• Reexamining Bankruptcy Auctions: Is that Your Final Answer?
  • November 5, 2010 | Author: Douglas S. Mintz
  • Law Firm: Cadwalader, Wickersham & Taft LLP - Washington Office
  • When selling assets under section 363 of the Bankruptcy Code or pursuant to a plan, debtors typically conduct auctions, selecting the highest or best bidder as the purchaser.  This enables debtors to maximize the value of their assets, while ensuring "finality and integrity in the process . . . ."1

    These considerations may conflict when a losing bidder objects to the approval of the sale, asserting that its bid is a higher or better offer and highlighting alleged flaws in the auction process.  This article considers two recent unpublished bench decisions from Judge James M. Peck of the United States Bankruptcy Court for the Southern District of New York, in which Judge Peck refused to order the reopening of auction proceedings to allow new bids.  The article also examines a seemingly contrary unpublished bench decision of Judge Kevin J. Carey of the United States Bankruptcy Court for the District of Delaware, in which Judge Carey agreed to recommence bidding based on his determination that it would result in increased value to the estate.  A likely critical distinction was that the objecting parties in Judge Peck's courtroom sought to make new offers they did not make at the auction, whereas Judge Carey required the debtors to accept a higher bid that had already been made before the end of the auction.

    Statutory Framework

    Section 363 allows a chapter 11 debtor to sell assets outside the ordinary course of the debtor's business, free and clear of existing liens, claims and encumbrances,2 so long as the debtor demonstrates a good "business reason" for the sale.3  Under sections 1123 and 1129 of the Bankruptcy Code, a chapter 11 debtor may likewise sell its assets free and clear of existing liens pursuant to a plan of reorganization. Although not required, this sale process may occur through a public auction.5  The auction process is typically governed by court-approved bidding procedures, which regulate the solicitation of purchasers, the selection of qualified bids, and the conduct of the auction. As with any sale of assets outside the ordinary course of business, if a debtor holds an auction and selects a winning bid, the debtor must obtain bankruptcy court approval of the sale and demonstrate that the selected bid is the highest or best offer.7  Bankruptcy courts will generally defer to a debtor's decision regarding the highest or best offer unless the decision is inconsistent with sound business judgment.8  In this situation, a losing bidder generally lacks standing to object to a sale. However, a losing bidder may have standing if the debtor fails to comply with the bidding procedures or if the losing bidder is also a creditor, which would have standing to object to the proposed sale as a party in interest independent of its role as a bidder.10 

    Finlay Enterprises, Inc.

    In In re Finlay Enterprises, Inc.,11 the debtors held an auction pursuant to court-approved bidding procedures to liquidate certain assets.12  At the auction, Synergies Corp. successfully bid $555,000 on a portion of the debtors' intellectual property.  After the debtors filed notice of the successful bids, Zale Corporation objected, asserting that (i) the debtors did not comply with the established bidding procedures; (ii) the auction never officially closed; (iii) after the debtors adjourned the auction, Zale submitted two bids greater than Synergies' winning bid; and (iv) Zale was prepared to submit a revised bid that was $200,000 more than the Synergies' winning bid.13  In response, the debtors contended that they fully complied with the bidding procedures and that Synergies outbid Zale, which elected to stop bidding.14  The debtors added, however, that although the auction had concluded, Zale's most recent bid was significantly higher than Synergies' bid, and the debtors would be open to considering Zale's bid so long as Synergies was given a chance to submit further bids.15  In addition, on the date of the hearing on the debtors' motion to approve the sale, Windsor Jewelers, Inc. filed a limited objection to the debtors' notice of successful bids, arguing that, before its representative left the auction, it submitted the highest or best bid on an asset that was subsequently sold to another bidder and that it would have been willing to bid significantly more on that asset if it were given the chance.16

