Finality in Auction Sales It Aint Over Till Its Over

The historical standard
regarding the finality of auction sales under judicial auspices was
set by
Justice Learned Hand in Knight v. Wertheim
& Co., 158 F.2d 838 (2d Cir. 1946):
"Except upon the extremist provocation, courts will not upset a
judicial sale at auction on the grounds that a new bidder has
appeared who
offers more than the knock-down price." While bankruptcy courts
differ as to the extent to which they are involved in the §363
of the
Bankruptcy Code sale process...some welcoming sales in their
courtrooms
and others prohibiting it...they unquestionably "play an active
role in bankruptcy sales."¹

Case law confirms at least superficial lip service to
this historical standard,² but adherence to Justice Hand
is far from
uniform. Indeed, the provocation necessary to entertain late bids,
at
least prior to confirmation of an auction, is anything but
"extreme." Most often the integrity of the auction is ignored
in favor of a new, perhaps more modern, standard, best described as
"following the money": "The governing principle at a
confirmation proceeding is the securing of the highest price for the

bankruptcy estate."³

It would be easier to accept this paradigm shift if
it was accompanied by uniformity in analysis and, therefore,
guideposts by
which lawyers can advise clients. Unfortunately, the grounds that
have been
used to justify accepting post-auction, pre-sale confirmation order
bids
are without a consistent approach. Constitutional, comparative,
equitable,
percentage and even psychological bases, individually and in
combination,
have been used by courts to justify accepting late bids. This lack
of clear
standards has diminished the integrity of the auction process and
created
such obvious uncertainty for bidders and their lawyers that one
published
decision even included the lawyers' entreaty to the court that
"we would love to see the court establish what procedures we follow
in the future so we don't get into this mess again."⁴

The Grounds for Accepting Late Bids

Courts have the least difficulty reopening auctions
when due process rights have been violated. This will arise where a
party-in-interest has a legally recognizable interest, such as a
right of
first refusal, to protect in connection with the assets being
sold.⁵

The cases adopting what can be called a comparative
analysis focus not on the procedural aspects of the auction, but
rather on
comparing bids, and have adopted ill-defined, adjective-laden terms
to
compare the auction bid with the post-auction bid. Is the original
bid
"grossly inadequate"?⁶ Is the late bid
"substantially
larger"⁷ or
"substantially better"?⁸ Does the discrepancy
"shock the conscience of the court"?⁹ While there may be
finality in such decisions due to the difficulty of upsetting, on
appeal, a
decision based on a judge's discretionary sense of financial
fairness, such decisions set no standards and offer little guidance.

The statistical cases attempt to quantify the
adjectives in the comparative cases. An 8.5 percent difference was
deemed
"relatively small,"¹⁰ while 15 percent was
"substantially
better"¹¹

and 35 percent made the initial bid "grossly
inadequate."¹² These cases do little to
protect the integrity of
the original auction, but they do provide some insight to a
particular
jurisdiction's sense of price point.

Courts using non-economic fairness as a standard vary
between an objective view,¹³ such as whether there was a
"level
playing field"¹⁴ or basing the decision on
what would affect the
validity of private transactions,"¹⁵ and a more subjective
standard (e.g., "no bidder
complained,"¹⁶ "[the bidder] recognized
that the perceived
finality of a sale does not turn entirely on the formal close of
bidding."¹⁷).

Finally, at the more arcane psychological level are
those decisions in which the courts seek to determine, and not
frustrate,
that which they decide should have been or was, depending on the
evidentiary record, the "reasonable expectations" of the
participants.¹⁸

The state of the law on the issue of accepting late
bids has been so diffuse that the Food Barn court felt the
need to state that, with respect to the
finality of bankruptcy auctions, "under appropriate circumstances, a

complete lack of standards, resulting in chaos, could conceivably
give use
to an independent claim that the court abused its discretion...."¹⁹

The most recent effort to calm this roiling water is
that of the Seventh Circuit with Corporated
Assets Inc. v. Paloian, 368 F.3d 761 (7th
Cir. 2004). Unfortunately, rather than establishing procedures more
certain
than those set by other courts, the decision disappointingly seems
to adopt
every approach ever taken to support allowing a post-auction,
pre-confirming order bid.

Corporated Assets Inc. v. Paloian

As is typical, the debtors, Goss Holdings Inc. and
Goss Graphic Systems Inc. (collectively, "Goss"), sought and
obtained court authority to sell certain of their operating assets
in
accordance with approved bid procedures. Also somewhat typically,
bidders
were required to qualify for the auction by submitting a bid, a
deposit, a
signed asset-purchase agreement, and financial data demonstrating,
in the
debtors' judgment, ability to consummate the purchase.

