Bankruptcy Code Section 363(b) gives a debtor the ability to sell its businesses and assets if doing so will benefit the debtor’s constituencies, including its general unsecured creditors. Bankruptcy courts generally require Section 363 sales to occur via an appropriately marketed public auction, with the bidder making the highest and best offer being deemed the successful bidder and the next highest and best bid declared the backup bidder.
An order of the bankruptcy court establishes auction guidelines, and the vast majority of these auctions have a clear successful bidder at auction whose bid is promptly approved by the court and who purchases the debtor’s assets at a scheduled closing. The small percentage of auctions in bankruptcy cases that go awry, including the ones described below, provide lessons to be learned.
Communication Between Section 363 Sale Bidders During Sale Process Inadvisable
For obvious reasons, the Bankruptcy Code allows a court to set aside a sale if the sale price was controlled by an agreement among potential bidders. The appearance of collusion among bidders, alone, even where none actually exists, can prove problematic. In a 2021 Pennsylvania bankruptcy case,i the bankruptcy court learned that one of the two bidders called the other while the auction was in process, allegedly to disclose to the competing bidder the existence of a fraud investigation relating to the asset that was being auctioned by the debtor. The court was skeptical of the bidder’s motives in communicating with his competitor during the auction and considered the bidder’s misconduct “as a brazen attempt to manipulate the Section 363 sale.” The court’s opinion provides the lesson to be learned: there is typically no reason for bidders to talk to each other during a bankruptcy court auction or throughout the sale process, and doing so will always raise the specter of collusion or other misconduct.
Pre-Auction Preparations and Issue Spotting Increase the Likelihood of Sale Approval
For successful bidders at auction who get a significant bargain, there is a risk that the bankruptcy court will set aside the auction results. Typically, a court will reopen bidding, and thereby upset the results of a properly conducted judicial auction, only if there was fraud, unfairness, or mistake in the conduct of the sale or if the price brought at the sale was so grossly inadequate as to shock the conscience of the court. Courts often reject auction prices that equal less than half of the expected value. In terms of unfairness, bankruptcy courts have denied approval of auction sales that provide only a partial payment to a single creditor, leaving all other creditors with nothing, as not being in the best interest of all creditors. Other bankruptcy courts have concluded that any of the following can justify denial of an auction sale: unfairness toward bidders, stifling of competition, inaccurate or otherwise insufficient advertisement, sham bidding or puffing, lack of due notice, and interference with the orderly conduct of the sale. The lesson learned is pre-auction preparations must be comprehensive and executed correctly.
Buyer’s Failure to Close Post-Auction
Even if the auction is successful and the bankruptcy court approves it, things can still go awry. For example, in a Section 363 sale process in a Chapter 11 case of a technology company pending before the US Bankruptcy Court for the Southern District of New York,ii the debtors selected one bid as highest and best. The only other bid received was selected as the backup bidder. When the time to close on the purchase of the technology business arrived, the successful bidder announced that it would not complete its purchase of the debtor’s business, even though it was obligated to do so. The debtors were forced to close on the sale of its business with the backup bidder for a substantially lower price. As a result, the debtors retained the original successful bidder’s six-figure cash deposit and commenced a lawsuit in the court against that bidder to recover damages associated with closing on a significantly lower-value bid. The lesson learned is that debtors should vet, and obtain as large of a deposit as possible from, those bidding at the auction of their assets.
The purchase and sale of a debtor’s businesses and other assets via public auction in bankruptcy cases is relatively routine and increasingly popular. Purchasers appreciate the buyer protections afforded them by bankruptcy court sale orders, and debtors and their creditors generally need the opportunity to liquidate their assets for as much value as the market will bear—and as quickly as possible. Focusing on the details and rules of the auction process will help minimize auctions that go awry while maximizing recoveries for a debtor’s creditors.
The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Ilan Markus, partner, at imarkus@barclaydamon.com; Janice Grubin or Jeff Dove, Restructuring, Bankruptcy & Creditors’ Rights Practices Area co-chairs, at jgrubin@barclaydamon.com and jdove@barclaydamon.com; or Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com.
iIn re Primel, 629 B.R. 790 (Bankr. W.D. Pa. 2021).
iiIn re GSI Wind Down, Inc., Case No. 22-11057-mew (Bankr. S.D.N.Y 2022).