The Third Circuit denied a $275 million break-up fee to a bidder that was unsuccessful in its attempt to buy the crown-jewel assets in the high-profile EFH bankruptcy case. In re Energy Future Holdings Corp., No 18-1109, 2018 U.S. App. LEXIS 25945 (3rd Cir. Sept. 13, 3018). The court held that the bidder’s efforts didn’t result in a benefit to the debtors’ estates. Therefore, the bidder’s request for an administrative expense in the form of the fee was rejected.
This issue reached the Third Circuit after the Bankruptcy Court in Delaware initially awarded the fee, but then denied it on a motion for reconsideration. The Bankruptcy Court realized that it had misunderstood a key fact when it awarded the fee. When it later realized how the fee could be triggered, the Bankruptcy Court said the bidder wasn’t entitled to the fee. The Bankruptcy Court reversed its prior decision and the appeal followed.[i]
This unusual set of circumstances over such a large break-up fee led the Third Circuit to observe that “this case is anomalous.” 2018 U.S. App. LEXIS 25945, at *41. Perhaps even more important than the result (except to the bidder that won’t receive $275 million) are statements the Third Circuit made concerning the deadline (or lack thereof) for a party to file a motion to reconsider and the test the Circuit applies to determine if a party should receive a break-up fee as an administrative expense claim, which are discussed below.
EFH and its affiliates filed for chapter 11 in 2014 after an LBO failed. The debt was incurred before the 2008 recession when investors thought that natural gas prices would rise. But prices declined due to fracking and other factors, and the EFH entities defaulted on the debt.
The debtors’ crown-jewel asset was Oncor Electric Delivery Company LLC (“Oncor”), which had been ring-fenced from bankruptcy and remained a non-debtor. In 2017, the Bankruptcy Court and the Public Utility Commission of Texas (“PUCT”) approved the sale of Oncor to Sempra Energy. But before that deal succeeded, the PUCT had rejected two other deals: one by NextEra Energy, Inc. (“NextEra”) and the second by Berkshire Hathaway Energy Company. The NextEra deal prompted the litigation over the $275 million break-up fee.
The proposed NextEra deal had an $18.7 billion implied total enterprise value and would pay the debtors $9.5 billion. The PUCT nixed the deal because NextEra sought changes to Oncor’s “ring-fence” protections. The PUCT would not accept these changes, characterizing them as “deal killers.”
With the deal dead, NextEra went back to the Bankruptcy Court and sought the $275 million break-up fee. Based on comments made to the court by the debtors’ counsel, Bankruptcy Judge Christopher Sontchi thought the fee could be awarded based solely on the PUCT’s denial of NextEra’s acquisition of Oncor. A creditor later moved for reconsideration of that award, noting that the fee could be awarded only if the PUCT denied the deal and the debtors terminated the merger agreement.
Judge Sontchi realized that the merger agreement didn’t include a deadline for PUCT approval or rejection of the deal. This meant that if the PUCT didn’t act, then at some point in time the debtors might have to terminate the merger agreement. And NextEra would never have reason to terminate the deal but could wait until the debtors did so (if a PUCT decision wasn’t forthcoming) and then seek to collect $275 million from the bankruptcy estates.
But, Judge Sontchi concluded, this would not justify an administrative expense award for a bidder in NextEra’s position. On reconsideration, Judge Sontchi ruled that NextEra had not demonstrated that the fee was an “actual, necessary cost and expense of preserving the estate.” Bankruptcy Code section 503(b)(1)(A).
On appeal, NextEra argued both that (i) the reconsideration motion wasn’t timely filed, and (ii) Judge Sontchi’s decision granting reconsideration should be reversed on the merits. In a 2-1 decision, the Third Circuit affirmed Judge Sontchi’s decision.
The Third Circuit, in an opinion by Judge Greenaway, concluded that the reconsideration motion was timely because the order at issue was interlocutory and not final. The court noted that it takes “a flexible, pragmatic approach to finality in the bankruptcy context.” 2018 U.S. App. LEXIS 25945, at * 22 (citing Century Glove, Inc. v. First Am. Bank of N.Y., 860 F.2d 94, 97 (3rd Cir. 1988)). The order approving the break-up fee was interlocutory because it didn’t necessarily resolve all issues at stake. At a later date, the Bankruptcy Court might need to decide how to allocate the fee (if it had been approved) among the various debtors and also determine if, as the debtors had also asserted, NextEra had breached the merger agreement.
And because the order was interlocutory, there was no deadline for a party to file a reconsideration motion. In contrast, if the order had been a final one, then time deadlines set forth in Fed. R. Civ. P. 60 and Bankruptcy Rule 9024 would have been applicable and might have barred reconsideration.
On the merits, the Third Circuit noted the Bankruptcy Court’s factual error was subject to review based on the standard of “clear error.” Since there error here “was central to the relevant legal calculus” – whether the break-up fee could and should be awarded – the Third Circuit concluded that it was a “clear or manifest error warranting reconsideration.” 2018 U.S. App. LEXIS 25945, at *33 (emphasis in original).
In the Third Circuit, break-up fees can be awarded as administrative expense claims if a bidder’s action produces a benefit to a debtor’s estate by (i) promoting competitive bidding, (ii) doing due diligence on the debtor that provides a “value of the debtor” that can “convert . . . to a dollar figure on which other bidders can rely,” and (iii) the bidder “adheres to its bid” if an auction is required. Id. at *35 (quoting Calpine Corp. v. O’Brien Environmental Energy, Inc. (In re O’Brien Environmental Energy, Inc.), 181 F.3d 527, 537 (3rd. Cir. 1999), and In re Reliant Energy Channelview LP, 594 F.3d 200, 207 (3rd 2010)).
The Third Circuit concluded that NextEra satisfied none of these tests. Instead, it “could simply wait for the Debtors to terminate, which would trigger payment of the $275 million Fee. Under those circumstances, the Termination Fee would provide no benefit to the estate.” 2018 U.S. App. LEXIS 25945, at *37.
In dissent, Judge Rendell noted that the case “presented a difficult situation for the Bankruptcy Court,” but also concluded that it “abused its discretion in granting reconsideration.” Judge Rendell believed that Judge Sontchi’s misunderstanding of a key fact didn’t rise to the level of “legal or factual error.” Id. at *43.