    At the hearing, Judge Peck ruled from the bench that the scope of his review of the auction was limited to whether the parties violated court-approved bidding procedures, stating that "the only reason that I should be dealing with this [objection] is if there is a legitimate concern that there has been a violation of a court order.  Only then does this dispute really rise to the level of judicial intervention."17  While Judge Peck agreed to consider the potential value that Zale's subsequent bid would bring to the estate, he noted that additional value "will not be what guides my review."18  Rather, Judge Peck focused his analysis on whether "there has or has not been a material deviation from the auction procedures that somehow prejudice[s Zale]."19

    Judge Peck emphasized that finality is of central importance to bankruptcy estate auctions.  Specifically, he stated that "the only way that auctions of assets can be conducted fairly, not only in the Finlay Enterprises'  bankruptcy but in every other case, is if the parties who participated [at] the auction recognize that it really matters whether they choose to bid or not to bid . . . ."20  Judge Peck found that "disgruntled" bidders, such as Zale, "ordinarily . . . do not have standing to be heard at a hearing such as this,"21 and also determined that Windsor and any other party who joined in objecting to the auction "in a me too fashion" had no standing.22  Judge Peck did not rule on Zale's motion from the bench, but rather took the matter under consideration so he could review the auction transcript and determine whether the bidding procedures order "was, in fact, respected."23  Approximately two weeks later, on November 25, 2009, Judge Peck entered an order approving, inter alia, the sale to Synergies and overruling any remaining objections to the sale, including the objections by Zale and Windsor.24

    Extended Stay Inc.

    Judge Peck returned to the theme of the paramount importance of finality in bankruptcy auctions at the hearing approving the sale in In re Extended Stay Inc.25  In Extended Stay, the debtors selected Centerbridge Partners, L.P. and Paulson & Co. Inc.-who were joined by Blackstone Real Estate Partners VI L.P. later in the auction process-(the "C/P/B Investors") as stalking horse bidders, and agreed to conduct an open auction, in accordance with court-approved bidding procedures, through which third parties could make higher and better offers.  The auction took place on May 27, 2010, and for nearly 19 hours, two bidders, the C/P/B Investors and affiliates of Starwood Capital Group Global, L.P., vied to become the debtors' plan sponsor.  After the C/P/B Investors submitted a high bid of $3.925 billion, the CEO of Starwood withdrew from the auction, stating "We are done, thank you very much, congratulations.  Good luck to you."26

    Two weeks after the auction's conclusion, Starwood objected to the debtors' motion to approve the sale to the C/P/B Investors, arguing that improper deviations from the court-approved bidding procedures denied Starwood the opportunity to make a higher or better offer during the auction.27  Specifically, Starwood argued that, in contravention of the bidding procedures, the special servicer and operating advisor for the Debtors' prepetition senior secured debt required only cash bids.28  Starwood asserted that this chilled bidding, resulting in a winning bid that did not maximize value for the debtors' estates.29  As a result, Starwood never made its best offer.30  The debtors, the C/P/B Investors, and other parties in interest characterized Starwood's objection as a case of "non-buyer's remorse"31 and an attempt to undermine an auction that complied with all ordered procedures and in which Starwood voluntarily and without objection participated, and from which it finally withdrew, again without making any objections.32

    At the June 17, 2010 hearing on the debtors' motion to approve the sale, Starwood unsuccessfully attempted to convince Judge Peck to reopen the bidding.  At the beginning of the hearing, Judge Peck noted that while he would be open-minded with respect to "credible assertions . . . that there was a deviation from the bid procedures," he was "very unsympathetic to the last minute pirating of this process."33  In an exchange with Starwood's counsel, Judge Peck dismissed Starwood's complaints, stating: "You were not limited in any way, you participated voluntarily in an auction and now you're complaining about it. . . . You accepted the rules, you participated pursuant to the rules.  And with all the creativity available to you[,] you could have come up with a bid that was the highest and best bid."34  After being unable to convince Judge Peck of any "deviation from the bid procedures," Starwood withdrew its challenge to the auction procedures, and the court approved the debtors' sale to the C/P/B Investors.35         

    Foamex International, Inc.

