The Delaware Supreme Court in C & J Energy Services, Inc., et al. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, No. 655/657 (“C & J Energy”) recently entered an order confirming that, even in a change of control situation, a board of directors does not need to actively shop a company before or after signing a merger agreement and can negotiate with only a single bidder in seeking a sale as long as there is a “viable passive market check” of the process.1
There has been a recent trend in bankruptcy cases to pursue a sale of substantially all a debtor’s assets through a sale under 11 U.S.C. §363 early in the case. These “fast track” 363 sales have drawn some criticism within the bankruptcy community as sometimes providing insufficient protection to various stakeholders and not always maximizing the value of the debtors’ assets2; however, if bankruptcy courts are willing to accept a pre-bankruptcy sale process similar to what the Delaware Supreme Court approved in C & J Energy, it is possible that a debtor could seek approval of a sale of substantially all its assets in the case’s infancy — or even as part of first day motions — without running an auction or seeking to engage multiple bidders pre-petition.
C&J Energy, Inc. (“C & J”) entered into a merger agreement with Nabors Industries Ltd. (“Nabors”)3; however, before C & J’s shareholders could approve the merger agreement the City of Miami General Employees’ and Sanitation Employees’ Retirement Trust (the “Plaintiffs”) brought a class action on behalf of itself and other shareholders to enjoin a merger between C & J and Nabors. In the class action litigation, the Plaintiffs asserted that C & J’s board of directors improperly entered into a change of control transaction without properly executing its fiduciary duties.4
The proposed merger between C & J and Nabors involved only a single bidder and there was a provision in the deal that prohibited C & J from soliciting other bids; however, C & J did have a “fiduciary out” of the deal if a superior proposal was presented during a lengthy passive market check of the transaction and, so as not to dissuade higher and better offers, there was only a modest termination fee of 2.27 percent of the value of the deal.5
The Delaware Court of Chancery reviewed the proposed merger and the process C & J’s board of directors undertook in arriving at the merger agreement. After conducting its analysis, the Court of Chancery issued a preliminary injunction enjoining the shareholder vote on the merger for 30 days and ordered C & J to solicit competing bids. The Court of Chancery held that even though C & J’s board had no conflict of interest in entering into the merger agreement with Nabors and was fully informed of C & J’s value, the court determined that there was a “plausible” violation of the board’s duties under Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).6
C & J and certain of its directors pursued an expedited appeal of the Court of Chancery’s order to the Delaware Supreme Court. In C & J Energy the Delaware Supreme Court reversed the order of the Chancery Court and allowed the merger to proceed to a shareholder vote without requiring C & J to solicit other bids.
In arriving at its decision to reverse the Court of Chancery, the Delaware Supreme Court noted, “[w]hen a board exercises its judgment in good faith, tests the transaction through a viable passive market check, and gives its stockholders a fully informed, uncoerced opportunity to vote to accept the deal, we cannot conclude that the board likely violated its Revlon duties.”7 The Delaware Supreme Court further noted that “[s]uch a market check does not have to involve an active solicitation, so long as interested bidders have a fair opportunity to present a higher-value alternative, and the board has the flexibility to eschew the original transaction and accept the higher-value deal. The ability of the stockholders themselves to freely accept or reject the board’s preferred course of action is also of great importance in this context.”8
Potential Impact on Fast Track Section 363 Sales in Bankruptcy
The Delaware Supreme Court’s determination that a board can comply with its fiduciary duties attendant to the sale of a company without engaging multiple bidders or actively confirming the market value through an auction process may provide debtors and asset purchasers a roadmap and persuasive authority for proceeding with an accelerated sale of substantially all a debtor’s assets in bankruptcy.9
Section 363 of the Bankruptcy Code allows a trustee or debtor-in-possession the opportunity to sell a debtor’s assets outside the ordinary course of business free of all liens, claims or interests after notice, a hearing and court approval.10 Although it is not required by the Bankruptcy Code, typically there is a public sale and auction process conducted.11 The C & J Energy court, however, highlighted that Delaware state law does not require an auction sale in order for the board to be found in compliance with its Revlon duties, holding that “…Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction.”12
Compliance with state law alone, however, may not be sufficient to satisfy the bankruptcy court. The publicity surrounding a bankruptcy filing and the ability to acquire assets in a manner not possible outside the bankruptcy context — free and clear of liens, claims or interests and with certain protections for good faith purchaser — may lead to the emergence of new bidders with higher and better offers after the commencement of the case. Consequently, a bankruptcy court may require a post-filing auction or it may delay the debtor’s proposed sale believing that the market for the debtor’s assets may be improved by slowing down the sale process.13
Conversely, even the most expedited public 363 sale and auction may materially impact the value of the debtor’s assets as any delay can result in further deterioration in value and ever-increasing administrative expenses associated with the bankruptcy case may further depress a potential recovery to creditors. A potential bankruptcy debtor seeking to combat these dual causes of diminution in value by proposing to sell its assets at the beginning of a bankruptcy case may be able to successfully follow the C & J Energy game plan of only engaging a single bidder; bypassing an auction sale process prior to, or after, its bankruptcy filing; and present an executed asset purchase agreement to the bankruptcy court for approval as soon as the filing date of the bankruptcy petition or shortly thereafter. If the bankruptcy court agrees that the debtor subjected the sale to a passive market check prior to the bankruptcy filing, that the debtor conducted a reasonable process in seeking to maximize its value and no creditor or rival bidder appears to object to the sale after sufficient notice, the bankruptcy court should allow the sale to proceed.
In C & J Energy the Delaware Supreme Court confirmed there is no exact blueprint for a board of directors to comply with their duties under Revlon in the selling a company. The analysis hinges on whether the board in exercising its business judgment makes a reasonable decision in seeking to maximize the value of the company during a sale. A sale in a distressed context pursuant to Section 363 of the Bankruptcy Code introduces certain statutory requirements that are not present in a non-bankruptcy sale of a company; however, a debtor will be faced with a similar duty to maximize the value of the assets — this time not for shareholders or equity, but for creditors. Debtors have argued that expedited 363 sales significantly reduce administrative expenses in bankruptcy cases and C & J Energy may provide support for a debtor who wants to pursue a sale of substantially all its assets at the beginning of a case without an auction process. As it was with the board in C & J Energy, the burden will be on the debtor to show that its presale process was reasonable and maximized the value of the assets. Debtors and asset purchasers should be prepared that an early 363 sale, especially without an auction, will likely draw intense scrutiny from the bankruptcy court and various creditor representatives; however, just as the Delaware Supreme Court did not see a need to stand in the way of the shareholder vote on a no-shop, single bidder sale, a bankruptcy court will likely approve an expedited sale under similar circumstance if the creditors are satisfied that the debtor’s sale process has resulted in the best deal for its assets.