Edgewater Growth Capital Partners LP v. H.I.G. Capital, Inc., 68 A.3d 197 (2013)
Edgewater Growth Capital Partners LP created the debtor and guaranteed its indebtedness. After several attempts to restructure the debtor, the company’s assets were sold at foreclosure. Edgewater sued when the secured lender’s affiliate purchased the assets, claiming the foreclosure sale violated the UCC. The court ruled that the foreclosure sale was public, commercially reasonable, and did not violate the UCC provisions governing post-default disposition of collateral. The court also ruled that Edgewater was responsible for repayment of the limited guaranteed amount, plus interest, attorney fees and costs incurred by the lender in the litigation brought by Edgewater.
Edgewater purchased and aggregated companies providing ATM services into one organization named Pendum. In the restructuring, Edgewater capitalized Pendum with little equity and burdened it with more than $70 million in senior secured debt. Edgewater’s inability to effectively create and manage an integrated business plan for the enterprise resulted in multiple financial covenant defaults, a series of forbearances, and ultimately, the demand by Pendum’s creditors for a permanent and strategic restructuring of Pendum. Edgewater failed to produce a restructuring plan. Further, the investment banker hired to sell Pendum as a going concern was unable to obtain an unqualified going concern opinion from Pendum’s auditor. Without that certification, it became clear that no investor would purchase the company as a going concern.
Following this sequence of events, the senior lenders became fed up and refused to further fund the company’s liquidity shortfall. The lenders chose, instead, to sell a majority of their senior debt position to an affiliate of H.I.G. Capital, Inc. (HIG). At this point, Edgewater had two choices: infuse the company with additional capital, or cede control of the company. Edgewater decided to cede control. The Edgewater-designated board members resigned and were replaced with restructuring professionals appointed by the lenders. When a last-ditch effort to restructure the company failed, all parties, including Edgewater, agreed that a bankruptcy filing would not provide the best result. Instead, the board of directors negotiated a foreclosure sale agreement with HIG under Article 9 of the UCC that required Pendum’s assets to be marketed and auctioned. Edgewater and the subordinated lender opposed the Article 9 sale in favor of an out-of-court reorganization, but neither entity was willing to fund the costs of reorganization. In fact, neither party was willing to fund the costs of an orderly Article 9 foreclosure sale.
HIG advanced the costs and expenses of hiring the financial advisor to market the assets, and covered the operational shortfalls stemming from Pendum’s continued operations during the two-month marketing period. When no buyer came forward in the market, Pendum’s assets were auctioned. Pendum Acquisition, Inc., an affiliate of HIG, was the only bidder, and purchased the company’s assets for the minimum bid amount set forth in the foreclosure sale agreement. Attempting to alleviate its obligation under a $4 million guaranty, Edgewater sued HIG and the purchaser, arguing that the foreclosure sale violated the Uniform Commercial Code because it was a private disposition and was not conducted in a commercially reasonable manner.
The Delaware Chancery Court ruled that Pendum Acquisition purchased Pendum’s assets in a commercially reasonable sale and that Edgewater had to make good on its guaranty. According to the UCC, every aspect of a post-default disposition of collateral by a secured party must be done in a commercially reasonable manner. It’s a fact-intensive inquiry and a case-by- case determination. Here, the court identified several factors supporting its conclusion that the sale was commercially reasonable: the debtor’s operations hemorrhaged cash; the assets had been aggressively marketed by a financial advisor; sophisticated entities, including other creditors and Edgewater itself, made no attempt to acquire the assets at a higher value; Edgewater’s own internal correspondence stated that it did not believe the assets were worth more than what Pendum Acquisition paid at auction; and, no one else bid at the open, properly noticed, auction.
