Can the Sequel Make More Money Than the Original?

The debtor then proceeds with the auction and, hopefully, obtains the highest and/or best offer, thus concluding Phase I. After the auction, Phase II begins and the debtor seeks the court's approval of the sale. Given human nature, whenever there's competition, there's usually controversy. One court recently wrestled with the submission of a late bid in the twilight between Phase I and II; ie, post-auction but pre-sale hearing. The Seventh Circuit's decision in Paloian canvassed the law, providing an overview to debtors and potential auction participants as to their respective rights upon such an occurrence, and more importantly providing some strategic guidelines to either stymie or abet late bidding.

Details of the Case

In Paloian, the debtor ran a court-approved auction for the sale of certain assets. Before the auction, the debtor altered the purchase agreement distributed to potential bidders, deleting language that required removal of certain the assets from their location by a deadline. Some (but not all) of the bidders were notified of the change before the auction, and debtor's counsel noted such change on the record of the auction. At the auction, Corporate Assets, Inc. (CAI) submitted the highest bid. After the Phase I auction, but before the Phase II hearing, a losing bidder, Myron Bolling Auctioneers (MBA), submitted a higher bid. Though announced on the record, certain of MBA's representatives were not made aware of the change in the form agreement until the auction ended, as the individuals representing MBA at the auction were apparently unable to contact all of the members of the MBA bidding group until after the auction. Following the auction, when all MBA's representatives were apprised of the change, MBA submitted a higher bid to the debtor. The debtor entertained the late bid and adjourned the sale hearing scheduled for two days later to conduct a second auction. At the new auction, CAI again prevailed, bidding an amount more than $350,000, and 15.7% higher, than its prior winning bid. At the sale hearing, CAI objected to the debtor's acceptance of MBA's late bid and the holding of the second auction, requesting that the court instead confirm the results of the first auction. Relying, inter alia, on a provision of the bidding procedures that allowed for the debtor to reject a bid that was not in the best interests of the estate at any time before entry of the sale order, the bankruptcy court overruled CAI's objection and confirmed the results of the second auction. On appeal, the district court affirmed.

Affirming the lower courts, the Seventh Circuit held that a court faced with a late bid must “walk a tightrope” between preserving the “integrity and finality of the auction process and to recognize the reasonable expectations of the parties” on the one side, and the “governing principle in confirming a sale, which is to secure the highest price for the benefit of the estate and creditors” on the other. In this balancing act, the court should look at the auction process on a “continuum.” On one end, once approved after a Phase II hearing, it takes “compelling reason” such as fraud, mistake, or gross inadequacy in price to upset a winning bid in favor of a higher late bidder. But in the twilight between Phase I and II, the bankruptcy court has broader discretion to authorize late bidding where the circumstances dictate, especially where the auction and bidding are “complex and fluid” or “informal and flexible,” such that there is no undue frustration of participants' reasonable expectations as to whether the highest bid at the auction would be subject to late overbids.

Ultimately, the Seventh Circuit agreed with the lower courts that, in essence, a combination of three factors militated toward allowing the late bid. Initially, on account of the bidding procedures provision allowing the debtor to reject bids that were not in the best interest of the estate up until the sale hearing, coupled with statements made by the debtor on the record of the auction indicating a “possibility” that the debtor would entertain a dramatically higher late bid, CAI was found to have had no reasonable expectation of finality before the sale hearing. Secondly, the subsequent auction leveled playing field as between the bidders, because not all bidders were informed prior to the first auction that material alterations had been made to the agreement (ie, the deletion of the equipment removal provision). Lastly, the court noted that the bid price from the second auction was “significantly more” that that garnered at the first auction (though the first auction price was not held to be grossly inadequate). Finding that the reasonable expectations of the participants were not compromised, the Seventh Circuit affirmed.

Conclusion

For debtors and auction participants, Paloian summarizes important guidelines to establishing auction procedures that provide either greater, or lesser, opportunity for the entertainment of late bids. Parties may have their own reasons for either result, but an estate may want the most flexibility to allow late bidding, thereby ensuring maximization of asset values. On the other hand, a bidder “in to win” at the auction needs finality. Initially, given the stricter inquiry when dealing with a post-hearing late bid, there is less the parties can do to affect the outcome, as that inquiry is generally limited to fraud, mistake, and gross inadequacy of price. However, there are a number of steps that may be taken that can affect whether a court will allow a late bid during the gap between Phases I and II.

