The Bottom Line:
Asset sales are a major part of chapter 11 cases. And with asset sales usually come expense reimbursements and break-up fees for stalking horse bidders. Although not as frequent an occurrence as compensating the stalking horse, instances arise in which potential non-stalking horse bidders will only agree to proceed with due diligence and bidding if they are reimbursed their expenses. On August 16, 2011, the United Stated Court of Appeals for the Fifth Circuit upheld a decision authorizing a debtor to reimburse qualified bidders participating in the second-round of bidding at an auction for the sale of a substantial estate asset. In the Matter of ASARCO, L.L.C., No. 10-40930, 2011 U.S. App. LEXIS 16892 (5th Cir. Aug. 16, 2011). In doing so, the Fifth Circuit elected to use the more liberal “business judgment rule” standard under section 363 and not the stricter standard outlined under section 503(b) used by certain courts in evaluating break-up fees. The Court also held that the bankruptcy court’s order authorizing the reimbursement of expenses was a final order, which was immediately appealable under 28 U.S.C. § 158(a).
Factually, in Asarco, the debtor conducted a sale of a potentially valuable asset – specifically, a district court judgment against the debtor’s parents for, among other things, actual fraudulent transfer. The debtor implemented a two-part bid solicitation process, subject to a topping auction. In order to generate additional bidding, the debtor sought permission to reimburse certain expenses incurred by bidders selected to participate in the second phase of the bidding process, including additional due diligence costs. The bankruptcy court approved the debtor’s request. The decision was appealed and the Fifth Circuit was faced with two questions: (i) did the Court have jurisdiction to hear the appeal (i.e. was the bankruptcy court order granting reimbursement of expenses a final, appealable order); and (ii) was the business judgment rule under section 363 the applicable standard.
The Fifth Circuit quickly resolved the first issue, holding that the bankruptcy court reimbursement order was a final, appealable order under 28 U.S.C. Section 158(a), which requires finality of decisions, judgments, orders or decrees in order for a district court or court of appeals to have jurisdiction. Appellants argued, unsuccessfully, that the order was not final because it did not detail the actual rights of reimbursement in the order itself, leaving the final determination of reimbursement to the future. Appellants looked to the Second Circuit’s decision in In re Integrated Resources Incorporated, 3 F.3d 49 (2d Cir. 1993), which held that the Second Circuit lacked jurisdiction over a bankruptcy court order approving a break-up fee, whose amount was subject to future, contingent events. However, the Fifth Circuit reasoned that Integrated Resources was not persuasive and that the Fifth Circuit and Second Circuit utilize different standards regarding bankruptcy appeals: the Second Circuit applies a more rigid rule, while the Fifth Circuit is more flexible considering orders final when they are “a final determination of the rights of the parties to secure the relief they seek, or a final disposition of a discrete dispute within the larger bankruptcy case.” In re Kizzee-Jordan, 626 F.3d 239, 242 (5th Cir. 2010). The Court held that the reimbursement order constituted a “final disposition of a discrete dispute within the larger case” and was “sufficiently separable from the rest of the bankruptcy proceeding to be appealable as a ‘final’ order under Sections 158(a) and (d).” ASARCO, 2011 U.S. App. LEXIS 16892 at 11.
In addressing the substantive standard the Court should apply to analyze the debtor’s motion to reimburse the expenses of the second-phase bidders, the Court examined the options – either section 363, which incorporates a business judgment standard, or section 503(b), which applies a stricter standard under which post-petition administrative expenses are paid only when they benefit the estate. Appellants contended that the business judgment standard was inappropriate for reimbursing expenses incurred by third parties in conducting due diligence during a sale process (i.e. the potential purchasers). They relied upon two Third Circuit decisions choosing to apply section 503(b) to break-up fees: In re Reliant Energy Channelview LP, 584 F.3d 200 (3d Cir. 2010); In re O’Brien Environmental Energy, Inc., 181 F.3d 527 (3d Cir. 1999). In both decisions, the Third Circuit rejected break-up fees for unsuccessful stalking horse bidders because the fees were not “actual, necessary costs and expenses of preserving the estate.” In Asarco, the Fifth Circuit distinguished those decisions from the present factual situation, where “a debtor requests the authority to reimburse expense fees ‘for second-round ‘qualified’ bidders in a multistage auction for a very unique and very valuable but potentially worthless asset.’” ASARCO, 2011 U.S. App. LEXIS 16892 at 17-18. The reimbursement order would pay expenses regardless of a bidder’s success; the reimbursement would serve to enhance, rather than chill, bidding; and the reimbursement order was entered prior to those bidders incurring their expenses. As a result, the Court held that the more applicable standard to follow was the business judgment standard.
Why the Case is Interesting:
Not all bankruptcy auctions are the same and not all auction processes respond to the same rules. In Asarco, the Fifth Circuit recognized that asset value maximization might require more flexibility – as determined in a debtor’s reasonable business judgment – to incentivize bidding. While the case applies to a potentially complicated asset being sold – in that case, a litigation claim – the flexibility to incentivize participants in a multi-stage auction to perform additional due diligence regarding an asset that was difficult to value was important.