Edgewater argued that a sale pursuant to a foreclosure sale agreement between a secured party and the company board was necessarily a private sale. The court disagreed. The court considered the commentary to the UCC on what constitutes a public versus a private disposition of collateral. Per the commentary, a public disposition is one at which the price is determined after the public has had a meaningful opportunity for competitive bidding. Meaningful opportunity is construed to mean that some form of advertisement or public notice precedes the sale date. Thus, the court concluded that a sale is a public sale when it is advertised and potential buyers have an opportunity to bid for the assets. The court held that the foreclosure sale agreement provided a meaningful opportunity for the public to bid on Pendum’s assets at auction. It was the means by which HIG was willing to infuse money into Pendum in order to fund an orderly liquidation by marketing the assets for sale to strategic and financial buyers, and then opening the sale process up to public auction. The court concluded that the agreement had a manifestly positive effect on the sale outcome. The fact that the minimum bid set forth in the foreclosure sale agreement was also the winning bid happened only after the opportunity for higher bids had come and gone and there were no other takers. The court reasoned that to accept Edgewater’s argument that a foreclosure sale agreement is per se a private sale would create counter- productive incentives for secured parties to fire-sell assets to the detriment of debtors.
Edgewater also argued that a two-month sale period was an artificial deadline that adversely affected the sale price. The court held that what constitutes a reasonable timeframe for the sale must be analyzed in the context of the debtor’s operational circumstances. By the time the foreclosure sale agreement was executed in December 2007, Edgewater ceded control of Pendum and the company was an insolvent, operational mess, unattractive to any purchaser. It had been operating at significant losses since its inception and had sought nine covenant default waivers, extensions, modifications or forbearances from its creditors. HIG acquired its first round of senior debt at 76 cents on the dollar in September 2007. A few months later it acquired additional senior debt at 72 cents on the dollar. The subordinated secured lender had written down its investment by 50 percent in June 2007 and wrote down its entire investment by September 2007. Additionally, Edgewater itself refused to infuse additional capital to extend the sale period. All of these factors established that the two-month sale period was commercially reasonable.
The court also extensively detailed the marketing process the financial advisor undertook, noting that he utilized the same zeal and strategy in his attempts to find a buyer for Pendum’s assets as he employed for marketing going-concern entities. The court accepted the testimony from HIG’s expert witness that not one potential buyer was overlooked. Each of the 44 parties that expressed an interest in the company as part of the marketing campaign received notice of the time and place of the auction. Additionally, notice of the auction was advertised twice in the Wall Street Journal. Accordingly, the court found the sale process to be commercially reasonable. Finally, the court concluded that the purchase price was commercially reasonable because it was the product of a commercially reasonable public sale in which no one else bid at the sale, and because Edgewater’s internal communications stated it was unwilling to purchase the assets for a higher price.
Edgewater’s aggressive litigation tactics substantially backfired on it. When entering judgment against Edgewater on the limited guaranty, the court interpreted the guaranty to cap the maximum indebtedness on the principal, only, and that HIG was entitled to recover principal, plus interest, and attorney fees and costs. The court cited to prior rulings holding that “a court of equity has broad discretion, subject to principles of fairness in fixing the [interest] rate to be applied.” Finding that Edgewater was utilizing litigation tactics not to ensure a better sale price, but to get out of its obligations under the guaranty and, in Edgewater’s words, “to gum up” the foreclosure process, the court used its powers of equity to award HIG principal in the amount of $1.8 million, plus interest compounded quarterly from June 25, 2008. The final blow to Edgewater was imposition of the attorney fees and costs. The fee-shifting language in the guaranty was broad and covered any fees and costs incurred by HIG arising out of or consequential to the protection, assertion, or enforcement of the guaranteed obligations. The broad language covered all fees and costs incurred by HIG in five years of litigation. It did not, however, cover the obligations HIG incurred indemnifying the Pendum board of directors.
The UCC’s requirement for commercial reasonableness in every aspect of the sale process is a fact-driven inquiry that will depend on the parties’ particular circumstances. This case highlights the benefits of using a foreclosure sale agreement to provide a structure that ensures a debtor’s assets are fairly marketed and that requires the public be given a meaningful opportunity to bid at an open, advertised auction. The case also highlights the detriment that can befall an aggressive and improperly motivated litigant. The possibility of compounding interest quarterly on $1.8 million in principal for five years, plus paying all of the secured party’s fees and costs incurred in litigation, should give a party pause before pursuing litigation where the real motivation is to evade contractual obligations rather than assert what the party truly finds to be a commercially unreasonable sale yielding an unfair purchase price.