Bidders in Section 363 auction sales face the possibility that a higher "upset" bid will be considered after the auction has closed. Whether the courts will allow such late bids in the pre-confirmation context depends on balancing the competing policies of maximizing creditor recovery and protecting bidders' expectations, and the integrity of the process. Post-confirmation bids are allowed only in extreme circumstances. The authors discuss the varied outcomes in these cases, and some steps parties-in-interest should take in light of the possibility of such bids.
Although reorganization remains the general goal in Chapter 11, over the last few years the balance sheets for most business debtors have been so leveraged that an asset sale pursuant to section 363 is the only viable option. Section 363 sales, as opposed to other forms of asset dispositions, have become so popular, in part, because they provide a relatively quick means to shed burdensome assets. It also benefits creditors by providing an open and generally transparent forum through which the assets are marketed and bid upon, thus increasing the likelihood of maximizing value.
From a buyer's perspective, a 363 sale process provides a unique and arguably superior method to purchase distressed assets. The sale confirmation order issued typically provides that the assets will be transferred free and clear of liens, claims, and encumbrances (and often without the risk of successor liability). Moreover, a section 363 sale process often allows a buyer to pick and choose the debtor's beneficial executory contracts and leases while leaving behind those that may be burdensome. 1
However, unlike private sales outside of bankruptcy, section 363 sales are almost always conducted through some form of auction and ultimately subject to court approval through a sale confirmation order. This element of judicial oversight creates a potential risk that even after the auction has closed, an "upset bid" might still be considered. The prospect of a phantom bidder swooping in after the auction and issuing a higher bid raises several interesting and challenging legal and policy issues: Should and are courts required to reopen bidding to entertain upset bids? What have the courts said with regard to upset bids? What, if anything, can or should a debtor, creditor, or stalking horse bidder do to deal with bids?
Overview of the Section 363 Sale Process 2
Section 363 of the Bankruptcy Code, provides that a "trustee, 3 after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate . . . ." 4 Importantly, pursuant to section 363(f), such property can be sold free and clear of any interest under the appropriate circumstances, such as where: the secured or interested party consents, the property sells for more than the interests are worth, or the interest to be stripped is subject to a bona fide dispute.
A bankruptcy court has broad discretion to conduct a sale in a manner it deems most appropriate. 5 However, it will typically be the debtor and secured creditor, often in consultation with a creditors' committee, who will drive the proposed sale process. Although the Bankruptcy Code does not contain specific requirements for the sale or bidding procedures other than to require basic due process (notice and a hearing), 6 local bankruptcy rules often do have such requirements.
The debtor must first determine which assets are to be sold and then commence marketing, a process which is sometimes undertaken pre-bankruptcy. Once a potential buyer is identified, the debtor and stalking horse bidder customarily negotiate an asset purchase agreement that provides the stalking horse with financial incentives such as a "break-up fee" to compensate it for the due diligence and other costs resulting from its role in the proposed sale should it ultimately be out-bid. The stalking horse bidder is also typically able to negotiate favorable bidding procedures submitted to the court for approval.
Once completed, the asset purchase agreement is filed with the court in a motion package which also contains the debtor's proposed bid and sale procedures, and a request to approve the breakup fee. The proposed procedures will define the form and scope of notice, scheduling of an auction date, and a deadline for other bidders to submit competing bids. Many 363 sale procedures also contain minimum bid increment provisions, requirements for prospective bidders to submit written bids in advance of the auction that contain detailed financial data evidencing their respective ability to close, and, of course, a deposit in the event of a successful bid. While not required, 363 sales are generally public.
The period leading up to approval of the bid procedures, as well as the auction itself, is a critical time for all parties-in-interest (i.e., secured and unsecured creditors, creditors' committees, and even prospective bidders). It is their chance to influence the bidding, auction, and sale approval procedures, whether by objection to the bidding and sale procedures motion or by way of negotiation. Assuming that the bidding and sale procedures order is not appealed, the debtor will then put creditors and potential bidders on notice of the upcoming auction, and the requirements and timing for bid submission pursuant to the order. 7 Following submission of the bids, the auction will normally occur within a few days. At the auction, the debtor will generally be required to select the highest bid (typically in consultation with the secured creditor and committee), unless the approved procedures require otherwise. If no competing bids are received, the stalking horse bidder will be the successful bidder by default.
