankruptcy law, and those claims could fare no better in SCII’s chapter 11 case.
Brenda Funk is an Associate at Weil Gotshal & Manges, LLP in Houston.