“Don’t care how; I want it now” – Veruca Salt, Willy Wonka and the Chocolate Factory
We continue our series of blog posts on the Report of the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 with a review of the Commission’s proposals regarding section 363 of the Bankruptcy Code, which deals with sales of some or all of the debtor’s property outside the ordinary course of business.
The most interesting recommendations are those involving sales of substantially all of the debtor’s assets, which would be governed by a new provision, called “Section 363x,” and would be subject to a greater degree of scrutiny, longer timetables, and certain other requirements more commonly found in connection with confirmation of a plan of reorganization. The Commission was motivated by increasingly shorter timetables for section 363 sales, many of which are set at the insistence of a secured creditor credit bidding its debt, or by some other prospective purchaser or financer of a debtor’s chapter 11 case. The Commission’s proposed timetables and requirements seek to reintroduce the “breathing spell” that is a traditional goal of chapter 11 and to afford parties in interest (and competing bidders) a reasonable period of time to assess the proposed sale.
Where sales of substantially all of a debtor’s assets are warranted, the Commission would still permit them to take place. But in proposing its changes to section 363, the Commission seems to be suggesting that rapid 363 sales should not be a debtor’s only path, and that the Bankruptcy Code should encourage meaningful, well-considered reorganizations pursuant to a plan of reorganization, or pursuant to a new “section 363x” sale bearing many of the hallmarks and protections of a traditional chapter 11 plan. Highlights of these changes and recommendations follow.
One of the major features of the ABI Report involves an attempt to afford a meaningful amount of time for a debtor and other parties in interest to assess the debtor’s situation and to make use of chapter 11 in the most productive way. Given recent pressure to effect quick (or nearly-immediate) sales of substantially all of a debtor’s assets and a wealth of data showing that chapter 11 cases are resolved much faster than was the norm even a decade ago, the ABI Report contemplates what is essentially a higher bar to sales of substantially all of a debtor’s assets in the first sixty days after a chapter 11 filing. The ABI Report references certain purported potential negative consequences of such quick sales, including not facilitating a robust auction, not providing the debtor sufficient time to explore other restructuring alternatives, not providing a reasonable time to assess the likelihood that a market that had declined will rebound during the pendency of the debtor’s chapter 11 case, and the potential for insufficient notice and opportunity for parties to perform reliable asset valuations or assert meaningful objections. Because prospective purchasers (or lenders, or other parties in interest) may otherwise impose upon the debtor a requirement to obtain approval for a proposed sale within just a few weeks (or even within days, in some cases), the ABI Report proposes to bar these quick auctions and sales unless the debtor or a party in interest “demonstrates by clear and convincing evidence that there is a high likelihood that the value of the debtor’s assets will decrease significantly” within those sixty days. Thus, although quick sales are not banned (and may, in certain circumstances, be in all parties’ best interest), the Commission proposes to raise the bar, permitting those sales only in limited circumstances, and only when absolutely necessary to preserve “significant” value.
Section 363x: The sale of substantially all of a debtor’s assets
In attempting to avoid sub rosa plans, or other reorganizations that skirt the requirements generally imposed in the context of a plan of reorganization, the Commission proposed introducing a new “Section 363x” to govern the sales of substantially all of a debtor’s assets. Although other assets sales will continue be guided by the debtor’s business judgment, these “363x” sales would impose the following additional requirements:
- The sale must:
- Be in the best interests of the estate;
- Comply with other applicable provisions of the Bankruptcy Code;
- Be proposed in good faith and not by any means forbidden by law;
- Satisfy in full allowed administrative expenses and certain other claims as contemplated in section 507(a)(2) and (3) of the Bankruptcy Code, unless the holder of such claim agrees otherwise; and
- Provide for the payment of all court and United States Trustee fees;
- Any reimbursements or payments of costs and expenses incurred in connection with the sale (for example, to the buyer’s advisors) must be subject to the approval of the bankruptcy court as “reasonable”;
- The proponent of the sale must:
- Provide adequate notice to all creditors and equity security holders who may be affected by any release or discharge in favor of the purchaser; and
- Comply with all applicable provisions of the Bankruptcy Code
These requirements map closely onto much of section 1129(a) of the Bankruptcy Code, the requirements to confirm a chapter 11 plan, but notably would not require the voting required for a chapter 11 plan. They nonetheless reflect an effort to ensure that those turning a company over to a new owner pursuant to a section 363 sale do not use the bankruptcy process as a vehicle to obtain benefits for themselves without paying their way through the bankruptcy process, and do not attempt to extract inappropriate value from the debtor’s estate without sufficient notice or oversight.
Because the chapter 11 plan process is a public one, and involves affirmative solicitation of all creditors, along with a court-approved disclosure statement setting forth “adequate information” for creditors to determine whether to approve the plan, it necessarily is a more public process. Moreover, chapter 11 plans are subject to approval or rejection by creditors. Even though a plan may still be confirmed if most (or, under the ABI Commission’s proposal, all) classes of creditors vote to reject the plan, the chapter 11 plan is still a widely disseminated document, and is subject to the heightened “cramdown” requirements in the event that it does not enjoy the support of all classes of creditors. On the other hand, the sale of substantially all of a debtor’s assets is subject to significantly less oversight and fewer procedural hurdles. In particular, such sales often provide for the reimbursement of fees and expenses incurred by the purchaser and for releases of claims against the purchaser or other favored parties, all without the procedural and substantive requirements otherwise imposed in connection with a chapter 11 plan. And in certain scenarios, a debtor may seek to use a section 363 sale to shed all of its assets, leaving little or nothing for even the administrative expenses of running and closing the chapter 11 case.
