Third Circuit Clarifies Standard For Allowance of Break-Up Fees in Section 363 Sales

Posted on February 8, 2010 by Kenneth L. Baum

In a recent decision, the United States Court of Appeals for the Third Circuit further defined its standard for awarding a break-up fee to an unsuccessful “stalking horse” bidder for a debtor’s assets. In In re Reliant Energy Channelview LP, ___ F.3d ___, 2010 WL 143678 (C.A. 3 (Del.) 2010), the debtors sought to sell their largest asset, a power plant, pursuant to Section 363 of the Bankruptcy Code. Following a comprehensive marketing process, the debtors accepted a $468 million bid of Kelson Channelview LLC (Kelson). The contract with Kelson simply required the debtors to seek an order approving certain bid protections and procedures, including the payment of a $15 million break-up fee to Kelson, if the bankruptcy court were to require the debtors to hold an auction, which it subsequently did.

In response to the debtors’ request to approve the proposed break-up fee, a potential competing bidder, Fortistar, LLC (Fortistar), argued that it was discouraged from submitting a higher bid by the proposed break-up fee. After the bankruptcy court refused to allow the break-up fee, Kelson withdrew its offer on the ground that it was no longer valid and did not participate in the auction process. The debtors accepted Fortistar’s bid, which exceeded Kelson’s original bid by $32 million, and the bankruptcy court approved the sale of the power plant to Fortistar. Kelson appealed the bankruptcy court’s denial of a break-up fee to the district court, which affirmed the bankruptcy court’s ruling. Kelson then appealed to the Third Circuit.

The court in Reliant noted its decision in Calpine Corp. v. O’Brien Environmental Energy, Inc. (In re O’Brien Environmental Energy, Inc.), 181 F.3d 527 (3d Cir. 1999), where it held that the allowance of a break-up fee was subject to the standard for allowance of an administrative priority claim under Section 503(b) of the Bankruptcy Code; that is, the fees had to be necessary to preserve the value of the bankruptcy estate. In O’Brien, the court ruled that a break-up fee did not meet that standard where the unsuccessful bidder would have bid even without the assurance of a break-up fee (which, in that case, it did).

The court in Reliant further defined the O’Brien standard by ruling that to preserve the value of the estate, the break-up fee must have either induced or preserved a bidder’s bid. The court held that because Kelson did not condition its bid on the provision of a break-up fee, but only required the debtors’ agreement to seek a break-up fee, the fee was not necessary to induce Kelson’s bid. Additionally, the court held that the break-up fee was not necessary to preserve Kelson’s bid because, among other things, it was reasonable to assume that Kelson would not have abandoned its contract with the debtors if no other bidders materialized.

Reliant teaches that buyers of assets in Section 363 sales who seek maximum bid protections, including a break-up fee, should make allowance of those protections a material condition of their contract with a debtor, and specifically provide that failure to obtain court approval of such protections will constitute an event of default under the contract.

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All Hope May Not Be Lost For a Seller of Goods to an Insolvent Buyer

Posted on August 3, 2009 by Kenneth L. Baum

In these days of economic uncertainty and write-offs, sellers should be aware of their right under Section 2-705 of the Uniform Commercial Code (UCC) to stop the delivery of goods in transit to an insolvent buyer who has not taken physical possession of the goods. “Insolvent,” within the meaning of the UCC, means that a buyer has “…generally ceased to pay debts in the ordinary course of business other than as a result of bona fide dispute ….” In some cases, litigation may be necessary to determine the issue of insolvency. Additionally, a buyer may refuse or defeat a demand to stop goods in transit where (a) it has actually received the goods in question, (b) a bailee of the goods (other than a carrier) acknowledges it is holding the goods for the buyer, (c) a carrier, through reshipment or warehousing, makes such acknowledgment to the buyer, or (d) the buyer has negotiated a negotiable document of title to the goods.

A seller’s right to stop in transit exists even where the buyer has filed for bankruptcy protection, as courts have held that a seller is not required to seek relief from the automatic stay provisions of the Bankruptcy Code before exercising its right to stop delivery. Moreover, because an effective stoppage of delivery divests the buyer of title to the goods at issue, goods purchased, but never received, by a buyer who has filed for bankruptcy protection, never become part of the bankruptcy estate.

Cole Schotz recently represented a client who stopped goods in transit to Fortunoff’s, which purchased a substantial amount of furniture and other merchandise on credit from various overseas sellers shortly before filing a Chapter 11 bankruptcy petition. In many cases, the bill of lading issued by the carrier provided that title to the goods passed to Fortunoff’s when they were loaded for delivery to New York. Upon learning of Fortunoff’s bankruptcy filing, many sellers (including our client), whose shipments had not yet arrived at Fortunoff’s New York warehouse facility, issued notices that they were stopping the shipments in transit pursuant to Section 2-705 of the UCC. The bankruptcy court in Fortunoff’s Chapter 11 case rejected Fortunoff’s argument that the passage of title and the application of the automatic stay rendered the sellers’ demands ineffective, and held that any goods that were the subject of a valid stop in transit demand were not property of Fortunoff’s bankruptcy estate.

As the Fortunoff’s example illustrates, a seller of goods to an insolvent buyer, including a buyer who has filed for bankruptcy protection, who seeks to minimize its losses should consider the stop in transit provisions of the UCC and seek relief in the bankruptcy court to ratify its actions.
 

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