Goss had the discretion to determine the highest and
best offer and present that bid to the court for approval after the
auction. Goss also had the discretion to impose additional terms and

conditions "prior to the sale hearing" although one could
question the impact of post-auction, pre-hearing additional
conditions
absent a material change in the financial condition of the high
bidder
post-auction.

Consistent with this discretion, Goss, in response to
concerns expressed by several prospective bidders, modified the
approved
asset-purchase agreement to assure buyers that removal of the
purchased
assets would not have to take place prior to June 1, 2002. Some
potential
bidders learned of this prior to the auction and others first
learned of
this at the auction. This modification was apparently material;
after it
was announced, bids increased by almost 40 percent.

The Auction

At the auction, held on a Monday but prior to
bidding, in response to a direct question about the finality of the
bidding
process (i.e.,
would bids be accepted post-auction at pre-hearing), counsel for
Goss
accurately but equivocally stated, "So I guess I can't give you
100 percent assurances that someone can't walk into court on
Wednesday and try to outbid whoever wins today, but I think that is
a very
slim possibility."²⁰

The only bidding at the auction was for second place.
The pre-auction high bid of $2.25 million by Corporate Assets Inc.
(CAI)
remained the highest offer. Myron Bolling Auctioneers (MBA) was the
second-highest bid at $2.075 million. A closing was scheduled for
the day
after the court hearing.

The Aftermath

The following day, MBA advised Goss that it was
willing to bid $2.45 million and that the reason it did not do so at
the
auction was because it first learned, at the auction, of the change
in the
Asset Purchase Agreement assuring that removal of the assets could
take
place at any time up to June 1, 2002. MBA was unable, prior to the
close of
bidding, to communicate with certain key members of its bidding
group. Once
it was able to contact those members, consensus was reached on the
higher
figure.

Based on this higher offer, Goss, backed by its
lenders and the committee, sought and obtained a continuance of the
sale
acceptance hearing, and Goss scheduled a second auction two days
later.

The second auction was held and CAI again won, this
time at $2.6025 million. The sale hearing the following week
produced one
of those great moments that are part of bankruptcy lore: CAI, the
high
bidder, not only objected to acceptance of its own bid, arguing that
its
earlier high bid should be approved but also sought compensation, as
an
administrative expense, for its costs in connection with the second
auction. The bankruptcy court accepted the results of the second
auction
and denied compensation. The district court affirmed.

The Integrity Analysis

As was its duty, the circuit court recognized the
process as a "judicial sale" and paid homage to the need to
uphold the integrity of such sales in the bankruptcy courts. In
perhaps its
strongest language, the court drew a bright line between the
standards that
apply after court confirmation of an auction and stated that until
confirmation of a sale, "the court enjoys broader discretion to
balance the goal of estate maximization against the interest in
regularity
and finality and the parties' expectations."²¹

Due Process

While not directly interposing constitutional
considerations into the analysis, the Seventh Circuit did uphold the

district court's conclusion that fundamental fairness did not
require
the winning bidder to be compensated for its legal fees in
connection with
the second auction.

Comparative and Percentage Analysis

These approaches were combined. The court twice
recited the percentage increase in bids post-auction, describing the

initial overbid of "roughly nine percent" to be
"significant" and the final bid of "approximately 16
percent" more than the auction bid to be "a significant
boon" to the estate although "perhaps insufficient to
demonstrate gross inadequacy in the original bid."

Expectation Analysis

The reasonable expectation of the parties was a
significant factor in Paloian.

Relying on Gil-Bern but with a scant evidentiary record, the
court
constructed a base of bidder's reasonable expectations based on
local
custom, the bidding procedures order and the statements of Goss's
counsel at the auction. From that, the court concluded that bidders
were at
least "alerted to the possibility" that the auction bid would
not end the bidding process.

Equitable Analysis

So as not to leave any door unclosed, the court
adopted equitable reasons as well for affirming the propriety of a
second
auction. The playing field wasn't "entirely level"
because some bidders knew, prior to the auction, of an important
modification to the bid terms,...i.e., the deletion of the
early-removal provision from the
asset-purchase agreement. This term was referred to as "highly
material" as reflected by the later increased bid. The second
auction
"redress[ed] that inequity."

Conclusion

What's a lawyer to do?

