Purchaser of Liquidating Chapter 11 Retail Case Assets Files Its Own Liquidating Chapter 11 Less than Three Months Later: A Growing Trend?

In late August 2008, Judge Allan L. Gropper authorized the debtors in the Steve & Barry's retail chapter 11 cases to sell substantially all of their assets (the sale) to BH S&B Holdings LLC, (BH S&B), including scores of real property leases and designation rights for dozens of other real property leases. In re Steve & Barry's Manhattan LLC, Case No. 08-12579-ALG, Docket No. 628 (Bankr. S.D.N.Y. Nov. 24, 2008). BH S&B is a special-purpose entity that was formed by investment firm Bay Harbour Management to be the "purchaser" of Steve & Barry's assets. The sale order authorized a joint venture of two well-known liquidation companies, Hilco Merchant Resources LLC and Gordon Brothers Retail Partners LLC (the liquidator), to conduct going out of business (GOB) sales at hundreds of the Steve & Barry's leased locations. Pursuant to the sale order and the asset-purchase agreement (APA), the purchaser had the obligation to pay all expenses associated with the GOB sales, including rent at the locations where lease designation rights had been sold to the purchaser. The APA also contemplated an escrow account and other means of giving the debtors, court, landlords and other parties in interest the comfort that the purchaser would meet its obligations created by the sale. Almost immediately after entry of the sale order, the liquidator began conducting the GOB sales and the proceeds of those sales began flowing through Steve & Barry's accounts.

Fast forward less than three months later to Nov. 19. Unable or unwilling to pay all of its sale-related obligations, the purchaser filed a chapter 11 bankruptcy petition. In re BH S&B Holdings LLC, Case No. 08-14604-MG.[1] At the first-day hearings in the purchaser's case, the "new debtor" asked Judge Martin Glenn to approve a debtor-in-possession loan and to authorize the retention of a new liquidating company to conduct new GOB sales at many of the locations formerly leased by Steve & Barry's. The "old debtors" objected to the DIP loan and GOB sale motions and asserted ownership of certain assets (e.g., inventory) that the new debtor was preparing to use and sell as part of the proposed GOB sales. The old debtors claimed that the assets in question were needed to pay postpetition administrative expenses in its chapter 11 cases arising from the purchaser's nonpayment of sale-related expenses. The purchaser argued that alleged unpaid sale-related expenses were only prepetition general unsecured claims in the new debtor's case, and therefore were not entitled to special treatment.[2]  

After Judge Glenn left the bench at the conclusion of the initial set of first-day hearings, counsel to the new and old debtors remained in the courtroom and attempted to resolve the disputes. It soon became clear, however, that the old debtor's counsel and counsel for the new debtor had widely differing interpretations of important and arguably ambiguous sections of the APA that governed ownership rights and security interests in, among other things, certain real property leases, the inventory and other assets contained therein, and millions of dollars of credit card receipts. What also became clear was that it would take a lot of effort, money and perhaps most importantly time to untangle the complex transaction created by the sale order and APA.

On Friday, the second consecutive day of contested hearings involving disputes between the new and old debtors about, among other things, (1) the priority and treatment of post-sale claims in the newly-filed cases, and (2) ownership of, and security interests in, leases, inventory, credit card payment proceeds, bank accounts and other assets, Judge Glenn announced that he and Judge Gropper would conduct a joint evidentiary hearing the following Monday in an attempt to resolve the myriad issues occasioned by the bankruptcy filing of the purchaser, and the resulting duel between bankruptcy estates for assets to pay claims. Judge Glenn urged both debtors to attempt to resolve as many issues as possible before Monday's hearing.

Over the weekend, both debtors negotiated a stipulation among themselves and the secured lender to old debtors that resolved many of the inter-estate disputes. The fact that the old debtors had control over bank accounts containing millions of dollars of proceeds from the GOB sales being conducted pursuant to the original sale order undoubtedly gave them the leverage necessary to negotiate successfully for the payment of all postpetition administrative expenses in the Steve & Barry's bankruptcy cases. The stipulation, which was "so ordered" by both judges after Monday's hearing, established a protocol that generally allows (1) parties to informally submit requests for payment of unpaid sale-related expenses, and (2) the old debtors to pay sale-related expenses (after review and an opportunity to object by the new debtor and its secured lender).  Through mid-December, it appeared that the stipulation has resulted in the payment of a substantial amount of the purchaser's sale-related obligations. Currently, the stipulation appears to be a good result given the complicated inter-estate issues and the avoidance of costly and time-consuming litigation that would otherwise have detrimentally impacted creditors of both debtors.

As an interesting sidenote, Judges Gropper and Glenn appeared to give serious consideration to the fact that the stipulation was being presented for court approval before a creditors' committee could be formed in the new debtor's bankruptcy case. As a result, the judges required that advance notice of certain actions to be taken under the stipulation be provided to the top 30 creditors in the new debtor's bankruptcy case. However, as one might expect, almost immediately after appointment of a creditors' committee in the new debtor's case, the committee moved under Rule 60 for reconsideration of the court's approval of the stipulation. The Rule 60 motion was denied on Dec. 17.
In light of current economic conditions, the correct answer to the above-captioned question may very well be "yes, this is a growing trend." If so, query whether §363 sales will fall out of favor, or if better proof of a purchaser's ability to perform will be required by bankruptcy courts.  Regardless, in the context of asset sales in chapter 11 cases, parties in interest need to consider the potential ramifications of an asset purchaser's post-sale (1) inability or unwillingness to comply with its obligations under a sale order, and (2) chapter 11 filing.