Following Paloian, if the estate desires flexibility to entertain late bids, it should place an unqualified reservation in the bidding procedures that the estate may reject any bid (even after the auction) that is not in the best interest of the estate until the sale is actually approved by the court. The procedures should further provide that the highest bid at the auction will not be “accepted” until the sale is actually approved (ie, do not “close” the auction). At the auction itself, the debtor should remind bidders up front that there are no guarantees until court approval (Further, the debtor should certainly be aware of and make others aware of any “local custom” in the subject bankruptcy court of accepting late bids at the sale hearing). The bidding procedures should not provide for a bid cutoff specified beyond which bids would not be accepted, and the debtor should not “accept” the highest bid at the auction, rather couching the highest bid as the bid that the debtor will recommend for approval with the bankruptcy court, provided that such presentation does not constitute acceptance of the bid.

While the above procedures may permit flexibility, they are likely not to encourage bidders to submit “best bids” at the auction, highlighting the inherent tension. As such, bidders at the auction should demonstrate their reasonable expectations that late bids will not be entertained. Some terms could include that there will be only one auction, and the debtor will refuse to entertain any bids after that auction. Further, bidders should require the debtor to accept the highest bid at the auction and actually close the proceeding. It is also critical that any pre-auction revisions to the form agreement be timely circulated to all potential bidders so there are no surprises on auction day. To the extent there are auction-day changes to the agreement (not unusual at all), all participants must be adequately informed of such changes, and should be required to note the same on the record of the auction (bidders should confirm that all parties have seen any changes). As a practical matter, the sale hearing should take place as soon as possible after the auction — a short gap means little opportunity. Lastly, the winning bidder who wishes to stay in the winner's circle is well advised to not seek to “amend” its winning bid after the close of the auction (other than to conform to the terms of the accepted bid). Bidders should not underestimate their ability to affect the course of an auction. Money can be persuasive and if people refuse to bid, the auction is a failure.

While none of the above considerations can guarantee a certain result given the direct conflict in approach, it is far more sensible to take pro-active steps towards establishing a process amenable (or not) to late bidding, rather than relying on an omission or error. Though the Paloian court allowed the late bid, in part, because of the debtor's failure to adequately notify bidders of the change in the form agreement, courts as a general matter tend to frown on parties who “kill their parents” and then claim court's mercy as an “orphan” — ie, imprudent is the debtor who relies solely on his own missteps to keep opportunity for late bidding open (and also the bidders who allowed such missteps to go unchecked). Likewise, as noted in Paloian, courts will frown on bidders who bide their time and withhold their best bid until after seeing how the auction plays out, thereby circumventing the auction process.

But while errors and omissions cannot be planned for, there are certain affirmative steps that parties can take to sculpt the auction process to either forestall or facilitate late bidding. With so many things that are unpredictable and out of parties' hands during a frenetic auction process, this is one area over which debtors and potentially other participants can exert some influence, an opportunity that parties should not let slip. Especially if one side is more focused than the other.

Talk about a balance of power. Debtors want to sell assets for maximum value. Bidders want to buy cheaply and with finality. While debtors want flexible auctions, if the rules are open-ended, bidders will stay home. So what happens to bidder confidence when, after the auction concludes, but before the sale is approved, a late bidder offers more money? Bankruptcy courts must weigh the potential benefits to the estate against the reasonable expectations of the auction participants and the impact of accepting a late bid on the integrity of bankruptcy auctions. Recently, the Seventh Circuit examined this tension in Corporate Assets, Inc. v. Paloian , 368 F.3d 761 (7th Cir. 2004) ( Paloian ) [as analysed in last month's issue].