The debtor will subsequently seek court confirmation of the auction result. In order to obtain confirmation, though the exact standard varies jurisdictionally, the debtor must generally show that there is a "good business reason" for selling the assets. 8 In addition, the court must independently evaluate the proposed price to determine whether it is "fair and reasonable" or the "highest and best." 9
The foregoing explanation of the 363 sale process presumes a normal progression from the decision to conduct a 363 sale through confirmation of the sale where the highest bidder, who properly follows the bidding procedures at the auction, becomes the confirmed purchaser. While there are many circumstances that could disrupt the 363 sale process, the possibility of an upset bidder intervening after the auction or even after court confirmation of the sale is a potentiality that some might fail to consider. Indeed, many might assume that because the parties and the court have gone through the time and expense of crafting detailed procedures for bidding and conducting the auction that it would be impossible to upset this process with post-auction or post-confirmation bid. However, they would be wrong.
The Law and Policy of Upset Bids
As unreasonable as it may seem to the "high" bidder, there is no per se prohibition against an upset bid being considered and possibly accepted after a bankruptcy auction has concluded. In fact, prior to confirmation, courts have broad discretion as to whether or not bidding should be reopened. Following confirmation, while that discretion narrows substantially, it does not completely disappear. 10
What has essentially developed through case law is a "sliding scale approach," described by the Seventh Circuit as "a continuum, along which the bankruptcy court's discretion to reopen the bidding in pursuit of estate maximization diminishes as the sale comes closer to becoming a fait accompli and as the expectations of the participants solidify. Once a court has confirmed the sale of the debtor's assets to the auction's victor, for example, the public interest in finality is high and the parties reasonably expect that the bidding is over." 11 Simply put, the closer the sale results are to confirmation, or if confirmation has occurred, the less likely it is that the sale will be upset. Accordingly, because confirmation is the most significant factor in the sliding scale approach, the applicable rules and representative cases are best viewed in a pre-confirmation and post-confirmation dichotomy. However, before examining the substantive and factual factors comprising the sliding scale approach, a policy discussion is necessary because, as can be gleaned from the above quoted statement of the sliding scale approach, the competing policy considerations are uniquely material to the upset bid analysis. Indeed, policy concerns are so paramount in the law of upset bids that the sliding scale approach is essentially the court's framework for determining whether each policy interest has been served or satisfied in reaching its final decision regarding the upset bid at issue.
There are typically two competing policy considerations whenever a court is asked to reopen an auction. The first involves the general goal in any bankruptcy sale – to obtain the highest and best price. For example, the Seventh Circuit has expressed in more than one opinion that the "governing principle" and "central purpose of bankruptcy . . . is to maximize creditor recovery." 12 The second involves the need to protect both the parties' and bidders' expectations, and the integrity of the sale/judicial process. In the words of the Fifth Circuit, "[a]uctions should not be empty exercises." 13 Several circuit courts have described their attempts to balance these interests as "walking a tightrope." 14
The first policy factor – asset maximization – is, in some sense, literal and straightforward. Indeed, as pragmatism is the hallmark of the bankruptcy courts, counsel can usually safely assume that the primary concern of the bankruptcy court is asset value maximization. However, despite strong statements from the judiciary favoring the central importance of asset maximization, many courts have required substantially higher offers in order to justify the reopening of bidding. For example, the First Circuit concluded in In re Gil-Bern Industries, Inc. that, even prior to confirmation, a "mere 2.4%" cannot justify the reopening of bidding. 15 Similarly, in Smith v. Juhan, the Tenth Circuit found that an upset bid 13 percent higher than the prior high bid was insufficient to upset the confirmed results. 16 In In re Burr Manufacturing and Supply Co., the Second Circuit refused to open a confirmed sale despite a later offer 36 percent higher than the confirmed sale price. 17 Therefore, a possible upset bidder should be cautious if relying solely upon the purported "governing principle," especially if the original auction results have been confirmed.
