Settlements as Sales under the Bankruptcy Code

When a debtor enters bankruptcy, the Bankruptcy Code gives the trustee (or debtor in possession) control over managing the assets of the estate. The trustee can sell or use these assets only after meeting requirements laid out in the Code. To sell an asset of the estate, the trustee must meet the requirements found in 11 USC § 363, which include providing notice to affected parties and a bankruptcy court hearing.

The trustee has more than just the power to sell assets of the estate. When a debtor has an outstanding cause of action against a third party, the Code gives the trustee the power to litigate or settle. Circuit courts disagree over whether a settlement of a cause of action should be classified as a sale under § 363. One circuit always treats settlements as sales, reasoning that § 363 is implicated because a cause of action is an asset of the estate that is sold by the trustee. Other circuits sometimes treat settlements as sales. Still another circuit never treats settlements as sales, reasoning that reaching a compromise to settle a cause of action is fundamentally different from selling an asset. 

The Code favors settlements, because settling disputes saves parties the time, money, and uncertainty of litigation. It is, therefore, important to know what level of court involvement in settlements the Bankruptcy Code requires—that is, whether courts need to approve settlements. When the trustee does settle, creditors want some assurance that the trustee bargained for the best deal possible, and court approval of the settlement serves this function. But whether bankruptcy courts can review settlement agreements depends on how the Bankruptcy Code is interpreted. However, construing the Code is problematic because it does not directly address whether settlements require court approval. Settlements may be reviewed by the bankruptcy court at the trustee’s discretion and do not have the same procedural protections of sales under § 363.