Texas District Court: Bankruptcy Sale Break-Up Fee Satisfied Both Business Judgment Test And Administrative Expense Standard

• Published date: 30 September 2022
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Mr Paul Green and Mark Douglas

Bankruptcy and appellate courts disagree over the standard that should apply to a request for payment of a break-up fee or expense reimbursement to the losing bidder in a sale of the debtor's assets outside the ordinary course of the debtor's business. Some apply a "business judgment" standard, while others require that the proposed payments satisfy the more rigorous standard applied to administrative expense claims. The U.S. District Court for the Southern District of Texas addressed this question in In re Bouchard Transp. Co., Inc., 639 B.R. 697 (S.D. Tex. 2022). The court affirmed a bankruptcy court order approving a $3.3 million break-up fee and more than $885,000 in expense reimbursement to a disappointed "stalking-horse" bidder in an auction of the debtors' assets, finding that the payments satisfied both the business judgment test under section 363(b) of the Bankruptcy Code and the standard for approval of administrative expense claims under section 503(b).

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. Most courts apply a "business judgment" standard to a proposed use, sale, or lease of property under section 363(b)(1) whereby "the bankruptcy court reviews the trustee's (or debtor-in-possession's) business judgment to determine independently whether the judgment is a reasonable one." Collier on Bankruptcy ("Collier") ' 363.02[4] (16th ed. 2022) (citing and discussing cases).

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, although 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 stalking-horse bidder in the event the 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 certain other rights related to the stalking-horse bid.

Outside of bankruptcy, a seller's decision to give such protections are typically accorded deference under the "business judgment" rule. In the bankruptcy context, however, several different approaches have been applied by courts in assessing the propriety of bid protections. See generally Collier at ' 363.02[7]. Some courts apply a business judgment standard to the issue, which involves the highest degree of deference to the debtor's decision to commit to the bidding protections under scrutiny. See, e.g., In re Diocese of Buffalo, N.Y., 637 B.R. 701, 704 (Bankr. W.D.N.Y. 2022); In re JW Res., Inc., 536 B.R. 193, 197 (Bankr. E.D. Ky. 2015); In re Genco Shipping & Trading Ltd., 509 B.R. 455, 465 (Bankr. S.D.N.Y. 2014). Other courts apply stricter scrutiny, requiring evidence that proposed bid protections are in the "best interests of the estate." Collier at ' 363.02[7] (citing cases).

Finally, some courts, and in particular the U.S. Court of Appeals for the Third Circuit, have generally allowed or disallowed bid protections, including break-up fees, according to the standard governing the allowance of administrative expenses under section 503(b). See In re Reliant Energy Channelview LP, 594 F.3d 200 (3d Cir. 2010); Calpine Corp. v. O'Brien Envtl. Energy, Inc. (In re O'Brien...