Who Wins in the Race to Get Break-up Fees Approved
Chapter 11 cases that contemplate a sale of all or a substantial portion of a debtor's assets under §363 of the Bankruptcy Code have become routine. In fact, chapter 11 cases that involve sales of assets seem to be more common than those that involve "stand-alone" reorganization plans. Thus, bankruptcy courts have become accustomed to seeing sale-related pleadings and requests for relief at the outset of a case. Often, the debtor signs an asset-purchase agreement on the eve of a bankruptcy filing and immediately seeks approval of bid and auction procedures and an asset sale. There was a time when motions to establish bidding procedures were filed and heard at the "first-day" hearing.1 This is no longer the general practice. Except in the extraordinary case, nearly all bankruptcy courts require noticed sale-procedures hearings, recognizing that notwithstanding the "procedural" name tag, sales "procedures" have an impact on substantive rights. And, although notice requirements might be modified in response to the exigencies of a particular case, most courts will wait until a creditors' committee is appointed and can be heard.
Nonetheless, provided that a reasonable amount of notice is given, sale procedures are routinely approved. Among these "routine" sale procedures is the granting of a break-up fee to an unsuccessful purchaser. It is unusual to come across a buyer that doesn't demand a break-up fee when contracting to buy assets that will be tested in a bankruptcy auction. And, so long as the break-up fee is within the 2-3 percent range, it is unusual for the break-up fee to be denied. Some courts apply the "administrative expense" test articulated by the Third Circuit in Calpine Corp. v. O'Brien Envt'l. Energy Inc. (In re O'Brien Envt'l. Energy Inc.), 181 F.3d 527 (3d Cir. 1999),2 while other courts continue to apply a business judgment standard such as that articulated in Official Committee v. Integrated Resources Inc. (In re Integrated Resources Inc.), 147 B.R. 650, 657 (S.D.N.Y.) 1992) (discussed below). Under either test, however, bankruptcy judges are looking more carefully at the circumstances under which break-up fees are granted and are requiring an appropriate evidentiary showing. Thus, without a stalking horse or an evidentiary showing of the benefit to the estate, it is difficult to obtain bidding protections for an open auction. Also, as is demonstrated by the Top-Flite case discussed below, even a signed stalking-horse agreement might not be enough if there are other bidders willing to move forward without break-up fee protection.
Prior to O'Brien, courts considering the propriety of a proposed break-up fee typically considered "(1) whether the relationship of the parties who negotiated the fee is marked by self-dealing or manipulation; (2) whether the fee hampers, rather than encourages, bidding; and (3) whether the amount of the fee is reasonable in relation to the proposed purchase price." In re Twenver Inc., 149 B.R. 954, 956 (Bankr. D. Colo. 1992). Accord, In re Bidermann Indus. U.S.A. Inc., 203 B.R. 547, 552 (Bankr. S.D.N.Y. 1997); Official Committee v. Integrated Resources Inc. (In re Integrated Resources Inc.), 147 B.R. 650, 657 (S.D.N.Y. 1992).
In O'Brien, however, the Third Circuit held that under the circumstances of the particular case, the payment of a break-up fee was appropriate only if the fee was among the actual, necessary costs and expenses of preserving the estate and therefore qualified as an administrative expense within the meaning of §503(b) of the Bankruptcy Code. O'Brien, 181 F.3d at 535. The Third Circuit distilled the inquiry to whether awarding break-up fees was necessary to preserve the value of the debtor's estate. Id. at 536.
Because O'Brien did not involve a request to approve the payment of a break-up fee prior to consummation of an auction, and instead involved a post-auction payment request by a disappointed bidder under §503(b) of the Bankruptcy Code, O'Brien is somewhat distinguishable from the case where approval of a break-up fee is sought before an auction.3
In two recent Delaware bankruptcy cases, Judge Walsh and Judge Walrath refused to approve break-up fees.4 While neither ruling is published, they serve to remind practitioners that notwithstanding how often such fees are granted, an appropriate factual showing must support such fees.