Procedural Options

In general, debtors have several procedural options in selling assets outside the ordinary course of business, with the common course being a court-approved auction process. Such asset sales are generally divided into two phases: Phase I, bid solicitation and auction, followed by Phase II, the sale hearing to approve the results of the auction (Section 363(b) of the Bankruptcy Code requires that the bankruptcy court approve of the sale of a debtor's assets outside the ordinary course of the debtor's business). Entering Phase I, a debtor may often already have a form of agreement with a “stalking horse” bidder that, inter alia, sets a minimum price for the assets in question. At the auction, other parties are invited to bid against the “stalking horse,” utilizing the same form of agreement. But other times a debtor may have no bidder lined up, and proceeds “naked” into Phase I. Either way, debtors generally seek court approval of auction procedures, which can establish who will be considered qualified to bid on the subject assets, the form of the bids, and actual procedures for the auction (such as minimum overbid requirements and the like). (Depending on the flexibility and rules of the subject bankruptcy court and/or judge, debtors seek approval of such procedures either before or [retroactively] after the auction. Obtaining pre-approval of the bankruptcy court can, of course, provide the debtor and the bidders with more of a measure of stability and certainty in respect of the process.)

The debtor then proceeds with the auction and, hopefully, obtains the highest and/or best offer, thus concluding Phase I. After the auction, Phase II begins and the debtor seeks the court's approval of the sale. Given human nature, whenever there's competition, there's usually controversy. One court recently wrestled with the submission of a late bid in the twilight between Phase I and II; ie, post-auction but pre-sale hearing. The Seventh Circuit's decision in Paloian canvassed the law, providing an overview to debtors and potential auction participants as to their respective rights upon such an occurrence, and more importantly providing some strategic guidelines to either stymie or abet late bidding.

Details of the Case

In Paloian, the debtor ran a court-approved auction for the sale of certain assets. Before the auction, the debtor altered the purchase agreement distributed to potential bidders, deleting language that required removal of certain the assets from their location by a deadline. Some (but not all) of the bidders were notified of the change before the auction, and debtor's counsel noted such change on the record of the auction. At the auction, Corporate Assets, Inc. (CAI) submitted the highest bid. After the Phase I auction, but before the Phase II hearing, a losing bidder, Myron Bolling Auctioneers (MBA), submitted a higher bid. Though announced on the record, certain of MBA's representatives were not made aware of the change in the form agreement until the auction ended, as the individuals representing MBA at the auction were apparently unable to contact all of the members of the MBA bidding group until after the auction. Following the auction, when all MBA's representatives were apprised of the change, MBA submitted a higher bid to the debtor. The debtor entertained the late bid and adjourned the sale hearing scheduled for two days later to conduct a second auction. At the new auction, CAI again prevailed, bidding an amount more than $350,000, and 15.7% higher, than its prior winning bid. At the sale hearing, CAI objected to the debtor's acceptance of MBA's late bid and the holding of the second auction, requesting that the court instead confirm the results of the first auction. Relying, inter alia, on a provision of the bidding procedures that allowed for the debtor to reject a bid that was not in the best interests of the estate at any time before entry of the sale order, the bankruptcy court overruled CAI's objection and confirmed the results of the second auction. On appeal, the district court affirmed.

Affirming the lower courts, the Seventh Circuit held that a court faced with a late bid must “walk a tightrope” between preserving the “integrity and finality of the auction process and to recognize the reasonable expectations of the parties” on the one side, and the “governing principle in confirming a sale, which is to secure the highest price for the benefit of the estate and creditors” on the other. In this balancing act, the court should look at the auction process on a “continuum.” On one end, once approved after a Phase II hearing, it takes “compelling reason” such as fraud, mistake, or gross inadequacy in price to upset a winning bid in favor of a higher late bidder. But in the twilight between Phase I and II, the bankruptcy court has broader discretion to authorize late bidding where the circumstances dictate, especially where the auction and bidding are “complex and fluid” or “informal and flexible,” such that there is no undue frustration of participants' reasonable expectations as to whether the highest bid at the auction would be subject to late overbids.