    In contrast to Judge Peck's focus on whether bidding procedures were followed and the need for finality in auctions, Judge Carey, in In re Foamex International, Inc.,36 demonstrated a willingness to consider the potential additional value to the estate in determining whether to reopen an auction for additional bidding.  In Foamex, the debtors conducted an auction pursuant to court approved bidding procedures to sell substantially all of their assets and selected Wayzata Capital Investment Partners LLC's $141.5 million all-cash bid as the winning bid.37  Wayzata's bid, however, was $5 million lower than the $146.5 million all-cash bid of the stalking horse bidder, MP Foam DIP LLC, an affiliate of first lien lenders MatlinPatterson Global Opportunities Partners III L.P. and MatlinPatterson Global Opportunities Partners (Cayman) III L.P.  The Matlin group made its all-cash bid subject to the condition that if the auction continued past the current round and the Matlin group made a subsequent bid, the debtors would permit the first lien agent, at the Matlin group's direction and request, to credit bid the entire first lien debt.  The Matlin group and the majority of the first lien lenders objected to the debtors' motion to approve the Wayzata purchase, arguing that the debtors violated the bidding procedures order by selecting an inferior bid, and violated section 363(k) of the Bankruptcy Code by denying the first lien agent the right to credit bid at the auction.38

    During the May 21, 2009 hearing on the debtors' motion to approve the sale to Wayzata, Judge Carey stated that although he believed the debtors complied with the bidding procedures, the debtors should have accepted the Matlin group's bid as the highest or best offer.39  Judge Carey was "convinced, based upon what has occurred, that there may be more value to be had for the estate . . . ."40  Judge Carey denied the debtors' motion to approve the sale, ordered that the auction resume and ordered that the debtors allow the first lien agent to credit bid pursuant to section 363(k) of the Bankruptcy Code during the resumed auction proceedings.41 

    The auction resumed on May 21, 2009, and the debtors selected the first lien agent's credit bid for $155 million, made at the Matlin group's direction, as the winning bid.42  On May 26, 2009, Wayzata objected to the selection of this bid and indicated that it was willing to increase its all-cash bid at a reopened auction.43  However, at the subsequent hearing to approve the sale to the first lien agent on May 26, 2009, Judge Carey was not convinced "that another round [of bidding] would be of any use."44  Thus, Judge Carey found that the first lien agent's bid was the highest or best bid and that it adequately reflected the value of the estate.45

    Conclusion

    The Finlay, Extended Stay, and Foamex cases demonstrate the conflict between the desire to maximize estate value and the need for the finality in auction proceedings.  Judge Peck in Finlay and Extended Stay approached this tension with a view toward finality, focusing on whether material and prejudicial deviations from the court-approved bidding procedures occurred.  Judge Carey in Foamex placed a greater emphasis on maximizing estate value when he reopened the debtors' auction, even though the debtors had followed the court-approved bidding procedures.  A key distinction between the cases may be that in Foamex, the Matlin group had actually made a higher bid during the auction that the debtors did not accept.  The Matlin group then contested the results and requested relief from the Court.  By contrast, in both Finlay and Extended Stay, the dissenting bidders failed to submit a higher or better offer, walked away from the auction, and then disputed the results in court.  Thus, to preserve their ability to challenge an auction, bidders are well-advised to make their highest or best offers as part of the auction process, regardless of any seeming variations from the procedures.  If the debtor then selects an offer the bidder believes is lower or less desirable than its last offer, the bidder will be best positioned to dispute the results before the bankruptcy judge.

