[1]Section 363 sales are a common vehicle for a debtor and its creditors to receive fair value for the debtor’s assets through an open auction process supervised by the bankruptcy court. An open auction process is designed to generate a number of competitive offers for the debtor’s assets. A debtor in possession[2] has a fiduciary duty to its stakeholders to maximize the value of its estate when selling assets pursuant to § 363 of the Bankruptcy Code.[3] However, that fiduciary duty to maximize value from a sale is not satisfied simply by conducting an arithmetic task of picking the highest sale price from multiple offers; rather, there are other pertinent factors that have a significant effect on value that need to be considered, as illustrated by a recent bankruptcy court decision from the Western District of Michigan.
In In re Family Christian, Case No. 15-643 (JFG) [Docket No. 931] (Bankr. W.D. Mich. June 18, 2015), the bankruptcy court issued a memorandum opinion (the “Family Christian Opinion”) denying the debtors’ motion to sell substantially all its assets to an insider, FCS Acquisition, LLC (“Acquisition”) because (1) the debtors failed to properly consider and value a number of factors other than the sale price, such as the value of avoidance actions and insider releases proposed to be sold in the purchase agreement, and (2) the debtors failed to establish the good faith of Acquisition, the insider purchaser.[4] Since the proposed sale would benefit an insider of the debtor, the court also applied heightened scrutiny to the sale transaction. Accordingly, the court found that the debtors did not properly select the “highest and best offer” under this heightened scrutiny and refused to approve the sale.[5]
Specifically, the debtors had not ascribed a particular value to the insider releases or the avoidance actions proposed to be assigned by the debtors to Acquisition in the purchase agreement. Since the debtors were assigning valuable avoidance actions to Acquisition, the bankruptcy court expected that the debtors or the creditors’ committee (which was heavily involved in the negotiations) would have presented evidence of the value of the releases and the avoidance actions.[6] However, no such evidence was presented to the bankruptcy court. No member of the creditors’ committee was present to testify at the sale hearing, nor was an affidavit submitted that could provide the court with an explanation as to the value of the assets and the fairness of the final sale price. The debtors even “confessed that they had yet to complete their analysis of the value of” the releases and the avoidance actions.[7] Accordingly, the court found that the debtors did not meet their burden of showing the “relationship of the sale price to the value of the assets being sold.”[8]
The debtors also failed to establish the good faith of Acquisition — in fact, neither the debtors nor the creditors’ committee presented any evidence whatsoever on that issue. The bankruptcy court specifically held that the mere fact that the creditors’ committee “emphatically supported the transaction with legal arguments” did not satisfy the debtors’ burden in showing the good faith of an insider purchaser. In particular, the bankruptcy court found “completely inappropriate” an ex parte communication between the CEO of the operating debtor and the principal of Acquisition during the auction. The CEO of the operating debtor had contacted the principal of Acquisition and asked that Acquisition increase its bid.[9] Additionally, the bankruptcy court ruled that the proposed sale “dictates terms of a future plan of liquidation” and did not give proper notice to creditors of the transaction, particularly of the proposed releases being granted by the debtors, since the auction did not have a stalking-horse bidder.[10]
In re Family Christian highlights important issues that practitioners need to consider when conducting auctions pursuant to § 363 of the Bankruptcy Code, particularly when an insider is involved and the bankruptcy court will, as a result, apply heightened scrutiny to any proposed transaction. First, the value of all consideration of the transaction must be considered, including nondebtor releases and any assignments of causes of action to the purchaser. This valuation may require the assistance of the creditors’ committee if the releases and assignments of causes of action benefit an insider. Second, extreme and diligent care must be used when an insider is bidding at an auction. There should be absolutely no ex parte communications, especially before the auction has closed. It is imperative that all communications be made publicly and be available to all bidders. Additionally, specific evidence of the insider purchaser’s good faith should be presented to the court (preferably by the creditors’ committee if it is involved in the negotiations). The mere fact that the creditors’ committee itself participated in negotiations and supports the transaction is not enough to satisfy a debtor’s burden of showing the good faith of the purchaser. Simply put, In re Family Christian stands as a reminder to all debtors conducting § 363 sales to not simply “mechanically accept a bid with the highest dollar amount,” but also to “evaluate other [pertinent] factors,” which (1) must include a valuation of all assets, causes of action being sold and any releases being given, and (2) may include, among other things, “contingencies, conditions, timing, or other uncertainties in an offer that may render it less appealing.”[11]
[1] The authors are associates in the Business Reorganization and Restructuring Practice Group of Willkie Farr & Gallagher LLP in New York. The views expressed herein are merely the views of the authors and do not represent the views of their firm. The authors would also like to thank Derek M. Osei-Bonsu, a summer law clerk at the firm, for his invaluable research assistance.
[2] The authors use the terms “debtor-in-possession” and “debtor” interchangeably throughout this article.
[3] See In re Continental Air Lines, Inc., 780 F.2d 1223, 1226 (5th Cir. 1986)
[4] See Family Christian Opinion at 36-37, 42-43.
[5] See id. at 46-47.
[6] See id. at 42.
[7] Id.
[8] Id.
[9] Particularly troubling was that the principal of Acquisition had hired the CEO of the operating debtor and that this CEO expected to be CEO of Acquisition if it ultimately purchased the debtors’ assets. See id. at 25, 37.
[10] Id. at 44.
[11] Id. at 31.