Upset Bids In Section 363 Sales

Bidders in Section 363 auction sales face the possibility that a higher "upset" bid will be considered after the auction has closed. Whether the courts will allow such late bids in the pre-confirmation context depends on balancing the competing policies of maximizing creditor recovery and protecting bidders' expectations, and the integrity of the process. Post-confirmation bids are allowed only in extreme circumstances. The authors discuss the varied outcomes in these cases, and some steps parties-in-interest should take in light of the possibility of such bids.

Although reorganization remains the general goal in Chapter 11, over the last few years the balance sheets for most business debtors have been so leveraged that an asset sale pursuant to section 363 is the only viable option. Section 363 sales, as opposed to other forms of asset dispositions, have become so popular, in part, because they provide a relatively quick means to shed burdensome assets. It also benefits creditors by providing an open and generally transparent forum through which the assets are marketed and bid upon, thus increasing the likelihood of maximizing value.

From a buyer's perspective, a 363 sale process provides a unique and arguably superior method to purchase distressed assets. The sale confirmation order issued typically provides that the assets will be transferred free and clear of liens, claims, and encumbrances (and often without the risk of successor liability). Moreover, a section 363 sale process often allows a buyer to pick and choose the debtor's beneficial executory contracts and leases while leaving behind those that may be burdensome. 1

However, unlike private sales outside of bankruptcy, section 363 sales are almost always conducted through some form of auction and ultimately subject to court approval through a sale confirmation order. This element of judicial oversight creates a potential risk that even after the auction has closed, an "upset bid" might still be considered. The prospect of a phantom bidder swooping in after the auction and issuing a higher bid raises several interesting and challenging legal and policy issues: Should and are courts required to reopen bidding to entertain upset bids? What have the courts said with regard to upset bids? What, if anything, can or should a debtor, creditor, or stalking horse bidder do to deal with bids?

Overview of the Section 363 Sale Process 2

Section 363 of the Bankruptcy Code, provides that a "trustee, 3 after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate . . . ." 4 Importantly, pursuant to section 363(f), such property can be sold free and clear of any interest under the appropriate circumstances, such as where: the secured or interested party consents, the property sells for more than the interests are worth, or the interest to be stripped is subject to a bona fide dispute.

A bankruptcy court has broad discretion to conduct a sale in a manner it deems most appropriate. 5 However, it will typically be the debtor and secured creditor, often in consultation with a creditors' committee, who will drive the proposed sale process. Although the Bankruptcy Code does not contain specific requirements for the sale or bidding procedures other than to require basic due process (notice and a hearing), 6 local bankruptcy rules often do have such requirements.

The debtor must first determine which assets are to be sold and then commence marketing, a process which is sometimes undertaken pre-bankruptcy. Once a potential buyer is identified, the debtor and stalking horse bidder customarily negotiate an asset purchase agreement that provides the stalking horse with financial incentives such as a "break-up fee" to compensate it for the due diligence and other costs resulting from its role in the proposed sale should it ultimately be out-bid. The stalking horse bidder is also typically able to negotiate favorable bidding procedures submitted to the court for approval.

Once completed, the asset purchase agreement is filed with the court in a motion package which also contains the debtor's proposed bid and sale procedures, and a request to approve the breakup fee. The proposed procedures will define the form and scope of notice, scheduling of an auction date, and a deadline for other bidders to submit competing bids. Many 363 sale procedures also contain minimum bid increment provisions, requirements for prospective bidders to submit written bids in advance of the auction that contain detailed financial data evidencing their respective ability to close, and, of course, a deposit in the event of a successful bid. While not required, 363 sales are generally public.

The period leading up to approval of the bid procedures, as well as the auction itself, is a critical time for all parties-in-interest (i.e., secured and unsecured creditors, creditors' committees, and even prospective bidders). It is their chance to influence the bidding, auction, and sale approval procedures, whether by objection to the bidding and sale procedures motion or by way of negotiation. Assuming that the bidding and sale procedures order is not appealed, the debtor will then put creditors and potential bidders on notice of the upcoming auction, and the requirements and timing for bid submission pursuant to the order. 7 Following submission of the bids, the auction will normally occur within a few days. At the auction, the debtor will generally be required to select the highest bid (typically in consultation with the secured creditor and committee), unless the approved procedures require otherwise. If no competing bids are received, the stalking horse bidder will be the successful bidder by default.

The debtor will subsequently seek court confirmation of the auction result. In order to obtain confirmation, though the exact standard varies jurisdictionally, the debtor must generally show that there is a "good business reason" for selling the assets. 8 In addition, the court must independently evaluate the proposed price to determine whether it is "fair and reasonable" or the "highest and best." 9

The foregoing explanation of the 363 sale process presumes a normal progression from the decision to conduct a 363 sale through confirmation of the sale where the highest bidder, who properly follows the bidding procedures at the auction, becomes the confirmed purchaser. While there are many circumstances that...