The menu of reasons an auction "ain't
over till its over" continues to be that extensive. Recent
decisions,
even at the circuit court level, do little to provide rules other
than
"bidder beware." Little heed is paid to Justice Hand's
statement that "there is no occasion equivalent to an auction whose
finality must be preserved if its advantages are to be preserved."²²
Also uncertain is the position of the debtor's lawyer with respect
to
a late bid, considering that the lawyer's duties might run to the
debtor,²³
but not to its shareholders,²⁴ to the creditors and the
court,²⁵
or generally to the estate.²⁶ While there is protection
for courts
accepting late bids based on bid procedure orders that allow for
modification at the discretion of the debtor's counsel, the more
room
for bid procedure modification at counsel's discretion, the less
integrity there is in the process. This could give rise to equitable
claims
of unfairness.

Certainly, one can safely conclude that a video or
stenographic recording of the auction is helpful as are bid
procedures and
notices that require the presence, at the auction, of bidder
principals or
agents with full authority. Having a uniformity of approach on the
issue of
late bids among the debtor, committee and lenders also increases
certainty.
Whether language in a bid procedures order that contains a deadline
for
offers will be sufficient to overcome the goal of estate
maximization is
uncertain. At a minimum, however, it will determine what the
expectations
should be.

Perhaps Paloian is yet another early chapter in a §363
of the
Bankruptcy Code sale book that eventually will point toward a clear
resolution. It looks, however, as if there's a long way to go.

Footnotes

¹ In re Winton Inn &
Restaurant Corp., 120 B.R. 631, 635 (E.D.N.Y. 1990). Return to article

² In re Webcor Inc.,
392 F.2d 893
(7th Cir. 1968), cert. denied, 393 U.S. 837 (1968); In re
Fulwood Enter. Inc., 105 B.R. 707 (Bankr.
M.D. Fla. 1989). Return to article

³ In re Chung King
Inc., 753
F.2d 547, 549 (7th Cir. 1985). Return to article

⁴ In re Food Barn
Stores Inc., 107
F.3d 558, 566 n.14 (8th Cir. 1997). Return to
article

⁵ In re Farmland
Indus. Inc., 284
B.R. 111, 120 (Bankr. W.D. Mo. 2002) ("[T]he court cannot sacrifice
the due-process rights of parties to the expediency of the
auction...."). Return to article

⁶ Food Barn, 107
F.3d at 566; In re Kendall Foods Corp., 122
B.R. 792 (Bankr. S.D. Fla. 1990). Return to
article

⁷ In re Wintz
Co., 219 F.3d
807 (8th Cir. 2000). Return to article

⁸ In re Wintex,
158 B.R.
540 (D. Mass. 1992). Return to article

⁹ Chung King,

753 F.2d at
550. Return to article

¹⁰ Id. at
550-551. Return to article

¹¹ Wintex, 158
B.R. at 540. Return to article

¹² Kendall, 122
B.R. at 792. Return to article

¹³ In re Quanalyze Oil
& Gas Corp., 250 B.R. 83, 92 (Bankr. W.D. Tex. 2000). Return to article

¹⁴ In re Brethren Care
of South Bend Inc., 98 B.R. 927 (Bankr. N.D. Ind. 1989). Return to article

¹⁵ In re Windspread
Corp., 92
B.R. 87 (Bankr. S.D.N.Y. 1988). Return to article

¹⁶ In re
Edwards, 228 B.R.
552 (Bankr. E.D. Pa. 1998). Return to article

¹⁷ In re Gil-Bern
Indus. Inc., 526
F.2d 627 (1st Cir. 1975). Return to article

¹⁸ In re Financial
News Network Inc., 980 F.2d 165, 170 (2d Cir. 1992). Return to article

¹⁹ Windspread, 92
B.R. at
87. Return to article

²⁰ Paloian, 368
F.3d at 764. Return to article

²¹ Paloian, 368
F.3d at 769. Return to article

²² Knight, 158
F.2d at 844. Return to article

²³ In re Office Prod.
of America Inc., 136 B.R. 983 (Bankr. W.D. Tex. 1992). Return to article

²⁴ In re Kendavis
Indus. Int'l. Inc., 91 B.R. 742 (Bankr. N.D. Tex. 1988). Return to article

²⁵ In re JLM Inc.,
210 B.R.
19 (2d Cir. B.A.P. 1997). Return to article

²⁶ In re Perez,

30 F.3d 1209
(9th Cir. 1994). Return to article