    1 Transcript of Record at 77, In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 21, 2009) [Docket No. 485].
    2 11 U.S.C. § 363(b), (f); see also Smart World Techs., LLC v. Juno Online Servs., Inc. (In re Smart World Techs., LLC), 423 F.3d 166, 169 n.3 (2d Cir. 2005) ("Section 363 permits sales of assets free and clear of claims and interests.").
    3 Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d. Cir. 1983).
    4 11 U.S.C. §§ 1123(a)(5)(D), 1129(b)(2)(A)(iii); 3 Collier on Bankruptcy ¶ 1129.04[2][b][i], [ii] (15th ed. rev. 2008).
    5 See Fed. R. Bankr. P. 6004(f)(1).
    6 See In re Gen. Growth Props., No. 09-11977 (ALG), 2010 WL 3638264, at *1,2 (Bankr. S.D.N.Y. Aug. 27, 2010); In re First Republic Group Realty, LLC, No. 09-13983 (MG), 2010 WL 3638032, at *1 (Bankr. S.D.N.Y. Aug. 18, 2010).
    7 See, e.g., In re First Republic Group Realty, LLC, No. 09-13983 (MG), 2010 WL 3638032, at *2 (Bankr. S.D.N.Y. Aug. 18, 2010); In re Integrated Res., Inc., 135 B.R. 746, 750 (Bankr. S.D.N.Y.), aff'd, 147 B.R. 650 (S.D.N.Y. 1992), appeal dismissed, 3 F.3d 49 (2d Cir. 1993).
    8 See Gen. Growth Props., 2010 WL 3638264, at *3 ("The Selling Debtors' determination that the Amended Purchase Agreement constitutes the highest and best offer for the Parcel constitutes a valid and sound exercise of the Selling Debtors' business judgment."); In re Verified Identity Pass, Inc., No. 09-17086 (SMB), 2010 WL 2822165, at *2 (Bankr. S.D.N.Y. Apr. 16, 2010) ("The Debtor has properly exercised its reasonable business judgment in determining to sell substantially all of the Debtor's Acquired Assets and in determining that the Buyer's offer represents the highest and best offer for the Acquired Assets.")
    9 3 Collier on Bankruptcy ¶ 363.02[1][c].  See also In re Trans World Airlines, Inc., No. 01-00056 (PJW), 2001 WL 1820326, at *10 (Bankr. D. Del. Apr. 2, 2001) ("However, it is not appropriate for a "bidder" to come into the hearing with a proposal which has not been properly presented to the debtor's board of directors and its advisors pursuant to a court ordered bidding procedure, but instead to seek to have the bankruptcy court exercise its independent business judgment and direct the debtor accordingly.").
    10 3 Collier on Bankruptcy ¶ 363.02[1][c].  See also Licensing by Paolo, Inc. v. Sinatra (In re Gucci), 126 F.3d 380, 388 (2d Cir. 1997) ("Creditors ordinarily have standing to appeal bankruptcy court orders that make a disposition of estate property since that sort of order directly affects the funds available to meet their claims.  In contrast, unsuccessful bidders usually lack standing to challenge a bankruptcy court's approval of a sale.").
    11 No. 09-14873 (JMP) (Bankr. S.D.N.Y.).
    12 Notice of Selection of Successful Bids at Auction, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 10, 2009) [Docket No. 357].
    13 Limited Objection by Zale Corporation to the Debtors' Notice of Selection of Successful Bids at Auction ¶ 7-12, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 11, 2009) [Docket No. 362].
    14 Debtors' Response to Limited Objection by Zales Corporation to the Notice of Selection of Successful Bids at Auction ¶ 3, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 12, 2009) [Docket No. 365].
    15 Id. ¶ 4.
    16 Limited Objection of Windsor Jewelers, Inc. to the Debtors' Notice of Selection of Successful Bids at Auction ¶ 4-5, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 12, 2009) [Docket No. 368].
    17 Transcript of Record at 44, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 12, 2009) [Docket No. 378].
    18 Id. at 45.
    19 Id.
    20 Id. at 44.
    21 Id. at 45.
    22 Id. at 46.
    23 Id. at 45.
