The Fifth Circuit approved a 3% breakup fee but didn’t decide whether approval is governed by Section 503(b), as an administrative expense, or by Section 363(b), as a payment related to a sale. If there be any doubt, the opinion shows that breakup fees are permissible in the Fifth Circuit, although the applicable standard is undecided.
In the appeal before the New Orleans-based appeals court, the facts found by Bankruptcy Judge David R. Jones of Houston satisfied even the more stringent administrative expense standard.
The chapter 11 case was touch and go. It wasn’t clear whether a sale would cover secured debt and administrative expenses. In advance of landing a buyer under contract, the bankruptcy court authorized the debtor to offer a 3% breakup fee and expense reimbursement subject to a cap. The authorization included a deadline for selecting the stalking-horse bidder.
With no buyer willing to become the stalking horse, the bankruptcy court extended the deadline several times. Ultimately, the deadline was midnight before the auction.
Just before the midnight deadline, a potential purchaser became the stalking horse by offering $110 million for the assets, conditioned on the debtor’s agreement to a $3 million breakup fee and $1.5 million in expense reimbursement. In addition, the stalking horse deal required a $500,000 overbid.
Consequently, any competing bid had to be $115 million.
The debtor notified the creditors’ committee about the terms of the stalking horse offer, but the committee did not file an objection before the auction.
At the auction, a competing bidder offered exactly $115 million. There was no more bidding. At the sale-approval hearing, the bankruptcy court approved the sale but scheduled a later hearing to approve the breakup fee and expense reimbursement.
After a five-hour hearing with live witnesses, Bankruptcy Judge Jones approved the $3 million breakup fee but only $1 million in expense reimbursement. He ruled that the fees and reimbursement were permissible both as an administrative expense and under the business-judgment rule as part of the sale.
On the committee’s appeal, the district court affirmed, also under both Sections 503(b) and 363(b). On the next appeal to the Court of Appeals, Fifth Circuit Judge Jerry E. Smith affirmed in an opinion on July 25.
Under both Sections 503(b) and 363(b), Judge Smith said that the appeal presented “quintessential” mixed questions of law and fact. He undertook appellate review for “clear error,” because the issues were “primarily” factual.
As to whether the statutory standard was under Section 503(b) or 363(b), Judge Smith pointed to the Third Circuit for saying that “some courts” examine breakup fees as administrative expenses under Section 503(b), while other courts frame the question in terms of the debtor’s business judgment in connection with a sale under Section 363(b).
Judge Smith said that the Fifth Circuit’s “leading precedent,” ASARCO, Inc. v. Elliott Mgmt. (In re ASARCO, L.L.C.), 650 F.3d 593, 603 (5th Cir. 2011), “gives mixed signals.” Like the two lower courts, he refrained from choosing among the statutes because the findings of fact satisfied even the more stringent Section 503(b).
To be an administrative expense, Judge Smith said it didn’t matter that the fees were not approved until after the sale, because the debtor made a deal with the stalking horse, who carried out its side of the deal and “wants its expenses paid.”
To be an allowable administrative expense claim, Section 503(b) demands that the breakup fee be both “actual” and “necessary” costs of estate preservation. Judge Smith saw “numerous benefits to the estate,” such as avoidance of a “poor auction” that would not cover secured debt and administrative expenses.
Judge Smith also found no reason to reverse the bankruptcy court’s findings that the fees were necessary, because the bankruptcy court’s findings about necessity were “plausible.”
Under Section 363(b)’s business-judgment rule, Judge Smith said that the debtor faced “multiple flawed options” and decided that the stalking horse fees were “the lesser of multiple evils.” He therefore found that the fees satisfied the test under Section 363(b) because they were “well within the bounds of reasonable business judgment.”
Judge Smith upheld the lower courts, holding that the payments “to the stalking horse bidder [were] justified under either the stringent administrative-expense standard or the more relaxed business judgment rule.”
The Fifth Circuit approved a 3% breakup fee but didn’t decide whether approval is governed by Section 503(b), as an administrative expense, or by Section 363(b), as a payment related to a sale. If there be any doubt, the opinion shows that breakup fees are permissible in the Fifth Circuit, although the applicable standard is undecided.
In the appeal before the New Orleans-based appeals court, the facts found by Bankruptcy Judge David R. Jones of Houston satisfied even the more stringent administrative expense standard.