The second policy factor – integrity and finality in the sale process – also receives serious attention from the courts and, functionally, is integral to the sliding scale approach. "Accepting a late bid may mean more money for creditors in the short run, but by upsetting the expectations of those who thought the bidding was at an end, it may in the long term undermine confidence in judicial sales and discourage prospective purchasers from making their best offers in a timely manner." 18 Ironically, the integrity of the process and respect for bidders' reasonable expectations is generally consistent with the goal of asset maximization, as most courts have found that the risk of an upset bid stifles aggressive bidding and ultimately results in lost value to the estate.
Practically speaking, the Seventh Circuit has found that the second policy factor is "satisfied if a court acts in a manner consistent with the rules by which the auction has been conducted and in compliance with the reasonable expectations of the bidders." 19 Some courts, including the Eighth Circuit, have found this to be a "deferential standard." 20 More specifically, as to the parties' expectations, the sliding scale approach is employed by courts to determine how "solidified" those expectations were; for example, if the results of the first auction have been confirmed, courts generally find that the parties expectations of finality are "adequately solidified" such that equitable reasons must exist to reopen bidding. 21 Conversely, prior to confirmation, "the court might appropriately conclude that consideration of a late bid would not unduly frustrate the reasonable expectations of the participants or compromise the integrity of the process." 22 Fealty to the court-approved bidding procedures will also be material to the integrity and expectation analysis. Several circuit courts have reasoned that when the procedures in the first auction were "informal and flexible" or "complex and fluid," the parties' expectations are less solidified. 23 For example, in the Seventh Circuit's decision to permit an upset bid prior to confirmation in Corporate Assets, Inc. v. Paloian (In re Goss Int'l Corp), it was dispositive that the debtor had discretion to reject bids and to impose additional conditions on the sale up until court confirmation. 24 Further, the First Circuit has acknowledged the local custom is also material to the integrity and expectation analysis. 25
Substantively, in the pre-confirmation context, the available decisions vary, with some courts adjudicating almost strictly on what additional value can be obtained, 26 while others refuse to reopen a properly conducted auction solely to accept a higher bid without some other evidence of unfairness in the sale. In any case, when allegations of impropriety are asserted with respect to the conduct of the auction, or a due process issue is found to exist (such as insufficient notice), the likelihood of reopening an unconfirmed sale rises substantially. 27 To be sure, in some cases such as where fraud or fundamental unfairness are found, the court may be required to reopen bidding such that it would be an abuse of discretion to fail to do so. 28
Post confirmation, however, "[t]he bankruptcy court's confirmation or refusal to confirm an asset sale will only be overturned in extreme cases, when the bankruptcy court has abused its discretion." 29 Thus, most courts agree that fundamental equitable issues (fraud, substantial unfairness, or mistake) are required to reopen a confirmed sale. 30 For example, in Cedar Island Builders, Inc. v. S.C. Sand & Gravel Co., the district court affirmed the decision of the bankruptcy court to reopen a sale, even though the additional bid was only slightly higher, because additional equities, including improper notice, existed. 31 In In re Chung King, Inc., the Seventh Circuit noted that defective notice is the most common justification for vacating a confirmed sale, but also provided that "[o]ther objections deemed sufficient . . . involve further irregularities in the judicial sale proceedings themselves such as unfairness toward bidders, stifling of competition, inaccurate or otherwise insufficient advertisement, sham bidding, or puffing and interference with the orderly conduct of the sale." 32 Based upon the foregoing, simply offering a higher price is very unlikely to be enough to reopen bidding post confirmation unless it is shown that the initial sale price was "so grossly inadequate as to shock the conscience of the court." 33
The Seventh Circuit decision in Goss Int'l Corp. presents a thorough example of how a typical auction process in bankruptcy can be reopened and the factors considered by a court. In that case, a debtor obtained court approval for its proposed bid procedures. There was an active secured creditor and a creditors' committee in the case. The bid procedures required that a specific form of asset purchase agreement (APA) be used for bid submission, which was required by a specific date together with proof of financial ability to close. In addition, the bid procedures allowed the debtor to modify such procedures at auction as circumstances might require. The form APA required that certain assets be removed by the successful buyer from the debtor's premises by a date certain. The APA also reserved the right of the debtor to require that such assets be removed even earlier, which apparently created some concern for prospective bidders. Prior to the auction, the debtor, however, removed the contingency related to the early removal of the assets, but this change was not widely circulated among the bidders. At the auction, one of the bidders inquired as to whether the final accepted bid at the auction could be later topped. Debtor's counsel indicated that any bid must be subsequently confirmed by the court and, therefore, while he expected the bids to be final, he could not guarantee an upset bid would not be considered by the court. At the conclusion of the auction, after consultation with the Committee and lenders, debtor's counsel advised that four bids would be submitted to the court at the sale hearing, with a bid of $2.25 million being the highest bid at that time.