Ultimately, the Seventh Circuit agreed with the lower courts that, in essence, a combination of three factors militated toward allowing the late bid. Initially, on account of the bidding procedures provision allowing the debtor to reject bids that were not in the best interest of the estate up until the sale hearing, coupled with statements made by the debtor on the record of the auction indicating a “possibility” that the debtor would entertain a dramatically higher late bid, CAI was found to have had no reasonable expectation of finality before the sale hearing. Secondly, the subsequent auction leveled playing field as between the bidders, because not all bidders were informed prior to the first auction that material alterations had been made to the agreement (ie, the deletion of the equipment removal provision). Lastly, the court noted that the bid price from the second auction was “significantly more” that that garnered at the first auction (though the first auction price was not held to be grossly inadequate). Finding that the reasonable expectations of the participants were not compromised, the Seventh Circuit affirmed.

Conclusion

For debtors and auction participants, Paloian summarizes important guidelines to establishing auction procedures that provide either greater, or lesser, opportunity for the entertainment of late bids. Parties may have their own reasons for either result, but an estate may want the most flexibility to allow late bidding, thereby ensuring maximization of asset values. On the other hand, a bidder “in to win” at the auction needs finality. Initially, given the stricter inquiry when dealing with a post-hearing late bid, there is less the parties can do to affect the outcome, as that inquiry is generally limited to fraud, mistake, and gross inadequacy of price. However, there are a number of steps that may be taken that can affect whether a court will allow a late bid during the gap between Phases I and II.

Following Paloian, if the estate desires flexibility to entertain late bids, it should place an unqualified reservation in the bidding procedures that the estate may reject any bid (even after the auction) that is not in the best interest of the estate until the sale is actually approved by the court. The procedures should further provide that the highest bid at the auction will not be “accepted” until the sale is actually approved (ie, do not “close” the auction). At the auction itself, the debtor should remind bidders up front that there are no guarantees until court approval (Further, the debtor should certainly be aware of and make others aware of any “local custom” in the subject bankruptcy court of accepting late bids at the sale hearing). The bidding procedures should not provide for a bid cutoff specified beyond which bids would not be accepted, and the debtor should not “accept” the highest bid at the auction, rather couching the highest bid as the bid that the debtor will recommend for approval with the bankruptcy court, provided that such presentation does not constitute acceptance of the bid.

While the above procedures may permit flexibility, they are likely not to encourage bidders to submit “best bids” at the auction, highlighting the inherent tension. As such, bidders at the auction should demonstrate their reasonable expectations that late bids will not be entertained. Some terms could include that there will be only one auction, and the debtor will refuse to entertain any bids after that auction. Further, bidders should require the debtor to accept the highest bid at the auction and actually close the proceeding. It is also critical that any pre-auction revisions to the form agreement be timely circulated to all potential bidders so there are no surprises on auction day. To the extent there are auction-day changes to the agreement (not unusual at all), all participants must be adequately informed of such changes, and should be required to note the same on the record of the auction (bidders should confirm that all parties have seen any changes). As a practical matter, the sale hearing should take place as soon as possible after the auction — a short gap means little opportunity. Lastly, the winning bidder who wishes to stay in the winner's circle is well advised to not seek to “amend” its winning bid after the close of the auction (other than to conform to the terms of the accepted bid). Bidders should not underestimate their ability to affect the course of an auction. Money can be persuasive and if people refuse to bid, the auction is a failure.

While none of the above considerations can guarantee a certain result given the direct conflict in approach, it is far more sensible to take pro-active steps towards establishing a process amenable (or not) to late bidding, rather than relying on an omission or error. Though the Paloian court allowed the late bid, in part, because of the debtor's failure to adequately notify bidders of the change in the form agreement, courts as a general matter tend to frown on parties who “kill their parents” and then claim court's mercy as an “orphan” — ie, imprudent is the debtor who relies solely on his own missteps to keep opportunity for late bidding open (and also the bidders who allowed such missteps to go unchecked). Likewise, as noted in Paloian, courts will frown on bidders who bide their time and withhold their best bid until after seeing how the auction plays out, thereby circumventing the auction process.

But while errors and omissions cannot be planned for, there are certain affirmative steps that parties can take to sculpt the auction process to either forestall or facilitate late bidding. With so many things that are unpredictable and out of parties' hands during a frenetic auction process, this is one area over which debtors and potentially other participants can exert some influence, an opportunity that parties should not let slip. Especially if one side is more focused than the other.