    24 Order Pursuant to Sections 105(a), 363 and 365 of the Bankruptcy Code and Bankruptcy Rules 6004, 6006 and 9014 Authorizing (A) the Sale of Assets, Free and Clear of Liens, Claims, Encumbrances and Other Interests and (B) Assumption and Assignment of Nonresidential Leases of Real Property, In re Finlay Enters., Inc., No. 09-14873 (Bankr. S.D.N.Y. Nov. 25, 2009) [Docket No. 399].
    25 No. 09-13764 (JMP) (Bankr. S.D.N.Y.).
    26 Transcript of Record at 22, In re Extended Stay Inc., No. 09-13764 (JMP) (Bankr. S.D.N.Y. June 17, 2010) [Docket No. 1102].
    27 Starwood's Objection to Debtors' Motion to Approved Investment Agreement and Disclosure Statement, In re Extended Stay Inc., No. 09-13764 (JMP) (Bankr. S.D.N.Y. June 14, 2010) [Docket No. 1051].
    28 Id. at 4-5.
    29 Id.
    30 See id. at 9.
    31 Debtors' Reply in Further Support of Their Motion for Approval of Disclosure Statement and for Selection of the C/P/B Investors as the Successful Bidder, at 3, In re Extended Stay Inc., No. 09-13764-JMP (Bankr. S.D.N.Y. June 16, 2010) [Docket No. 1070].
    32 Statement in Response to Starwood's Objection to the Debtors' Motion to Approve Investment Agreement and Disclosure Statement, at 2-3, In re Extended Stay Inc., No. 09-13764-JMP (Bankr. S.D.N.Y. June 16, 2010) [Docket No. 1075].
    33 Transcript of Record at 27-28, In re Extended Stay Inc., No. 09-13764 (JMP) (Bankr. S.D.N.Y. June 17, 2010) [Docket No. 1102].
    34 Id. at 33, 34
    35 Id. at 82, 85-86; Order (I) Pursuant to Sections 105 and 363(b) of the Bankruptcy Code Approving Investment Agreement with Successful Bidder, (II) Approving Disclosure Statement Reflecting the Successful Bid, (III) Establishing Solicitation and Voting Procedures, (IV) Scheduling a Confirmation Hearing, and (V) Establishing Notice and Objection Procedures for Confirmation of the Debtors' Proposed Plan of Reorganization, In re Extended Stay Inc., No. 09-13764-JMP (Bankr. S.D.N.Y. June 22, 2010) [Docket No. 1098]
    36 No. 09-10560 (KLC) (Bankr. D. Del.).
    37 Debtors' Omnibus Response to Objections to Debtors' Motion for Entry of, Among Other Things, An Order (A) Approving the Proposed Sale, (B) Authorizing the Assumption and Assignment of Certain Executory Contracts and Unexpired Leases, and (C) Granting Certain Related Relief, In re Foamex Int'l Inc., No. 09-10560 (KJC), (Bankr. D. Del. May 21, 2009) [Docket No. 451].
    38 Objection of the Majority First Lien Lenders to Debtors' Motion to Approve the Sale of Substantially All of Their Assets, In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 21, 2009) [Docket No. 446].
    39 Transcript of Record at 75, In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 21, 2009) [Docket No. 485].
    40 Id. at 77.
    41 Id.  For further information on recent developments in credit bidding, see Douglas S. Mintz, Leslie W. Chervokas & Mark Arinci, Philly News: Third Circuit Upholds Bidding Procedures Denying Lenders Opportunity to Credit Bid, Restructuring Rev. (Fin. Restructuring Dep't, Cadwalader, Wickersham & Taft LLP), June 2010, at 1-5, available at http://www.cadwalader.com/list&under;newsletters.php?newsletter&under;type&under;id=7&newsletter&under;id=7; Stephen Johnson & Mark Arinci, Third Circuit Expected to Rule on Secured Creditors' Right to Credit Bid in Connection with Chapter 11 "Cramdown" Plan, Restructuring Rev. (Fin. Restructuring Dep't, Cadwalader, Wickersham & Taft LLP), February 2010, at 1-6, available at http://www.cadwalader.com/assets/newsletter/RR&under;Feb&under;2010.pdf#page=1.
    42 Objection of Wayzata Investment Partners LLC, Wayzata Opportunities Fund II, L.P., and Foam Holdings, LLC to Debtors' Motion to Approve Sale of Substantially All of Their Assets, In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 26, 2009) [Docket No. 465].
    43 Transcript of Record at 32, In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del. May 26, 2009) [Docket No. 493].
    44 Id. at 112.
    45 Id. at  111-12, 113.