Asset sales pursuant to 11 U.S.C. §363(b)(1)¹ may be conducted either by private sale or public auction.² Many debtors choose the latter option, hoping that competitive bidding will result in a higher purchase price. Auctions also allow a debtor to demonstrate to the bankruptcy court and its creditors that it obtained the highest and best price in the market for its assets.

But what happens when the debtor discovers that a subsequent bidder is willing to pay more for the debtor's assets than the price obtained at auction? In Corporate Assets Inc. v. Paloian, 368 F.3d 761 (7th Cir. 2004), the Seventh Circuit attempts to answer that question.

The Background

The chapter 11 debtors sought approval to sell certain personal property (assets) located at a manufacturing facility. The debtors sought and obtained bankruptcy court approval for specific bidding procedures for the auction and sale of the assets. Chief among these procedures was a modification provision that gave the debtors, in consultation with their lenders, authority to reject any bid that was inadequate, insufficient or contrary to the best interests of the debtors, their estate or their creditors at any time prior to bankruptcy court approval.

The debtors' draft asset-purchase agreement contained a provision where any successful bidder would have to remove the assets from the facility prior to a certain date. This provision caused great concern among potential bidders, and several bidders made their bids contingent upon its deletion. In light of these concerns, the debtors deleted the removal provision. The decision proved fruitful, as bids increased approximately $600,000. However, not all of the prospective bidders were informed of this change prior to the auction. Among these bidders was Myron Bolling Auctioneers (MBA).

At the beginning of the auction, the debtors' attorney stated there was a slim chance that the auction would not be final and that a subsequent bidder could appear at the sale approval hearing and present a higher offer. Nevertheless, the debtors' counsel indicated that the debtors intended to take the highest bid at the auction and present it to the bankruptcy court for approval.

At the auction, Corporate Assets Inc. (CAI) submitted a high written bid of $2.25 million for the assets. No other bidder matched that amount, although there was competitive bidding to be the second-highest bid. MBA ultimately tendered the second-highest bid of $2.075 million.

The next day, and prior to a hearing confirming the sale, MBA increased its bid to $2.45 million. MBA explained that it had not been able to inform all of its bidding group that the removal provision had been deleted prior to the completion of the auction. Once this information was provided to the entire MBA bidding group, the group authorized the increased bid.

The debtors requested, and the bankruptcy court granted, a continuance of the sale hearing and a second auction prior to the rescheduled hearing date. All bidders were notified of the second auction, which was won by CAI's final bid of $2.6025 million, an amount approximately 16 percent higher than its high bid at the first auction. CAI filed an objection at the continued sale hearing, arguing that it should be allowed to purchase the assets for its initial $2.25 million bid.³

Procedural History

The bankruptcy court denied CAI's objection. It recognized that there was a need to preserve the integrity and finality of the auction process and to recognize the reasonable expectations of the auction's participants. However, there is a competing interest to consider: securing the highest sale price for the benefit of the estate and creditors. The bankruptcy court reasoned that the second auction was proper because it was not contrary to the reasonable expectations of the bidders (the bidding procedures gave the debtors the right to reject any bid prior to an order approving the sale) or the integrity and finality of the auction process (the modification provision meant that no bid was final until the entry of a sale order). Furthermore, the bankruptcy court reasoned that the auction had not taken place on a level playing field because not all of the bidders were aware that the removal provision had been deleted until they arrived at the auction.

The district court affirmed. First, it echoed the bankruptcy court's recitation of the competing interests at issue: (1) the integrity and finality of public auctions and (2) the best interests of the debtors' creditors. The district court first found that in light of the bidding procedures and the comments of the debtors' counsel at the auction, reopening the auction did not depart from the bidders' reasonable expectations, as no bidder could have had adequately solidified expectations that a high bid at the auction would be accepted. Furthermore, the district court reasoned that the second auction was in the best interests of the estate. Sixteen percent may not be sufficient to demonstrate gross inadequacy as to the original bid, but it did represent a significant boon to the estate.

