The Third Circuit handed down an opinion that will be cited (incorrectly) for the notion that a stalking horse bidder is entitled to an administrative expense claim even in the absence of a breakup fee.
Properly read, the opinion makes these practice points: (1) the bankruptcy court should not deny a stalking horse’s administrative claim on a motion to dismiss or a motion for summary judgment, unless (2) the purchase and sale agreement was artfully written with an ironclad provision precluding the stalking horse from receiving any compensation other than a highly circumscribed breakup fee.
In short, the Third Circuit found loopholes in the debtor’s drafting of the purchase agreement and reorganization plan.
The Vanishing Breakup Fee
Electric energy giant Energy Future Holdings Corp. agreed to sell its Oncor regulated electric distribution business for a price that would have brought $9.8 billion into the chapter 11 estate. The agreement included a $275 million breakup or termination fee payable to the purchaser if the debtor were to terminate the agreement for almost any reason.
At the approval hearing, however, the bankruptcy judge understood that the buyer would not earn the termination fee if state regulators were to refuse to approve the sale and the debtor terminated the agreement. Misunderstanding the breakup fee, the bankruptcy judge approved the purchase agreement and the breakup fee in September 2016. State regulators did not disapprove the sale until April 2017.
The regulators wanted to ensure that Oncor would not go bankrupt. The regulators refused to approve the sale because the buyer would not accept conditions limiting its ability take money out of Oncor or operate the business in a fashion that could endanger Oncor’s financial stability.
After a second rejection by the regulators, the debtor terminated the agreement. At that juncture, the buyer seemed entitled to the $275 million breakup fee because the agreement, as written, called for the payment if the debtors terminated, even though the regulators had disapproved the acquisition. The agreement had no deadline for the buyer to obtain regulatory approval.
After termination of the agreement with the buyer, the debtor sold the business to another purchaser for several hundred million dollars less. The successful buyer was willing to live with the limitations on the operation of the business imposed by the regulators.
In July 2017, bondholders filed a motion for reconsideration, asking the bankruptcy judge to revoke approval of the termination fee that he had granted in September 2016.
Ruling on the creditors’ motion for reconsideration, the bankruptcy judge said it became clear that the purchaser would appeal the regulators’ decision “to all levels of review, leaving the debtors no choice but to terminate” the sale agreement and “risk triggering the termination fee or else incur months or years of continued interest and fee obligations.”
In his October 2017 opinion revoking approval of the breakup fee, the bankruptcy judge said the debtor had been “forced to terminate the [purchase] agreement [in July 2017] to pursue a lower offer because [the purchaser] had the debtor in a corner.” In re Energy Future Holdings Corp., 575 B.R. 616 (Bankr. D. Del. 2017). To read ABI’s report, click here.
The Third Circuit accepted a direct appeal and upheld the bankruptcy court in September 2018. In re Energy Future Holdings Corp., 904 F.3d 298 (3d Cir. Sept. 13, 2018). For ABI’s report on the circuit decision, click here.
Denial of the ‘Admin’ Claim
In the post hoc reconsideration and revision of the breakup agreement, both the bondholders and the circuit court recognized that the erstwhile buyer was entitled to seek an administrative expense claim under Section 503(b)(1)(A) for “the actual, necessary costs and expenses of preserving the estate.”
Of course, that’s what happened. The stalking horse filed an application for a $60 million administrative claim. Bondholders filed a motion to dismiss the administrative claim and a motion for summary judgment.
On several grounds, the bankruptcy court tossed out the administrative claim, granting both the motion to dismiss and the motion for summary judgment. The district court affirmed, prompting another appeal to the Third Circuit.
The Circuit Finds a ‘Plausible’ Claim
The Third Circuit reversed and remanded in a 38-page opinion on March 15 by Wendy Beetlestone, a district judge in Philadelphia sitting by designation.
Judge Beetlestone cited authorities laying out the constituents of an allowed administrative claim. In this writer’s view, her description of an allowed administrative claim is broader than it is in practice and, in some situations, narrower than in practice.
For instance, Judge Beetlestone held that the merits of an administrative claim are judged with the benefit of hindsight. Traditionally, counsel fees are judged by the perceived merits of the services at the time they are rendered.
There is a feature to the case that could make it altogether distinguishable when compared to later cases. In balancing the benefit to the estate against the costs to the estate, Judge Beetlestone noted how the buyer had been enticed to spend tens of millions given the assurance of a breakup fee that was later denied.
Judge Beetlestone decided that the buyer laid out a plausible claim that should not have been rejected on a motion to dismiss. It was erroneous, she said, to find no plausible benefit to the estate. She concluded that the work performed by the buyer had drawn a “roadmap” for later purchasers that “assisted in and sped up” the eventual sale of Oncor.