The following day, one of the bidders contacted the debtor and asserted that it had not been made aware of the deletion of the early asset removal contingency from the APA and offered $2.45 million. After consultation with the committee and the lenders, the debtor sought court approval to open the auction, which was granted. At the second auction, the original bidder, subject to a reservation of rights, again won, but this time at a price of $2.6025 million. The bankruptcy court confirmed the results of the second auction and noted that while being mindful of the need to protect the integrity and finality of the auction process, found that the obligation to obtain the highest and best price together with the circumstances arising from the auction process itself supported the outcome.
On appeal by the successful bidder, the Seventh Circuit noted that "The bankruptcy court thus was within its discretion to conclude that the benefit to the estate in the second auction outweighed the bidders' expectations as to the results of the first auction, and the finality and integrity of public auctions." 34
There were several factors that are worth noting in this case. The first is that the upset bid arose before the original bid was confirmed and thus the court had more discretion to allow additional bidding. Furthermore, the second bidder apparently did not have notice of a material change in the APA prior to the initial auction; the court-approved bid procedures allowed for changes in the bid process during the auction; the Debtor informed the initial winner that the bid had to be confirmed by the court and that there was some risk, albeit minimal, of a higher bid; and, finally, the subsequent winning bid confirmed by the court was materially higher (nine percent) than the original. 35
Representing Parties-in-Interest
The risk that a court might allow an upset bid after an auction has taken place requires that the major parties-in-interest actively participate in the formulation of the bid procedures, the service of notice, and the conduct of the auction itself. Each should have an interest in seeing that the bid procedures have been followed, adequate notice given, and the sale and auction process conducted properly. However, because of the differing roles that various parties-in-interest serve in the case, their interests are not wholly aligned.
For example, counsel to the debtor naturally will seek to ensure that the highest possible sale price is obtained. To do so, as occurred in Goss, provisions in the court-approved sale procedures could be included, which allow modification during an auction to address changing circumstances. In addition, making clear that bids must be confirmed by the bankruptcy court should serve as a reminder to bidders that the court will still exercise independent judgment to determine if the highest and best price has been obtained. Furthermore, avoiding statements at the auction which would attempt to prevent the debtor from accepting a higher bid before confirmation should be avoided, if possible. Interestingly, the investment banker for the debtor may be the party most concerned over the potential opening of an auction to allow upset bids. It has been argued that the marketing process and long-term reputation of the investment banker can both be harmed in the market generally if potential buyers cannot be assured that their "highest and best bid" presented as a result of a thorough marketing process can be topped.
Not surprisingly, the unsecured creditors committee's one and only goal should generally be to obtain the highest possible sale price. Thus, flexibility in applying the bid procedures and encouraging competitive bidding will be of paramount concern. In addition, the Committee will want consultation and possibly veto rights with respect to bids received.
The ideal outcome for the stalking horse bidder is to be confirmed as the buyer without need to increase its bid and to protect its downside by receiving a breakup fee in the event it is not confirmed as the buyer. Counsel to the stalking horse bidder should be deeply involved in the creation of the asset purchase agreement to ensure that it contains the most advantageous provisions for compensating the stalking horse for its due diligence and contribution to the auction, while also preparing for the likelihood of being outbid. It should also confirm that notice has been adequately given. The stalking horse bidder enjoys the unique ability as a potential buyer to help craft bid procedures, including possibly setting minimum bids and restricting unilateral changes to the bid procedures and other auction rules. Strict adherence to these procedures at auction may help block an attempt to open bidding later. To the extent possible, the stalking horse bidder (and for that matter, any "highest and best bidder" at auction) may wish to seek formal commitments from the other major case participants that they will not support any subsequent or late bids if the stalking horse's bid is highest at auction. Creating such a record at the auction will bolster the winning bidder's arguments concerning the need to protect the expectation interests of bidders and thus the integrity of the sale process.
