Secured Creditors in Section 363 Sales Be Aware -Your Proceeds May Be Used to Satisfy the Debtor’s Unpaid State Tax Liabilities

October 12, 2015

It is a basic feature of sales under section 363 of the U.S. Bankruptcy Code, that the purchaser takes free and clear of all claims and interests, such claims and interests attach to the proceeds of the sale in accordance with their priorities. Among the interests that are extinguished by the free and clear sale orders are states’ taxing authorities’ rights to pursue a purchaser under bulk sale statutes for the seller/debtor’s unpaid tax liabilities.1 Thus, it would appear that secured creditors should feel comfortable that if the sale proceeds are less than their claim, the entirety of the sale proceeds would be used to pay their secured claim. As shown by Illinois Department of Revenue v. Elk Grove Village Petroleum, LLC,2 however, this may not be the case. As the case shows, states may jump the bankruptcy priority line through an entitlement to adequate protection of their interest; that interest being the right to pursue the purchaser. 


Elk Grove Village Petroleum, LLC and its affiliates (the “Debtors”) filed chapter 11 petitions in January 2013. In October 2013, the bankruptcy trustee moved to sell the Debtors’ gas stations pursuant to sections 363(b) and (f) of the Bankruptcy Code. Prior to filing for bankruptcy, United Central Bank (“UCB”) made to the Debtors loans secured by mortgages on the real properties on which the gas stations operate. UCB’s claim amounted to a little over US$14 million. The Debtors subsequently accrued approximately US$1.8 million in pre-petition tax liabilities to the State of Illinois.3 The tax liens on account of these tax liabilities were recorded after recordation of UCB’s liens. 

In its limited objection to the sale of the gas stations, the Illinois Department of Revenue (the “IDOR”) argued that under the Illinois Income Tax Act and the Retailers’ Occupation Tax Act (the “Bulk Sales Acts”), it had the right to pursue any purchaser personally for the Debtors’ outstanding tax liabilities. Since, however, the application of section 363(f) of the Bankruptcy Code, which permits the trustee to sell property “free and clear” of “any interest,” would extinguish this right, the IDOR sought “adequate protection” for this interest, arguing that “the sale order needs to provide that proceeds are held subject to IDOR’s Illinois Bulk Sales Transferee Liability claims in the amounts set forth above pending determination by the Court of IDOR’s right to collect on such claims vis-à-vis the claims of any other party including United Central Bank.” 

In November 2013, after conducting a hearing, the bankruptcy court approved the sale of the gas stations and held that the IDOR deserves no additional language to preserve its interests. The sale order authorized the sale “free and clear of all liens, claims, encumbrances and interests, with all liens, claims, encumbrances and interests to attach to the proceeds.” The trustee closed the sale of the gas stations over the next two months, and received net sales proceeds of about US$5 million. 

In January 2014, UCB filed a motion for allowance of its secured claim and turnover of sale proceeds. The IDOR objected to the allowance motion and filed a cross-motion for partial turnover of the sales proceeds, requesting that the bankruptcy court order the trustee to turn over sufficient funds from the sales proceeds to satisfy the Debtors’ outstanding tax liabilities as “adequate protection” for the IDOR’s Bulk Sales Acts interest. 

Ruling on these motions, the bankruptcy court found that UCB’s secured claims were deemed allowed in the full requested amount of US$14 million and that the IDOR’s claims were allowed, consisting of priority and general unsecured claims. The bankruptcy court then determined that the IDOR’s right under the Bulk Sales Acts to pursue the purchaser for the Debtors’ outstanding tax liabilities was an “interest” extinguished by the Sale Order. Despite the IDOR having lost that “interest,” the bankruptcy court found that the loss “was without value and thus was not entitled to ‘adequate protection.’” That was because, the bankruptcy court reasoned, UCB was senior to the IDOR, thus leaving the IDOR with no funds to which it is entitled. 

The District Court Reverses 

Although the district court agreed with the bankruptcy court that the IDOR’s claim was subordinate to UCB’s, it held that the bankruptcy court’s analysis omitted a crucial consideration: “[T]he issue is not limited to whether UCB held a superior claim over the money the purchaser would have been required to withhold under the Bulk Sales Acts to cover the Debtors’ outstanding tax liabilities. That is because the IDOR’s rights under the Bulk Sales Acts are not limited to going after just the sales proceeds, whether or not those proceeds have been transferred to the Debtors (or their bankruptcy estate) or held by the purchaser. Rather, the Bulk Sales Acts empower the IDOR also to go after the purchaser ‘personally’ if he does not remit the amount withheld from the sale to the IDOR upon demand.” 

The purchaser’s personal liability to the IDOR under the Bulk Sales Acts, the district court ruled, had value: “The IDOR’s statutory right… has value even though UCB may have a superior claim to the sale proceeds. UCB has not asserted a superior claim over the purchaser’s personal assets or shown that, even if it did have a superior claim, the purchaser lacked sufficient personal assets to satisfy both UCB and the IDOR’s claims.” Thus, the IDOR’s ability to go after the purchaser personally was a mechanism enabling the IDOR to satisfy the Debtors’ unpaid tax liabilities regardless of the priority of IDOR’s claims against the Debtors, and that interest was the one that deserved adequate protection. 

Notably, UCB had argued that the equities favored it because, had it chosen to foreclose on its collateral instead of consenting to a section 363 sale in bankruptcy, the Bulk Sales Acts would not have applied, and the IDOR could not have collected its unpaid taxes. UCB’s interest was thus receiving worse treatment in bankruptcy than in foreclosure proceedings. Under the facts of the case the district court rejected this argument since UCB had voluntarily taken this risk, holding: “Future creditors will weigh the risks and benefits of choosing to proceed or not with a bankruptcy sale under Section 363 when, as here, the debtor has outstanding tax liabilities. UCB agreed to have the Debtors’ gas stations sold in bankruptcy, and this Court must interpret the Bankruptcy Code accordingly.” 

UCB also attempted to rely on a 14 year old letter issued by the IDOR where it stated the Bulk Sales Act do not apply to bankruptcy sales. The court found the letter to be unpersuasive since Illinois law provides that these letters are not binding and may not be relied upon by taxpayers. 


The district court opinion provides valuable lessons to be followed at least until it is reversed or not followed in the jurisdiction in which a section 363 sale takes place. First, a purchaser must research the relevant bulk sales statutes of the relevant taxing jurisdiction to determine whether they provide similar exposure to the purchaser as is the case in Illinois. Two, the purchaser should insist that an amount sufficient to pay the tax liabilities is held in escrow pending a final order as to its disposition. Third, special attention should be given to this issue in a credit bid context. Finally, secured creditors and the committee of unsecured creditors, in valuing alternative transactions, should consider this potential haircut to their recovery. 


1) In re Elk Grove Village Petroleum, 510 B.R. 594 (Bankr. N.D. Ill. 2014).
2) Case No. 14 C 5072 (N.D. Ill. Sep. 30, 2015) [Docket No. 22].
3) See Elk Grove, 510 B.R. at 602.

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