Bankruptcy Asset Sales Do They Meet the Fair and Reasonable Test

Bankruptcy Asset Sales Do They Meet the Fair and Reasonable Test

Journal Issue: 
Column Name: 
Journal Article: 
When a liquidation is required, modern technology allows sales to be held in many ways beyond the traditional auction method. These methods include orderly liquidation, using the Internet and the eBay sales approach. eBay has proven to be very successful, but not all assets can be sold by this method, and it may take longer than the more immediate on-site auction process. It is probably best when only a few or very select group of items need to be sold that would not stand on their own as an auction sale.

Would an eBay sale or any orderly liquidation stand the reasonable-sale test? The answer is "maybe." It's recommended to have some idea of the items' value(s) before the sale takes place to avoid any after-the-fact criticism from those who feel the items sold for below their worth.

Level of Trade

Knowing the level of trade or the unique characteristics within the prevailing market is important. Let us assume that the items are unique to a particular market and there are few buyers—if any—in the marketplace. In fact, the very reason for bankruptcy may be the problem associated with the product and its acceptance. This may mean that the specialized equipment may not have value to anyone else due to the economic conditions associated with the product and associated equipment. The level of trade may have been considered to other users only, rather than being sold to dealers. It has to be reasonable to the particular market approached by a buyer.

Benefits of Public Auctions

Public auctions are deemed fair, as they are advertised to interested parties who have the occasion to participate in the bidding. That very competitive environment provides the appearance of a fair and reasonable sale in light of the conditions prevalent at that time—conditions such as failure or bankruptcy that cause many to anticipate low bidding. The reverse of this is that most public sales at auction in bankruptcy as opposed to a standard non-compelled auction, show better results. A sale at auction—with public bidding that is well-advertised to the appropriate markets—is the essence of having held a sale that allows reasonable and proper returns.

Know the appraiser and ensure that he or she is familiar with the liquidation concept and has some historical data showing the results. No appraiser is perfect, and if he or she indicates as much, look elsewhere.

The advertising must be properly directed to the appropriate markets and the sale performed in a reasonable and acceptable manner. To test the waters, it's a good idea to obtain an appraisal immediately before the sale by one who is familiar with the various markets and can provide an exit strategy; this may or may not be the prospective auction company. An auction market is, according to the Uniform Standards of Appraisal Practice (USPAP), a level of trade. What that actually means is that the auction sale is not a level of trade, but rather a method of selling to various levels of trade. Levels of trade are associated with manufacturers, dealers, distributors, retailers and the users of various types of assets. When an auction sale takes place, any of these may (or may not) show up. Therefore, it is a type of sale that would vary depending on the assets. An auction sale's very nature and variable draw of customers allow it to be considered a reasonable method of recovery.

Timing of Appraisals Makes a Difference

Various problems can arise at an auction. One could be obsolescence from the time of the appraisal to the date of sale, making the appraisal date very important. An excellent example of this involved an auction sale that was four to five years after the appraisal date, and the sale at auction was not in line with the appraisal, which was accomplished under the value concept of orderly liquidation. The reason for the very low recovery was the obsolescence of the technique (technological change). Therefore, the newer method of manufacturing was what drove the market. The equipment was not as state-of-the-art as it was at the time of the appraisal. Complaints of values not holding up were made by those who had made loans at the time of the appraisal. Conditions had changed, therefore the sale, held at liquidation (auction), may have provided good results or that which would be indicative of the market conditions at the sale date. Had the technology at the original appraisal been the same as that of the sale date, the results would have been different.

Measurement of an Appraiser

Do not rely on prior appraisals, but get an update via a new appraisal. Know the appraiser and ensure that he or she is familiar with the liquidation concept and has some historical data showing the results. No appraiser is perfect, and if he or she indicates as much, look elsewhere. In addition, some familiarity with bankruptcy and the problems associated with it, including the various terms, could be good for the seller if the sale is out of a bankruptcy estate. An appraiser should be skilled at recognizing absorption—such as large quantities of an item in which the market could not absorb it without dramatically low discounts, which could create a reason for orderly liquidating—followed by an auction at a later date.

Prepare for Collateral Attack

Using a good auctioneer or liquidator is important. However, available facts may not be known without consulting an advisor. Appraisers are the best at regarding values and the areas that affect those values. Simply conducting a sale may be fair and reasonable because of the method(s) used, as stated earlier. However, everything is subject to an attack by those who were not paid in full, and all sales need to be fair and reasonable in light of the circumstances. There is no question that a compelled sale and the need for immediacy may affect the results of a sale. Timing can be everything.

Value Added from an Appraiser

That sales require enough worth to allow the cost associated with good value support is obvious. However, the need to do this may exist when the results could pay for themselves due to a suggested good marketing strategy. The court and the unsecured creditors need some understanding of the unique characteristics at the time of a sale, and this kind of support could be just what is needed to provide that. There is very little of this type of work around today, and perhaps the idea of a reasonable sale as supported is not necessary. It has become a requirement and may need to be looked at in the future.

The Reasonable Test

An understanding of the reasonable-return test is that it may not be fair market value as typically understood. The willing-buyer-and-willing-seller test simply is not prevalent in most bankruptcy sales; rather, it is a willing buyer and an unwilling seller in concept. That is, after all, what compulsion means within the concept of liquidation. One may argue that the seller—a trustee—is not compelled. However, compulsion as the known reason for the sale is the bankruptcy. In many cases, the perception may be confused with other facts that may or may not apply. It is the perception that creates the scenario of a compelled sale and the resulting values based on sales under those type of concepts.


Have some idea that can pass the credibility test of prices that you know would represent good value. This is better backed up by a value opinion in which all of the results can be used as a measurement to the anticipated values under the appropriate concept. The return has to be recognized as the overall total (more so than individual numbers), since things will differ in sales due to various factors. A good appraiser uses averaging to represent the results, even if the methods are different. The appraised individual numbers may add up to the total, which the sale may bring at a minimum. Comparing the individual numbers may not be as appropriate as the total of the study. Individual numbers assigned in an appraisal are always considered reasonable and usually can be supported, whereas the actual results may vary in a sale, which may be conducted by someone else. Anticipated values are, at best, a good way of arriving at a conclusion of how much the sale should bring. The seller can search the Internet and compare, adjusting downward to remove warranties or condition differences, the removal requirement from the current location and other factors. Even without the expert opinion of an accredited appraiser, there are many things that the seller can do to show that the results of the sale are, in light of the prevailing conditions, fair and reasonable.

Bankruptcy Code: 
Journal Date: 
Friday, July 1, 2005