Conclusion
Today's economic and investment environment will continue to favor 363 sales as a fast and efficient means to expedite a bankruptcy. Despite the substantial time and effort needed to formulate detailed bidding and sale procedures, the facts and circumstances of any given case may require a court to reopen a closed auction, or even a confirmed sale, to entertain a potential upset bid. Therefore, early and thorough planning is essential.
Footnotes
1 See 11 U.S.C. § 365.
2 As the focus of this article is on upset bids, this overview of the 363 sale process is not intended to be comprehensive and, instead, is provided to establish the basic context for the discussion concerning upset bids.
3 Pursuant to 11 U.S.C. § 1107(a), a debtor in possession in a Chapter 11 case has the same rights and duties as the trustee. Therefore, references to "debtor" are also to the trustee when appropriate.
4 11 U.S.C. § 363(b)(1).
5 Am. Plant Food Corp. v. United Argi Products, Inc. (In re Farmland Indus.), 289 B.R. 122, 125 (B.A.P. 8th Cir. 2003).
6 Fed. R. Bankr. P. 2002 and 6004.
7 Parties-in-interest that failed to successfully influence the procedures prior to entry of a bid procedures order, may attempt to immediately appeal. Such appeals, however, are seldom permitted prior to confirmation of the sale. Indeed, though courts appear to apply varying standards, bid procedures orders are generally deemed interlocutory because they usually do not result in termination of the litigation or proceeding. See, e.g., Farmland Indus., 289 B.R. at 125 ("To determine whether an order is final, we must consider the extent to which the order leaves the bankruptcy court with nothing to do but execute the order; the extent to which delay in obtaining review would prevent the aggrieved party from obtaining effective relief; and the extent to which a later reversal would require recommencement of the entire proceedings."). Courts considering whether or not bidding procedures orders are immediately appealable generally take a pragmatic approach, considering factors such as: (1) whether additional work remains, (2) whether only legal issues remain, (3) the order's impact on estate assets, (4) necessity of further fact-finding, (5) preclusive effect of order, and (6) judicial economy. Kelson Channel View LLC v. Reliant Energy Channel View, LP (In re Reliant Energy Channelview, LP), 397 B.R. 698, 700 (D. Del. 2008). In terms of actually granting an appeal and reversing an interlocutory bidding procedures order, courts have applied the following practical-minded test: "whether (1) refusal would result in wasted litigation and expense; and (2) an immediate appeal may materially advance the ultimate termination of the litigation." Unsecured Creditors Comm. (In re Great Northern Paper, Inc.), 289 B.R. 497, 499 (D. Maine 2003).
8 See, e.g., In re Savage Indus. Inc., 43 F.3d 714 (1st Cir. 1994).
9 See generally Stephen Indus., Inc. v. McClung, 789 F.2d 386 (6th Cir. 1986); In re White Motor Credit Corp., 14 B.R. 584 (Bankr. N.D. Ohio 1991); In re Del. & Hudson Ry. Co., 125 B.R. 169 (D. Del. 1991).
10 See In re Hart's Mfg. Co., 383 B.R. 720, 724 (Bankr. W.D. Tenn. 2008) (courts have the discretion, if not an obligation, to review sales for reasonableness and adequate price); In re Food Barn Stores, Inc., 107 F.3d 558, 565 (8th Cir. 1997) (same).
11 Corp. Assets, Inc. v. Paloian (In re Goss Int'l Corp), 368 F.3d 761, 768 (7th Cir. 2004) (emphasis added).
12 Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537, 548 (7th Cir. 2003); see also Goss Int'l Corp, 368 F.3d at 767 ("The governing principle at a confirmation proceeding is the securing of the highest price for the bankruptcy estate." (quoting In re Chung King, Inc., 753 F.2d 547, 549 (7th Cir. 1985))).
