The decision of whether and how to sell assets in a bankruptcy proceeding can trigger a number of disagreements, and the bidding process itself can attract some unusual bids. For example, in some cases, the Trustee may not feel that selling a particular asset is worth the time and trouble; however, a creditor may disagree. Another example occurs in a case in which the bankruptcy estate has potential claims for breach of contract or torts. In such a case, the breaching party or tortfeasor may be willing to offer the highest and best price to buy (and, thus, resolve) those claims against itself. In some cases, the most valuable bid may be a non-cash one. However, if the benefits of such a non-cash bid are public benefits, or do not otherwise ultimately produce cash with which to pay the creditors entitled to be paid, the Trustee may not be able to accept that bid. In some cases, it is difficult to evaluate the value of a bid in terms of the ability of the bidder to perform of of the Trustee's costs of keeping the bankruptcy proceeding open or of performing its own obligations under the terms of the bid. The purpose of this article is to high-light some of the case law dealing with such conflicts
I. Applicable Law.
A. A Defendant May Buy, from the Trustee, a Cause of Action Against that Defendant. The Trustee may sell, as an asset of the bankruptcy estate, any cause of action the debtor has against a third party. Furthermore, the buyer, in such a sale may be one of the defendants. In re: Nicole Energy Services, 385 B.R. 201, 2008 Bankr. LEXIS 1007 (Bankr. E.D. Ohio, 2008); Travelers Casualty and Surety Company v. Future Claimants Representative, 2008 U.S. Dist. LEXIS 23496 (N.J., 2008); Simantob v. Claims Prosecutor, L.L.C. (In re Lahijani), 325 B.R. 282, 2005 Bankr. LEXIS 887, 44 Bankr. Ct. Dec. (LRP) 247 (B.A.P. 9th Cir., 2005).
B. Section 363 and Bankruptcy Rule 9019 Analyses of Bids. Such a proposed sale of a cause of action, particularly to a defendant, needs to be analyzed under both Section 363 and under the "fair-and-equitable" standard governing compromises under Fed. R. Bankr. P. 9019. Nicole, Travelers, and Lahijan, all supra.
In Nicole, the Court set forth the applicable standards, for approval under Section 363, as follows:
Under the law of this Circuit, the Court may approve a sale of all of a debtor's assets under § 363(b) "when a sound business purpose dictates such action." Stephens Indus., Inc. v. McClung, 789 F.2d 386, 390 (6th Cir. 1986). In making its determination under the Stephens Industries analysis, the Court considers the following factors: whether the terms of the proposed sale reflect the highest and best offer for the assets, whether the negotiations were conducted at arm's length, and whether the sale is in the best interest of the estate and its creditors. . . .
Thus, when deciding whether to approve a § 363 sale, a court must "'expressly find from the evidence presented before [it] at the hearing a good business reason to grant such an application [to sell].'" Id. at 389 (quoting Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983)). The party seeking approval of the sale bears the burden of demonstrating that there is a sound business purpose for the sale. See Lionel, 722 F.2d at 1071. The objecting party must "produce some evidence respecting its objections." Id.
The Lionel court provided a roadmap--which was followed by the Sixth Circuit in Stephens Industries--to guide bankruptcy courts when deciding whether there is a sound business purpose for a proposed sale:
In fashioning its findings, a bankruptcy judge must not blindly follow the hue and cry of the most vocal special interest groups; rather, he should consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity holders, alike. He might, for example, look to such relevant factors as the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and, most importantly perhaps, whether the asset is increasing or decreasing in value. This list is not intended to be exclusive, but merely to provide guidance to the bankruptcy judge.
Id.; Stephens Indus., 789 F.2d at 389. Stated differently, the sound-business-purpose test requires "1) [a] sound business reason; 2) accurate and reasonable notice; 3) [an] adequate price; and 4) good faith." In re Country Manor of Kenton, Inc., 172 B.R. 217, 220 (Bankr. N.D. Ohio 1994). . . .
In this regard, the Court emphasized the importance bidding procedures and auction in assuring the highest return to the creditors of the bankruptcy estate.
The Court, in Nicole, also discussed the possible need for good faith:
Some courts have held that "when a bankruptcy court authorizes a sale of assets pursuant to section 363(b)(1), it is required to make a finding with respect to the 'good faith' of the purchaser." . . . The Court need not and therefore does not reach the issue of whether an affirmative finding of good faith is required to approve a sale. Such a finding, however, is appropriate here.
"The 'good faith' requirement, although not expressly contained in § 363(b), has been grafted on to the approval of sales . . . because that requirement appears in § 363(m) governing appeals. . . ." In re Congoleum Corp., 2007 Bankr. LEXIS 1707, 2007 WL 1428477 at *2 (Bankr. D.N.J. May 11, 2007). "[T]ypically, the misconduct that would destroy a purchaser's good faith status at a judicial sale involves fraud, collusion between the purchaser and other bidders or the trustee, or an attempt to take grossly unfair advantage of other bidder[s]." In re Weatherly Frozen Food Group, Inc., 149 B.R. 480, 483 (Bankr. N.D. Ohio 1992) (internal quotation marks omitted). In assessing the good faith of a purchaser, courts have considered factors such as: (1) whether the sale was negotiated at arm's length, see id.; (2) whether any officer or director of the debtor holds any interest in or is otherwise related to the potential purchaser, see id.; and (3) whether fraud or collusion exists among the prospective purchaser, any other bidders or the trustee. See Abbotts Dairies, 788 F.2d at 147.