Pillowtex: Pre-approval of Bid Procedures
Pillowtex filed a chapter 11 case in Delaware on July 30, 2003. One of the first-day motions filed in the Pillowtex bankruptcy case was the "Motion of Debtors and Debtors-in-possession for an Order (A) Approving Global Bidding Procedures and (B) Authorizing Debtors to Grant Pre-Approved Bid Protections to Prospective Purchasers" (the Global Bid Procedures Motion). The Global Bid Procedures Motion was heard on Aug. 20, six days after a creditors' committee was appointed in the case. Through the Global Bid Procedures Motion, Pillowtex sought pre-approval of certain bidding procedures and bid protections to apply to certain asset sales involving the transfer of more than $1 million in aggregate consideration. The global bidding procedures would allow Pillowtex to (1) review initial expressions of interest and accept initial bids, (2) negotiate and enter into purchase agreements with bidders, (3) solicit additional bids and conduct an auction and then (4) submit the final bid to the bankruptcy court for approval. The global bidding procedures also would authorize Pillowtex to offer initial bidders certain bid protections, including the payment of break-up fees and the reimbursement of expenses without first seeking court approval of such bid protections.
At the hearing on the Global Bid Procedures Motion, the court addressed a provision in the motion that provided for preapproval of break-up fees and expense reimbursements. Pillowtex characterized the requested relief as "standard," noting that a virtually identical order had been approved in Pillowtex's previous chapter 11 case. Transcript of Hearing at 28, Pillowtex (Aug. 20, 2003; docket item no. 261). However, under the standard set out in O'Brien, the bid must be considered in the context of the marketing process in order to determine whether or not a bidder is entitled to a break-up fee. As discussed above, if a break-up fee serves to induce an initial bid, it might be permissible; where it serves to advantage a favored purchaser over other bidders by increasing the cost of the acquisition to the other bidders, it is impermissible. Under the procedures proposed by Pillowtex, the debtor and committee determined the break-up fee was appropriate. Id. at 32.
After hearing arguments from the parties, Judge Walsh stated that "everybody is aware that where a bid procedure motion is brought on with a contract with a stalking horse, it is not a difficult case to make out to get a break-up fee in most instances. But it is a fact and circumstance decision and authorizing it in advance simply does not allow for that decision." Id. at 33. Accordingly, Judge Walsh found that the O'Brien decision precluded him from giving carte blanche authority to Pillowtex or its creditors' committee to execute contracts with break-up fees.
SHC Inc. (Top-Flite Golf): A Competing Bidder Spoils the Break-up Fee
SHC Inc., a preeminent producer of golf balls worldwide, commenced its chapter 11 cases along with certain affiliates on June 30, 2003, in the District of Delaware. Top-Flite filed a motion on July 3 seeking approval of bid procedures and related relief in connection with its asset-purchase agreement with Callaway Golf Co. ("Callaway" and the "Callaway Bid Procedures Motion"). Top-Flite had entered into an agreement to sell substantially all of its assets to Callaway for $125 million. The asset purchase agreement with Callaway provided for Callaway to receive a break-up fee and expense reimbursement and did not require Callaway to post a deposit. The Callaway Bid Procedures Motion was heard on July 23, 2003. Competing bidder Adidas-Salomon (Adidas) filed an objection to the bidding procedures and appeared at the hearing. Adidas made an evidentiary showing that it had pursued Top-Flite for an extensive period of time and argued that Top-Flite did not fully consider their bid. In its objection, Adidas stated that it was prepared to immediately execute the same asset purchase agreement that Callaway executed, but without requiring a break-up fee and with a purchase price increase of $1 million. Adidas was also prepared to post a $12 million deposit. Objection of Adidas-Solomon AG to Debtors' Motion at 2-3, Top-Flite (July 16, 2003; docket item no. 57).
During the hearing, Top-Flite argued that Adidas had no standing to object to the bid procedures. Transcript of Hearing at 30-31, Top-Flite (July 23, 2003; docket item no. 160). Judge Walrath disagreed, finding that whether there is a another bidder willing to bid without break-up fee procedures is relevant to her consideration of whether or not the bid procedures are reasonable. Id. at 31-32. Thus, Judge Walrath heard testimony and argument from Top-Flite and from Adidas.