13 First Nat'l Bank v. M/V Lighting Power, 776 F.2d 1258, 1261 (5th Cir. 1985); see also Goss Int'l Corp, 368 F.3d at 767-68 ("[A]n interest in the finality and integrity of the process by which bids are accepted and approved. "If parties are to be encouraged to bid at judicial sales, there must be stability in such sales and a time must come when a fair bid is accepted and the proceedings are ended."" (quoting Chung King, Inc., 753 F.2d at 549)).
14 See, e.g., Goss Int'l Corp., 368 F.3d at 768 (internal citation omitted); In re Fin. News Net. Inc., 980 F.2d 165, 166 (2d Cir. 1992).
15 526 F.2d 627, 629 (1st Cir. 1975) (the movants in Gil-Bern had attempted to reopen bidding at the confirmation hearing).
16 311 F.2d 670, 672 (10th Cir. 1962).
17 217 F. 16, 20-21 (2d Cir. 1914).
18 Chung King Inc., 735 F.2d at 554; see also J.J. Sugarman Co. v. Davis, 203 F.2d 931, 932 (10th Cir. 1953) ("Refusing to confirm a sale to a high bidder merely because an intervening higher bid has been received is the surest way to destroy confidence in judicial sales and defeat the purpose sought to be accomplished thereby to realize the greatest amount from such sales to those entitled to receive the proceeds thereof.").
19 Goss Int'l Corp., 368 F.3d at 766.
20 Food Barn Stores, Inc., 107 F.3d at 566.
21 Goss Int'l Corp., 368 F.3d at 767.
22 Id. at 766 (internal citations omitted).
23 Food Barn Stores, 107 F.3d at 566; Fin. News, 980 F.2d at 170.
24 Goss Int'l Corp., 368 F.3d at 770-71.
25 See Gil-Bern, 526 F.2d at 629.
26 See, e.g., Hart's Mfg. Co., 383 B.R. at 724 (declining to confirm a sale because the price was "grossly inadequate" (1/6th the appraised value) and provided only partial payment to a single creditor).
27 For example, in In re Blue Coal Corporation, the district court found that a great inadequacy in price together with some element of unfairness in the bidding is sufficient to deny confirmation and permit subsequent bidding. 168 B.R. 553 (M.D. Pa. 1994). Most recently, in In re Bigler, LP, a case from the Southern District of New York, the bankruptcy court found that even prior to confirmation, absent some evidence of equitable misconduct or inequity, a higher price alone is usually insufficient to permit an upset bid. 443 B.R. 101 (Bankr. S.D.N.Y. 2010).
28 See, e.g., In re WPRV-TV, Inc., 983 F.3d 336, 340-41 (1st Cir. 1993).
29 Goss Int'l Corp., 368 F.3d at 767; WPRV-TV, Inc., 983 F.3d 336 (same).
30 See, e.g., WPRV-TV, Inc., 983 F.2d at 340; Goss Int'l Corp., 368 F.3d at 768; Food Barn Stores, Inc., 107 F.3d at 564.
31 151 B.R. 298, 302 (D.R.I. 1993).
32 Chung King, Inc., 753 F.2d at 550-51 (internal citations omitted).
33 The Fifth Circuit permitted a sale to be opened post-confirmation because the actual value of the property was 180 times its confirmed sale price. M/V Lighting Power, 776 F.2d at 1259. Additionally, in In re Kendall Foods Corporation, proposed bids of 53.7 percent, 42 percent, and 39 percent below fair market value were found grossly inadequate. 122 B.R. 792, 793 (Bankr. S.D. Fla. 1990); see also In re Stanley Eng'g Corp., 164 F.2d 316, 318 (3d Cir. 1947), cert. denied, 332 U.S. 847 (1948); Chung King Inc.,753 F.2d at 550-51 (noting that an 8.6 percent or 12.5 percent difference in a confirmed sale price and later offer are not disparities shocking the conscience such that a confirmed sale may be opened).
34 Goss Int'l Corp., 368 F.3d at 767.
35 See, e.g., Goss Int'l Corp, 368 F.3d at 768-69; Cedar Island Builders, 151 B.R. at 302 ("[A] bankruptcy court possesses broad initial discretion in granting or denying confirmation of a sale of assets . . . ." (internal citations omitted)).
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