The Court, in Nicole, also set forth the applicable standards, for approval under Bankruptcy Rule 9019, as follows:
Because the sale effectuates a settlement of claims held by the estate, the Court also must evaluate the agreement between the Trustee and TCO as a compromise under Fed. R. Bankr. P. 9019. In doing so, the Court must review the agreement under the "fair-and-equitable" standard. See Bauer v. Commerce Union Bank, 859 F.2d 438, 441 (6th Cir. 1988) (requiring court to apply fair-and-equitable standard to evaluate proposed compromises). The test for determining whether the proposed compromise is fair and equitable requires the Court to evaluate: (1) the Debtor's probability of success if the litigation proceeds; (2) what difficulties may arise in the collection of any judgment; (3) the complexity, expense and delay that the parties will face; and (4) whether the proposed settlement satisfies the paramount interests of creditors and takes into account their views. See Fishell v. Soltow (In re Fishell), 47 F.3d 1168 (table), 1995 WL 66622 at *3 (6th Cir. 1995).
C. Non-Cash Bids Can Be Accepted by the Trustee. The consideration offered in such a sale need not be in cash. In Lahijani, supra, the defendant offered all cash to purchase a cause of action against itself. The other bidder for that cause of action was a creditor who offered a lower amount of cash plus a percentage of the amount of the recovery that creditor/bidder received in prosecuting that cause of action. However, the trustee demanded that all bids be in the form of only cash. In remanding the case, the Court held that the bankruptcy court should have evaluated the present value of the offered percentage of recovery, including by multiplying the anticipated recovery by the percentage of risk involved in achieving that recovery.
D. An Additional Alternative for Causes of Action under the Trustee's Avoidance and Recovery Powers. The Bankruptcy Court is obligated to consider allowing a creditor to recover, "for the benefit of the estate any property transferred or concealed by the debtor" pursuant to Section 503(b)(3)(B). Such a creditor has standing to sue on behalf of the trustee, but needs to proceed at its own risk and expense, subject to reimbursement under Section 503(b). Lahijani, supra.
E. A Bid is Not Improved by Providing Non-Economic Benefits that Do Not Increase the Amount of Cash Realized by the Estate from the Sale. The number of job created or other public benefits are not factors that weigh against the creditors' rights to receive cash. In In re Gulf-State Steel, Inc., 285 B.R. 497, 2002 Bankr. LEXIS 1317 (Bankr. N.D. Ala., 2002), the court rejected an argument to accept a lower bid because of "the number of jobs created in the local community . . . the effect on the community . . . environmental issues . . . the preferences of the local government".
F. A Bid is Not Improved by Providing Value to Creditors Beyond Bankruptcy Statutory Priorities. In re United Healthcare Sys. Inc., 1997 U.S. Dist. LEXIS 5090 (N.J., 1997).
II. Application of Some of the Law to Some of the Facts in this Case.
A. Ability of the Respective Bidders to Pay as Promised. David is a recent dental school grad with no experience managing an office or paying employees. vs. Ken has successful established his dental practice, albeit only recently and though breach and theft. Is the Stalking Horse Bidder licensed to practice dentistry.
B. Timing of the Payments in Relation to the On-Going Expenses of the Estate. The bankruptcy court needs to consider the present value of the bids. Lahijani, supra. Ken's bid provides a large up-front cash infusion, a high interest rate, and monthly installments and delays final payment for only 2 years.
C. Costs, to the Estate, of Performing Its Obligations under the Bid. Whether, and on what terms, the equipment lease is accepted or rejected after the bidding. Ken's bid leave the equipment lease with the estate, causing rejection damages.
D. Weighing the Costs of the Assumption and Acceptance of the Equipment Lease for the Stalking Horse Bidder vs. Rejection Damages if No One Else Buys the Lease.
E. The Stalking Horse Bidder's Bid is Not Improved by the Fact that It Offers to Hire the Former Employees of the Debtor.
III. Issues Not Addressed Here.
A. Whether the customer list is "personally identifiable information" under Section 363(b)(i), depending upon the debtor's policies in effect upon the commencement of the case and whether a consumer privacy ombudsman is appointed. If it is "personally identifiable information", settlement of potential litigation may make Ken the only possible "purchaser".
B. Successor liability by buying the Debtor's dental business as a going-concern, vs. buying just certain assets. Degree of protection provided by a Court Order with respect thereto. Notice issues.
C. Whether the Court should consider only bids that comply with the technical bidding procedures previously approved by the Court. For example, Ken did not pre-qualify as a "Qualified Bidder", is not willing to buy "all or substantially all" of the assets to be sold under the Asset Purchase Agreement, and is not paying all "cash".
D. Whether the settlement of all lawsuits by a Trust
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E. Whether sales of substantial assets should take place as part of a plan of reorganization, instead of under Section 363. See Ind. State Police Pension Trust v. Chrysler LLC (In re Chrysler LLC), 576 F.3d 108 (2d Cir., 2009); In re Chrysler LLC, 405 B.R. 84 (Bankr. S.D.N.Y., 2009); In re Gen. Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y., 2009).
F. In a sale in bulk of assets separate to separate liens or with unsecured assets, how to allocate the purchase price.
G. Whether the "Minimum Initial Overbid Amount", the "Break-Up Fee" or the "Expense Reimbursement" amounts encourage a sale for the benefit of the bankruptcy estate vs. chill bidding.