The Decision

The Seventh Circuit also began by noting that the two competing interests in an auction—maximizing creditor recovery on one hand, and the interest in finality and integrity of the bidding and auction process on the other—come into direct conflict in the context of an upset bid. Id. at 767-68. Surveying the case law on upset bids, the appeals court noted a sliding scale of discretion in allowing upset bids, and that the bankruptcy court's discretion diminished the closer a sale came to reality and the expectation of bidders solidified. Id. at 768. At one end of the scale, you have a sale approved by an order of the bankruptcy court. Id. There, the parties have a high expectation of finality, and a belated bid should only be allowed where it shows the initial purchase price to be so grossly inadequate as to shock the conscience of the court or if the original auction was tainted by fraud, mistake or some comparable defect. Id. (citing In re Chung King Inc., 753 F.2d 547, 550 (7th Cir. 1985); In re Webcor Inc., 392 F.2d 893, 899 (7th Cir. 1968)). At the other end of the scale, no order approving the sale has been entered, and the court has broader discretion, which may include setting aside a bid if greater financial gain for the estate exists. Id. (citing In re Food Barn Stores Inc., 107 F.3d 558, 565-66 (8th Cir. 1997); In re Financial News Network Inc., 980 F.2d 165, 170 (2d Cir. 1992)). Because no sale order had been entered in the debtors' case, the Seventh Circuit reasoned that the bankruptcy court had broad, but not unbounded, authority to accept additional bids. Id. at 769.

CAI argued that even absent a sale order, it had every reason to think that bidding on the assets was concluded and that the bankruptcy court's approval of CAI's high bid was a mere formality. Id. The Seventh Circuit acknowledged that the record yielded some support for this argument: the bidding procedures provided for a single auction, the debtors' counsel stated that when the auction closed it would be final and only a slim possibility existed of an upset bid, the auction was conducted in a straightforward manner, CAI clearly had the highest bid at the auction, and there was no indication that further bidding was anticipated. Id. In light of these facts, CAI urged the appeals court to follow the First Circuit's decision in In re Gil-Bern Indus. Inc., 526 F.2d 627, 629 (1st Cir. 1975), which held that absent local custom to the contrary, it was an abuse of discretion for a bankruptcy court to refuse to confirm an auction bid in a fairly conducted sale merely because the debtor received a slightly higher bid after the auction.

The Seventh Circuit declined to read Gil-Bern as creating a bright-line rule, noting that later decisions from the First Circuit did not rigidly apply the standard espoused in Gil-Bern. Id. at 770 (citing In re Muscongus Bay Co., 597 F.2d 11, 13 (1st Cir. 1979)). Furthermore, the Seventh Circuit noted that even though no local custom of allowing upset bids had been established in this case, certain circumstances alerted bidders to the possibility that the original auction may not have been final. Id. First, there were the bidding procedures (specifically, the modifications provision), which should have tempered any expectation that the close of the auction was the final acceptance of a bid. Id. at 770-771. Second, the first auction did not occur on a level playing field because not all bidders, specifically MBA, knew about the deletion of the removal provision from the asset-purchase agreement. Id. at 771. Therefore, the upset bid was not a nefarious attempt to withhold a party's highest bid, but rather a higher bid based on new information. Id. Third, the upset bid offered significantly more money to the estate. Id. Although the appeals court noted that the upset bid's approximately 9 percent increase of the purchase price probably was not sufficient to justify setting aside a sale order, no order had been entered in the case at bar, and therefore, the high threshold for setting aside a bid was not implicated. Id. at 771-72.

Analysis

The decision in Corporate Assets Inc. raises questions as to which, if any, of the three "circumstances" relied on by the appeals court, standing alone, would justify allowance of an upset bid prior to entry of an order confirming a sale. The first factor identified by the Seventh Circuit was that the sale procedures, which allowed the debtors to reject any bid, should have made any potential bidder aware that no bid was final until approved by the bankruptcy court. The sale procedure argument carried the day in In re WPRV-TV Inc., 983 F.2d 336 (1st Cir. 1993), and J.J. Sugarman Co. v. Davis, 203 F.2d 931 (10th Cir. 1953), and appears to support authorization of an upset bid in and of itself. This outcome would be strengthened where potential bidders receive the sale procedures prior to the auction and sign a consent to be bound by their terms.