By requiring these affirmative showings from the debtor, the ABI Commission proposes to require the debtor to put forth sufficient evidence of its good faith that the proposed sale would benefit its estate, and to facilitate input from all parties in interest who might be affected by the proposed sale. Moreover, the ABI Commission seeks to ensure that value is not inappropriately extracted from the debtor’s estate solely to benefit the purchaser or other favored parties, at the expense of the debtor’s creditors and other parties in interest.
Finality of Auctions
As we’ve noted in previous posts, another “hot” issue in recent years turns on the finality of auctions in bankruptcy if new bids come in after the auction has been closed and a winner has been declared. On the one hand, if the new bid could bring in more value for the debtor’s estate, it is tempting to reopen the auction or to otherwise permit the new bid to be considered and accepted, even after the previously stated deadline. On the other hand, this approach could jeopardize the utility of all auctions in bankruptcy, if the “last and final” bid at an auction can be abandoned in favor of future higher bids. Indeed, there would be little incentive for bidders to place their highest and best offer at the appropriate time if the auction is not actually the time and place for determining a winning bidder. Reflecting the Commission’s concerns regarding the integrity of auctions in bankruptcy, the ABI Report proposes to prohibit courts from reopening an action “unless the court finds extraordinary circumstances or material procedural impediments (such as the lack of adequate notice or an improperly conducted sale process) to the auction process that may have had a material effect on the sale results.” To make matters even more clear, the ABI Report further states that the potential for a higher purchase price should not, alone, constitute extraordinary circumstances sufficient to overturning an otherwise final auction.
Free and Clear Sales
The ABI Commission would reaffirm the ability of a debtor to sell property “free and clear” of most interests under section 363(f) of the Bankruptcy Code (to the extent permitted by the U.S.) and adopt a broad definition of interest to include most claims, including generally successor liability claims. Excluded from these “free and clear” sales would be easements and other covenants that run with the land, environmental liabilities that run with the land, successor liability under federal labor laws (but not including certain other forms of successor liability), and competing or disputed ownership interests. Moreover, the ABI report recommended clarifying that “free and clear” sales not be permitted to frustrate state or federal police and regulatory power. Finally, the Commission recommended that sections 365 and 1113 continue to govern disposition of a debtor’s executory contracts/unexpired leases and collective bargaining agreements, respectively.
The ABI Commission would also reaffirm a secured creditor’s right to credit-bid the value of its allowed claim in connection with a section 363 sale. The ABI Commission recognized that section 363(k) permits a court to limit credit bidding “for cause,” which some courts have interpreted to include scenarios in which (i) the court is concerned with the conduct of the secured creditor (for example, where the creditor undertakes an “overly zealous” strategy) or (ii) the amount of the secured creditor’s claim is uncertain. In those scenarios, courts have been wary of allowing secured creditors to credit bid their entire claim because such a bid could chill or even “freeze out” other competitive bidders by virtue of an inflated or misdirected bid. The ABI Commission recognized that all credit bids can chill competing bids, but concluded that any such chilling effect does not, by itself, yield sufficient “cause” for curbing a secured creditor’s right to credit bid up to the amount of its allowed claim. To encourage competitive bidding, however, the ABI Commission recommended that courts take steps to mitigate this chilling effect of credit bidding by ensuring that robust auction and sale procedures are proposed and approved in the chapter 11 case.
All of the ABI Commission’s recommendations reflect a keen awareness of the recent trends in chapter 11 in connection with section 336 sales of a debtor’s assets, and of the need to balance a meaningful and robust sale process with each party’s ability to exercise its rights vis-à-vis the debtor and its assets. Although secured creditors and potential stalking horse bidders might lose some of the s leverage that they currently enjoy, the ABI Commission’s proposals would enable unsecured creditors and other parties in interest – who, in recent years, have lost a good deal of leverage in chapter 11 cases – to more fully assess the chapter 11 case and to become heard and involved in protecting their own interests. More importantly, however, the ABI Commission seems intent on preserving the traditional hallmarks of the chapter 11 process by (i) affording debtors a meaningful breathing spell before a secured creditor or prospective purchaser can insist on a sale of substantially all of the debtor’s assets; and (ii) ensuring that auctions in bankruptcy and robust and reliable, even if adherence to bid and auction procedures deprives debtors in certain cases of their opportunity to take advantage of a late bid that might yield greater value for the estate. Although bankruptcy courts in certain circumstances might feel compelled to accommodate requests by debtors on their watch to accomplish a quick emergence from chapter 11 or to entertain a late bid for the debtor’s assets, the ABI Commission would require courts to subject any such attempts to heightened scrutiny, and would force sale proponents to recognize that any deviations from the norm must be justified under the circumstances, and not simply the result of a potential purchaser’s unilateral demands.