The Breaking News on Break-Up Fees: A Survey of Current Break-Up Fees in § 363 Sales

Approval of bid protections in connection with the sale of significant assets pursuant to § 363 of the Bankruptcy Code has become an established practice in chapter 11 cases.[1] In nonbankruptcy transactions, bidding incentives like break-up fees and expense reimbursements are measured against a business judgment standard. In bankruptcy, however, courts have adopted a variety of tests. Some courts continue to apply the business judgment rule.[2] Others may apply a “best interests of the estate” test.[3] The majority of courts seem to have adopted yet another approach articulated by the Third Circuit in Calpine Corp. v. O’Brien Envtl. Energy Inc. (In re O’Brien Envtl. Energy Inc.),[4] concluding that the administrative expense provisions of § 503(b) of the Bankruptcy Code govern in the bankruptcy context, and as a result, the debtor has the burden of establishing that a break-up fee provides some post-petition benefit to the debtor’s estate.[5]

Over time, the Third Circuit has identified at least three instances in which bidding incentives may benefit the estate: (1) a break-up fee or expense reimbursement may preserve the value of the estate if assurance of the fee “promote[s] more competitive bidding, such as by inducing a bid that otherwise would not have been made and without which bidding would have been limited”;[6] (2) “if the availability of a break-up fee and expense reimbursement were to induce a bidder to research the value of the debtor and convert the value to a dollar figure on which other bidders can rely, the bidder may have provided a benefit to the estate by increasing the likelihood that the price at which the debtor is sold will reflect its true worth”;[7] and (3) a break-up fee can also ensure that a bidder adheres to its bid rather than abandons its offer in the event that an auction is required.[8] But none of the foregoing is determinative. “Rather, it is ultimately within a bankruptcy court’s discretion to approve or deny a termination fee based on the totality of the circumstances of the particular case.”[9]

While not adopted by the Third Circuit, the lower court in O’Brien looked at nine factors in deciding whether to approve a break-up fee. In looking at the totality of the circumstances, those factors will be instructive:

1. the presence of self-dealing or manipulation in negotiating the break-up fee;
2. whether the fee harms, rather than encourages, bidding;
3. the reasonableness of the break-up fee relative to the purchase price;
4. whether the unsuccessful bidder placed the estate property in a “sales configuration mode” to attract other bidders to the auction;
5. the ability of the request for a break-up fee to serve to attract or retain a potentially successful bid, establish a bid standard or minimum for other bidders, or attract additional bidders;
6. the correlation of the fee to a maximum of value of the debtor’s estate;
7. the support of the principal secured creditors and creditors’ committees of the break-up fee;
8. the benefits of the safeguards to the debtor’s estate; and
9. the substantial adverse impact of the break-up fee on unsecured creditors, where such creditors oppose the break-up fee.[10]

Likewise, courts applying the business judgment rule will look at similar factors:

1. the relationship of the parties who negotiated the fee must not be tainted by self-dealing;
2. the break-up fee must encourage, rather than hamper, the bidding; and
3. the amount of the fee must be reasonable relative to the proposed purchase price.[11]

Of note, these tests each look at whether the amount of the fee is reasonable relative to the proposed purchase price. “A break-up fee should constitute a fair and reasonable percentage of the proposed purchase price, and should be reasonably related to the risk, effort, and expenses of the prospective purchaser.”[12] As part of this inquiry, bankruptcy courts will look at whether the fee is in accord with industry averages.[13]

Because the above tests make the then-current market practice for fees relevant, we reviewed the break-up fees approved in large commercial chapter 11 cases filed since June 2020 in the District of Delaware, Southern District of New York and Southern District of Texas. The below chart summarizes our findings.[14]

[2]See, e.g., In re 995 Fifth Ave. Assocs. L.P., 96 B.R. 24, 28 (Bankr. S.D.N.Y. 1989) (holding that business judgment standard protects break-up fees and other contractual provisions negotiated in good faith).

[4] 181 F.3d 527, 534–35 (3d Cir. 1999).

[5] See O’Brien, 181 F.3d at 533.

[6] Id. at 537.

[7] Id.

[8] See Reliant Energy Channelview LP v. Kelson Channelview LLC (In re Reliant Energy Channelview LP), 594 F.3d 200, 206–07 (3d Cir. 2010).

[9] In re Energy Future Holdings Corp., 904 F.3d 298, 314 (3d Cir. 2018).

[10] See O’Brien, 181 F.3d at 536.

[11] See Official Committee of Subordinated Bondholders v. Integrated Resources Inc. (In re Integrated Resources Inc.), 147 B.R. 650 (S.D.N.Y. 1992).

[12] Id. at 662.

[13] Id.

[14] Please note that this is not an exhaustive list of all break-up fees approved in these districts during this time period. Note also that we found that debtors sought approval of break-up fees in only approximately one-third of the sales in our sample set.

[15] The court approved the sale to a bidder other than the stalking-horse bidder and reserved for a later date the propriety of the break-up fee and expense reimbursement.