However, does this circumstance become insufficient if the sale procedures are not received until the auction? Furthermore, one should be mindful that in Sugarman the winning bid was ultimately 20.4 percent higher than the original bid and that the bids in WPRV-TV were rife with inadequacies and potential fraud, and tainted by the factual history. Did these facts influence the respective courts as much as or more than the bidding procedures?

The second circumstance highlighted by the Seventh Circuit was the lack of a level playing field at the auction. This removed any taint or untrustworthy motive as to MBA's upset bid. The Second Circuit accepted an upset bid in Financial News, where the bidding was highly complex, the competing parties amended their bids multiple times, and evidence was taken as to the value of certain components of the bids. Therefore, it appears that this reason, too, may be sufficient in and of itself to justify acceptance of an upset bid.

On the other hand, is an unlevel playing field created when one bidder has obtained, at its own expense and volition, a Phase II environmental analysis on a property, and a second bidder, also at its own expense and volition, has ordered a Phase II but has yet to receive the results? Would it have been inequitable for the debtors in this case to have accepted a bid that was contingent upon the deletion of the removal provision and a bid that was not?

Finally, the third circumstance identified by the Seventh Circuit was that the upset bid represented a significant boon to the estate. This factor certainly can stand on its own as evidenced by the Eighth Circuit's decision in Food Barn (upset bid 6.7 percent higher, final bid was 40 percent higher than initial bid). However, the increase must rise above some threshold, as Gil-Bern found a 3.3 percent increase insufficient. The Seventh Circuit hints that there may be a minimum threshold when it states that in a complex and fluid or an informal and flexible bidding process, "financial gain for the estate and its creditors might suffice as a basis for reopening the bidding process without an additional showing that the initial bids were grossly inadequate or that the original bidding was tainted by fraud or some other irregularity." Corporate Assets Inc., 368 F.3d at 768 (emphasis added). This hint is not elaborated, however, as in the body of its opinion, the Seventh Circuit merely states that the "grossly inadequate" standard used in conjunction with confirmed sales (i.e., Chung King, which rejected an 8.6 percent higher upset bid) does not apply in that case. Id. at 771-72.

What increase would be insufficient? It seems that a bankruptcy court's decision would face much greater scrutiny for a 1 percent increase than a 10 percent increase. However, what if the sale is for tens or hundreds of millions of dollars? In that scenario, even a percentage increase would convey a substantial benefit to the estate. Furthermore, what if the upset bid was 5 percent higher but paid over time, whereas the original auction bid was paid at closing? Should present value be used?

Finally, would a debtor be wise to accord bidding protections to high bidders at auctions as well as to "stalking horse" offers in an effort to elicit bidders' highest and best bids? Should or can bidding procedures include a provision that for any upset bid to be considered it must be a certain percentage in excess of the highest bid obtained at an auction?

Conclusion

As a practical matter, a non-final auction creates the opportunity for a debtor and estate to obtain the highest purchase price for its assets, including upset bids. However, to pass judicial scrutiny, such an auction, at a minimum, must have rules approved by the bankruptcy court that (1) are provided to all prospective bidders prior to the auction, (2) make clear that no sale is final until approved by the bankruptcy court, and that the debtor may reject any and all bids prior to that time and (3) should require bidders to acknowledge their receipt and understanding of the rules.

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Footnotes

¹ Section 363(b)(1) provides that "[t]he trustee, after notice and a hearing, may use, sell or lease, other than in the ordinary course of business, property of the estate." Return to article

² "All sales not in the ordinary course of business may be private sale or by public auction." Fed. R. Bankr. P. 6004(f)(1). Return to article

³ CAI also sought an administrative expense claim for the costs it incurred as a result of the second auction, which is not discussed herein. Return to article