Restructuring

Contributed by Doron P. Kenter.

“I’d buy that for a dollar” – Bixby Snyder, RoboCop

Over the past ten years or so, sales of substantially all of a debtor’s assets in bankruptcy have become ever more common.  These sales (as opposed to plans) bring with them a host of different procedures and practicalities.  A decision from the Seventh Circuit Court of Appeals addresses one of those quirks – namely, can a third party with no other interest in the bankruptcy case insert itself in the proceedings on the basis of its failed attempt to participate in the sale process?
In In re New Energy Corporation, the debtor sought to sell most of its assets (i.e., an ethanol plant and related assets) through a competitive auction process.  The court-approved bid procedures required all bidders to post a $250,000 bond and required the ultimate winning bidder to make an up-front cash payment.  Notwithstanding these requirements, Natural Chem Holdings proposed an alternative bid, pursuant to which it would lease New Energy’s ethanol plant for one year, with an option to then purchase the plant at a price significantly higher than that which had been offered by the leading bidder.  Natural Chem refused to post the $250,000 bond in support of its bid because (it argued) that bond would have been forfeited to New Energy if Natural Chem was unable to pay its winning bid in cash up front.  (That forfeiture was partial compensation for the losses attendant to any delay in closing the sale and/or in running a second auction.)
After the bankruptcy court confirmed the sale (and denied a motion to reconsider same), Natural Chem appealed, but did not seek a stay of the sale pending appeal.  Accordingly, the sale closed, and the district court affirmed.
On appeal to the Seventh Circuit, Natural Chem argued that the sale should be unwound because the winning bid – from a joint venture – was a product of collusive bidding, in violation of section 363(n) of the Bankruptcy Code.  As an initial matter, the Seventh Circuit could simply have concluded (as it did in the final paragraph of its decision) that the appeal was moot, in light of section 363(m) of the Bankruptcy Code, which provides that the reversal of a sale order does not affect the validity of a sale that had already closed.  Because the sale was not stayed pending appeal, Natural Chem’s appeal could have ended there.  But instead, the Seventh Circuit principally based its decision on its conclusion that Natural Chem lacked standing to challenge the sale, for two separate reasons:
First, Natural Chem had not submitted a genuine qualified bid in the auction of New Energy’s assets.  Moreover, it was not a creditor of New Energy.  Accordingly, it suffered no harm as a result of the sale.  Instead, the Seventh Circuit suggested that Natural Chem simply occupied the role of an innocent and “public-spirited” bystander who, for some unknown reason, beseeched the court to address these alleged infirmities in the auction and sale.
Second, even if Natural Chem had submitted qualified bid and a cash deposit at New Energy’s auction, it would not have been harmed by any collusion on the part of the winning bidders.  Instead, the court noted, any depression of the sale price as a result of this collusion would have made it easier for Natural Chem to bid and to win the auction.  Any such collusion could have harmed New Energy’s creditors, but it would not have harmed Natural Chem.  Accordingly, even if it had submitted a qualified bid with a cash deposit, Natural Chem would have no reason to complain of any violations of section 363(n).
To be sure, the decision that a “non-bidder” does not have standing to challenge an auction in bankruptcy is not new.  Bid procedures are put in place for a reason, and careful drafting and negotiations on the “front end” can help to ensure that only serious bidders are given a seat at the table.  These bid procedures can also help to protect the integrity of the auction process, so that winning bids are not called into question on the courthouse steps.
On the other hand, bid procedures are often put in place long before debtors and their advisors have been able to assess all of their options and before potential bidders have had an opportunity to develop alternative proposals.  Indeed, it is frequently only the stalking horse bidder (if any) who has a say in the bid procedures – and the stalking horse bidder would likely prefer to make it difficult for third parties to submit competing bids.  If a potential bidder is excluded from the auction process simply because it did not (or could not) strictly comply with the bid procedures or the debtors’ stated requirements, should it be deprived of the ability to challenge the auction?  To challenge the basis for its exclusion?
Of course, debtors can always modify their stated requirements if a truly better offer comes along.  For example, if New Energy had been confident that Natural Chem’s alternative transaction could yield a better result for the estate, it could have pursued that proposal.  However, there may be cause for concern where a debtor ignores better alternatives so that it can offer a “sweetheart deal” to a particular purchaser, where a leading bidder (or another party in interest) exercises undue influence over the debtor’s decision-making ability, or where the parties with standing do not recognize that the selection of the winning bidder may have been problematic.
What relief, then, for the would-be bidder who is unfairly excluded from the auction and therefore deprived of any opportunity to have her day in court?  Should she be able to raise concerns that the creditors’ committee, the court, or some other party in interest could have raised, so as to sensitize the court to any conflicts or infirmities in determination of the winning bidder?
On the other hand, contrast this scenario to a traditional plan of reorganization, in which third party non-creditors wouldn’t have standing to be heard simply because they could have been involved in some other (unproposed) strategy for emergence from chapter 11.  Should the initiation of a 363 sale open the door so that these third parties can second-guess the debtor’s business decisions (or at least put them before the court) where they could not do so in the plan context?
The difference, however, lies with the level of scrutiny that the court must apply when it confirms a plan of reorganization.  In the plan context, a critical mass of impaired creditors must affirmatively vote to accept a plan, whereas no affirmative creditor involvement is required in a sale.  Moreover, in proposing a plan, the proponents must show, and the court must conclude, that the plan conforms to applicable law, including the extensive rules set forth in section 1129 of the Bankruptcy Code – and even parties without standing might sensitize the court to these independent duties that it has with respect to plan confirmation.  These requirements do not exist in connection with section 363 sales, which generally involve significant deference to the debtor’s business judgment.  Because sales do not involve the aforementioned steps that exist in the plan context, should “would-be” bidders be able to be heard in opposition to such a propose sale?  Even if they don’t technically have standing, should they be permitted some amount of latitude, if only to sensitize bankruptcy courts to potential infirmities in the auction/sale process?  Or must courts simply ignore any such challenges out of hand?  If so, could “would-be” bidders simply work through others, such as by alerting parties with standing (for example, the creditors’ committee) of any infirmities or alternative challenges, which they might then raise before the court?