At the conclusion of the argument, Judge Walrath issued the following ruling: "I will in the first instance approve Calloway [sic] as a stalking horse with no break-up fee whatsoever. In the event Callaway is not interested in that, I will approve Adidas as the stalking horse on the exact same terms, no break-up fee. So let's take 10 minute[s] and see who signs first." Id. at 104. Judge Walrath's ruling appears to be based on her concern that Adidas was not given appropriate consideration in the stalking horse selection process. She did not imply that anytime another bidder shows up at the last minute with a better deal that that bidder can trump the stalking horse.
After a brief recess, Top-Flite advised the court that Callaway was prepared to remain the stalking horse and would withdraw the break-up fee requirement. On that basis, the Callaway Bid Procedures Motion was granted.5
It has become routine to obtain a hearing and consideration of auction procedures and bid protections in the early days of a chapter 11 case. However, courts are not likely to simply rubber-stamp these motions. The lessons from Top-Flite are that debtors must show that the stalking horse has a deal likely to bring value to the estate and that the O'Brien standard (break-up fee is appropriate only if there is a showing that the fee is an actual, necessary cost and expense of preserving the estate) is met. The Top-Flite decision also makes clear that debtors should fully vet potential offers before selecting a stalking horse with which it will proceed forward. Pillowtex reminds us that practitioners should be fully prepared and should not assume that anything is standard or pro forma. Thus, in open auctions without a stalking horse, bidding protections will be granted only if the appropriate evidentiary showing is made.
1 Although the bankruptcy community commonly uses the term "first-day hearings," the hearing is rarely on the first day of the case; instead, absent an unusual circumstance, in most jurisdictions the hearing to consider the motions that are filed on the first day is generally set within 48 hours of the commencement of the case. Return to article
2 See, e.g., AgriProcessors Inc. v. Iowa Quality Beef Supply Network LLC (In re Tama Beef Packing Inc.), 290 B.R. 90, 98 (BAP 8th Cir. 2003) (showing that administrative claim for break-up fee benefited the estate "in some demonstrable way" required; applies nine O'Brien factors); Corradino v. Lamb (In re Lamb), 2002 WL 31508913, *2 (Bankr. D. Md. Oct. 11, 2002) (breakout fee request made only after bidder was unsuccessful not necessary to preserve estate value); cf. In re American Appliance, 272 B.R. 587, 601 (Bankr. D. N.J. 2002) (bank's request to receive reimbursement of post-petition rental payments if unsuccessful in acquiring leasehold interest must await sale of interest in order to determine whether it constitutes actual, necessary cost of preserving value of the estate). Return to article
3 As one commentator stated:
Indeed, O'Brien reflects the general difficulty of obtaining court approval of bidding incentives after the bidding process. With the benefit of hindsight, courts can subject such incentives to the strictest scrutiny. As one court has observed, characterizing a bidding incentive as "a permissible type that promotes bidding, or a harmful strain that discourages bidding, appears to be no more than conclusory judicial labels that are affixed by hindsight after the [bidding incentive] has been scrutinized by the courts." Cottle v. Storer Comm. Inc., 849 F.2d 570, 576 n.7 (11th Cir. 1988) (quoting Leo Herzel, et al., Misunderstanding Lockups, 14 Sec. Reg. L.J. 150, 1177 (1986)). In O'Brien, the court gleaned from robust bidding that the bidders believed they could acquire O'Brien cheaply, and thus the prospect of receiving a break-up fee was unnecessary. Of course, if the bidding had been slow or nonexistent, the court could just as well have blamed the break-up fee. This ability to blame a break-up fee after weak bidding, but look elsewhere after spirited bidding, makes predictability impossible. At a minimum, a potential purchaser seeking a break-up fee ought to obtain court approval of the fee before the auction and be prepared to support that request with evidence of benefit to the estate, perhaps in the form of minimum bid increases or "topping" protections.Kugler, Robert T. and Boettge, Douglas R., "In Search of the Elusive Break-up Fee," 19 Am. Bankr. Inst. J. 14, 37 (Sept. 2000) (emphasis added). Return to article