Bankruptcy and going out of business sales

In re Crawford Furniture Mfg. Corp., --- B.R. ----, 2011 WL 6325859 (Bkrtcy.W.D.N.Y.) 

Bankruptcy is a rara avis around here, but this case highlighted its interaction with consumer protection law.  Debtors, two related furniture companies, sought authority to enter into an agreement to conduct a going out of business sale without complying with state law restrictions on such agreements.  Crawford proposed to retain Highfill, Inc., to assist with the liquidation process. Highfill would provide additional merchandise “to enhance the marketability of the inventory on hand or to replace damaged inventory.”  The parties “anticipated that the majority of sold merchandise would derive from consigned goods not owned by either of the debtors.”  The agreement also required Highfill to conduct “an aggressive advertising program.”  Crawford therefore sought an exemption from state and local laws and regulations that would otherwise apply to a liquidation sale, including regulations about advertising. 

NY’s AG and the US Trustee opposed the motion, noting that New York regulates going out of business sales in various ways.  “For example, General Business Law § 583(d)(12) prohibits generally the augmentation of pre-existing inventory, and General Business Law § 590(a) limits going-out-of business sales in New York to a maximum of sixty days.”  Crawford argued that it wasn’t seeking exemption from health or safety regulations, so it was no big deal. 

This opinion memorialized the court’s order approving a modified agreement.  A debtor in possession in Chapter 11 generally enjoys the rights and powers of a trustee and can operate the business in its ordinary course.  But a going out of business sale is not the ordinary course, so a hearing was required.  The Bankruptcy Code generally requires trustees (etc.) to manage property according to the requirements of valid state laws, thus making the initial motion inappropriate. 

Under NY law, a merchant must secure a license before starting a going out of business sale.  The application must contain a full inventory of the merchandise to be sold.  The merchant must also agree not to sell goods acquired on consignment and it may not augment inventory during the course of the sale.  Outside bankruptcy, therefore, the proposed agreement was banned.  However, the law also provides that it won’t apply to people acting pursuant to an order or process of a court of competent jurisdiction.  So, if the court grants them leave, debtors need not comply with the law’s precise requirements.  The question was whether such an exercise of discretion was appropriate. 

“If the going-out-of-business sale involved only a liquidation of property of the bankruptcy estate, then this court might have granted a broader license for strategies that aim to maximize a return for creditors. But when a debtor seeks to augment its inventory significantly with property that it does not acquire in the ordinary course, the arrangement threatens to become a ruse to avoid the restrictions of state law.”  With no defined limit to the allowable new inventory, Highfill could launder sales of non-debtor merchandise free of consumer protection law.  Though NY’s law might allow a judicial order to suspend its ordinary requirements, “we should not use that authority unless the sale serves primarily to liquidate assets of the bankruptcy estate.” 

Crawford thus negotiated a more restrictive arrangement, to which the NY AG and the US Trustee agreed.  The court approved it, because Crawford offered proof “that its existing mix of inventory was inadequate to maximize a return through liquidation.”  Because consumers often wanted to buy its furniture in combination with other items—a bed frame with a mattress, for example—Crawford needed to offer an attractive combination of merchandise.  Thus, the revised agreement allowed supplementing existing inventory with “upholstered and bedding inventory” having a retail value not greater than $3,000,000.  In addition, the agreement ensured marketing merchandise similar to that which Crawford sold prior to filing for bankruptcy: only merchandise that was domestically produced; no carpeting or wood veneer products, since it hadn’t sold them before. Highfill also promised to approach the debtor's current vendors first when placing orders for additional consigned inventory. 

This adequately balanced consumer protection with maximization of creditors’ recovery.  “When a debtor assumes a liquidating mode, the core bankruptcy objective is to maximize the recovery of value from estate assets. A debtor exceeds this objective when it adopts strategies that are primarily designed to liquidate other property under the guise of a bankruptcy sale.”  Even when fulfilling the legitimate goal of liquidating estate property, the court stated that a sale should never “violate the underlying intent of state law with regard to consumer protection.” 

Thus, the court would only approve a proposal “designed primarily to market estate property and not as a subterfuge to evade state laws regarding the sale of unrelated merchandise,” which meant limiting inventory from outside manufacturers “to complementary items of a quantity that is reasonably needed to facilitate the sale of estate assets.”  Though it would grant relief from some provisions of NY law, the gains to the creditors from this waiver had to outweigh any decreased protection to the consuming public.  For example, Crawford demonstrated that it would maximize recovery if it could extend the sale through the holiday season.  Given that it had agreed to a variety of disclosures and other procedures to protect the interests of prospective customers, the court found that customers would derive only minimal benefit from a strict limit on the length of the proposed sale.  

Otherwise, the debtors had to satisfy all other applicable state laws, including laws regulating deceptive practices and false advertising.  In particular, they needed “transparent procedures that are reasonably designed not to mislead purchasers, creditors and other interested parties.”  Thus, in promotion and advertising, “the debtors may not mislead potential customers into believing that they are necessarily purchasing the discounted assets of a bankruptcy estate.”  The parties agreed not to use “liquidation” or “bankruptcy” in any of their ads, and within stores Highfill would put different colors of tags on consigned inventory versus debtors’ inventory, and post signs disclosing the different sources. In addition, the parties agreed not to raise prices prior to the commencement of the sale.  The court found that these practices should minimize the risk of deceiving consumers.