Stalking Horse Bidder May Be Entitled To Administrative Priority For Expenses Despite Failure To Close Bankruptcy Sale

• Published date: 03 October 2021
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, M&A/Private Equity, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Mr Brad Erens and Mark Douglas

In In re Energy Future Holdings Corp., 990 F.3d 728 (3d Cir. 2021), the U.S. Court of Appeals for the Third Circuit ruled that even though a "stalking horse" bidder failed to obtain necessary regulatory approvals to close an anticipated bankruptcy asset sale, the bidder potentially could receive an administrative claim for a break-up fee and expenses if it could demonstrate that its efforts provided value to the estate. The ruling represents an expansive view on this issue and may provide bidders with enhanced protection for their bids. In so ruling, the Third Circuit reversed lower court rulings, directing the bankruptcy court on remand to determine whether the bidder's actions conferred an actual benefit on the estate. The parties ultimately entered into a settlement that, if approved by the bankruptcy court, would result in the bidder receiving $4 million.

Allowance of Administrative Expenses in Bankruptcy

Section 503 of the Bankruptcy Code provides that, "[a]fter notice and a hearing, there shall be allowed, administrative expenses, . including-(1)(A) the actual, necessary costs and expenses of preserving the estate." 11 U.S.C. ' 503(b). According to the Third Circuit, for a claim to be entitled to administrative expense status under this provision, it must "arise from a [postpetition] transaction with the debtor-in-possession," and "be beneficial to the debtor-in-possession in the operation of the business." Calpine Corp. v. O'Brien Envtl. Energy, Inc. (In re O'Brien Envtl. Energy, Inc.), 181 F.3d 527, 532-33 (3d Cir. 1999); accord In re Philadelphia Newspapers, LLC, 690 F.3d 161, 172-73 (3d Cir. 2012). The party asserting an administrative expense claim bears the burden of demonstrating that it is entitled to administrative expense status. O'Brien, 181 F.3d at 533.

The U.S. Supreme Court has ruled that postpetition tort claims may also be allowed as administrative expenses if those claims arise from actions related to the preservation of a bankruptcy estate, even if those claims have no discernable benefit to the estate. Reading Co. v. Brown, 391 U.S. 471, 477, 88 S.Ct. 1759 (1968) (holding that fire damage costs resulting from the negligent actions of a bankruptcy receiver acting in the scope of his authority are an "actual and necessary" expense of reorganization). Although Reading involved interpretation of the former Bankruptcy Act, subsequent decisions have recognized that its analysis applies to section 503(b) of the Bankruptcy Code. See, e.g., Philadelphia Newspapers, 690 F.3d at 173-74; In re B. Cohen & Sons Caterers, Inc., 143 B.R. 27 (E.D. Pa. 1992); In re Hayes Lemmerz Int'l, Inc., 340 B.R. 461 (Bankr. D. Del. 2006); In re Brooke Corp., 485 B.R. 650 (Bankr. D. Kan. 2013); In re Women First Healthcare, Inc., 332 B.R. 115 (Bankr. D. Del. 2005).

Stalking Horses and Break-Up Fees

Section 363(b)(1) of the Bankruptcy Code authorizes a bankruptcy trustee or chapter 11 debtor in possession, "after notice and a hearing," to use, sell, or lease property of the estate outside the ordinary course of business. While a sale under section 363(b)(1) is most frequently undertaken by means of a public auction, in which assets are generally sold to the highest bidder, the bankruptcy court may also approve a private sale entered into between the debtor and a purchaser.

Generally speaking, the initial bidder in a public auction held under section 363-the "stalking-horse bidder"-sets the minimum price and other terms of the transaction. Because of the time and effort expended by the stalking-horse bidder in performing due diligence and engaging in the negotiations necessary to arrive at the initial bid, bankruptcy courts generally will allow reasonable bid protections for the bidder in the event the stalking-horse bidder does not prevail at the auction. Those bid protections, which are typically the subject of extensive negotiations, often include reimbursement of expenses incurred by the bidder in connection with the transaction, a "break-up" fee equal to a specified percentage of the bidder's purchase price, auction procedures, and...