Judge Beetlestone overturned the grant of summary judgment because she found loopholes in the purchase and sale agreement and in the reorganization plan that allowed the buyer to assert an administrative claim.
Some language in the opinion could be read to mean that a stalking horse buyer is entitled to an administrative expense claim even in the absence of a breakup fee. For instance, Judge Beetlestone said that the buyer
plausibly contends that its labor in drafting the [purchase and sale agreement and the reorganization plan] (later relied upon [by the eventual purchaser]), settling with creditors objecting to the merger, and proving to future bidders that Debtors’ interest in Oncor would necessarily have the [regulators’ conditions] attached saved Debtors from reinventing the wheel even after the deal with [the purchaser] fell through. These arguments find support in the record.
Given evidence that the original buyer’s work benefitted the debtor’s estate, Judge Beetlestone said it was error for the lower courts to conclude that the buyer had not made a plausible case for costs necessary to preserve the estate.
Judge Beetlestone summed up the holdings on the last page of the opinion. She said that the buyer
plausibly alleged that through a post-petition transaction, the [purchase and sale agreement], it benefitted the estate by providing valuable information, and accepting certain risks that paved the way for the later . . . deal [with the eventual purchaser]. The precise monetary value of this benefit cannot be distilled from pleadings alone. And likewise, the costs [the debtor] allegedly imposed on the estate are equally uncertain. With respect to the motion to dismiss the question before us is not whether [the debtor] actually benefitted the estate, but whether it plausibly alleged that it did so.
Judge Beetlestone reversed both lower courts and remanded for the bankruptcy court to undertake further proceedings “consistent with this opinion.”
Observations
The opinion might be understood to mean that any bidder, not necessarily just a stalking horse, can plead a plausible claim for an administrative expense. However, statements in the opinion should be read in the context of a buyer who only found out years later that it would not receive a seemingly ironclad $275 million breakup fee. Perhaps the result in the Third Circuit was a one-off event born from a sense of rachmones.
Curiously, the opinion does not cite, discuss or analyze Section 503(b)(3)(D), which allows an administrative claim to a creditor, indenture trustee, equity holder or committee who makes a “substantial contribution” in a case under chapters 9 or 11.
Does the Third Circuit’s decision open the door to asserting a valid administrative claim on a basis broader than Section 503(b)(3)(D)? Does the opinion mean that the equivalent of a substantial contribution claim could be given to a party not listed in Section 503(b)(3)(D)? Would the Third Circuit have reached a different conclusion if Section 503(b)(3)(D) were taken into consideration? Do the limitations in Section 503(b)(3)(D) become virtually meaningless if any participants in a chapter 11 case, not just creditors, are entitled to an administrative claim for benefitting the estate?
Fundamentally, and perhaps correctly, the opinion could be nothing more than a pronouncement about pleading. Judge Beetlestone did not bluntly insinuate that the disappointed purchaser is entitled to an allowed claim, although it is possible to read the opinion as suggesting that some claim should be allowed on remand.
For bankruptcy judges, the opinion is cautionary. Given the Third Circuit’s liberal standards for pleading a plausible administrative claim, bankruptcy courts should slog through a trial and make findings of fact to disallow a claim.
For debtors’ counsel, the opinion means that purchase agreements and chapter 11 plans should be tightly written to obviate the possibility of a valid administrative claim even if the stalking horse is not entitled to a breakup fee.
The Third Circuit handed down an opinion that will be cited (incorrectly) for the notion that a stalking horse bidder is entitled to an administrative expense claim even in the absence of a breakup fee.
Properly read, the opinion makes these practice points: (1) the bankruptcy court should not deny a stalking horse’s administrative claim on a motion to dismiss or a motion for summary judgment, unless (2) the purchase and sale agreement was artfully written with an ironclad provision precluding the stalking horse from receiving any compensation other than a highly circumscribed breakup fee.
In short, the Third Circuit found loopholes in the debtor’s drafting of the purchase agreement and reorganization plan.
The Vanishing Breakup Fee
Electric energy giant Energy Future Holdings Corp. agreed to sell its Oncor regulated electric distribution business for a price that would have brought $9.8 billion into the chapter 11 estate. The agreement included a $275 million breakup or termination fee payable to the purchaser if the debtor were to terminate the agreement for almost any reason.
At the approval hearing, however, the bankruptcy judge understood that the buyer would not earn the termination fee if state regulators were to refuse to approve the sale and the debtor terminated the agreement. Misunderstanding the breakup fee, the bankruptcy judge approved the purchase agreement and the breakup fee in September 2016. State regulators did not disapprove the sale until April 2017.
The regulators wanted to ensure that Oncor would not go bankrupt. The regulators refused to approve the sale because the buyer would not accept conditions limiting its ability take money out of Oncor or operate the business in a fashion that could endanger Oncor’s financial stability.