Recovery of Damages By Bankruptcy Bidders

The sale of a debtor's assets through a bankruptcy court supervised auction process has become more commonplace and, some theorize, under the amended law, may increase in popularity. Often, the process includes the use of a “stalking horse” agreement establishing a baseline of price and other terms for the sale of the assets. In return, the stalking horse bidder obtains certain bid protections (ie, break-up fees and/or expense reimbursements). At the close of the auction, either the stalking horse bidder either places the highest initial (or competing) bid or is outbid, maintaining a claim for the bid protections.

Although it is not common, circumstances can arise where, after the conclusion of an auction and court approval but prior to completion of the sale, the auction may be reopened due to, among other factors, a newly discovered impropriety casting doubt on the validity of the auction. If a court thereafter invalidates the results of the initial auction, what happens to the original highest bidder, which may have incurred certain expenses in preparing to consummate the previously approved sale? At least one court recently ruled that the estate may be held responsible to the initial “winner” for certain closing costs as administrative expenses.

Facts

In In re Women First Healthcare, No. 04-11278 (MFW) (Bankr. D. Del. Oct. 21, 2005), the Debtor entered into a stalking horse arrangement with Sun Pharmaceuticals Industries, Ltd. (Sun) for the sale of certain pharmaceuticals (the Bactrim Assets). The court approved the arrangement, and Sun was guaranteed a break-up fee and certain expense reimbursements in the event that it was outbid. Sun was not outbid, however. The court approved the sale order on Sept. 22, 2004, and the Debtor and Sun each began working towards the consummation of the sale.

Shortly thereafter, the Mutual Pharmaceutical Company, Inc. (Mutual) contacted the Debtor, stating that it was interested in buying the Bactrim Assets. Mutual was the exclusive manufacturer of Bactrim for the Debtor, and indicated that, as an interested party, it had not received proper notice that an auction for the Bactrim Assets would take place. Mutual filed a motion to reconsider the sale of the Bactrim Assets with the Bankruptcy Court several days later on Oct. 4, 2004.

At this point, the Debtor began to proceed along a parallel track, simultaneously preparing to close the sale with Sun in order to ensure that the sale would go forward if Mutual's motion was denied, while also working with Mutual to qualify it as a bidder should Mutual's motion be granted and the auction reopened. Ultimately, over Sun's objection, the Court granted Mutual's motion, vacated the initial Sun sale order, and set Nov. 10 as the date for the a new auction of the Bactrim Assets.

Mutual prevailed at the Nov. 10 auction, and Sun subsequently filed an administrative claim against the estate for approximately $300,000 — the amount it claimed to have spent in preparing to consummate the sale of the Bactrim Assets, from the now-vacated Sept. 22 sale order through the new auction ordered by the court on Nov. 10. Mutual and the U.S. Trustee (UST) objected to the claim. As discussed below, the court allowed the claim in part and denied it in part, setting forth certain general guidelines for when the estate can be held liable to the bidder who relied upon a prior court order.

Legal Analysis

As a threshold matter, the court declined to adopt Sun's general equitable argument under ' 105(a) of the Bankruptcy Code. The court reasoned that although ' 105(a) grants courts broad authority to issue any order “necessary or appropriate” to carry out the Code's provisions, ' 105(a) does not create substantive rights that would otherwise be unavailable under the Code. Section 105(a) creates no independent basis for allowance of the expense claim. However, the court found that Sun was entitled to recovery of a portion of its expenses under two separate legal theories: 1) tort; and 2) ' 503(b)(1)(A).

Tort

The court concluded that Sun was entitled to an administrative claim covering those costs it incurred due to the Debtor's tortious conduct. Specifically, the court found that by failing to provide Mutual with notice of the asset sale, but still representing to Sun that it had notified all potentially interested parties, the Debtor had committed the tort of negligent misrepresentation to Sun. Thus, any activities in which Sun engaged in reasonable reliance on that misrepresentation gave rise to a valid administrative claim.

Notably, the court relied upon Reading Co. v. Brown, 391 U.S. 417, 477 (1986), in which the Supreme Court held that a party that had incurred damages as a result of the tortious conduct of the debtor-in-possession (or trustee) was entitled to an administrative claim for reasons of fundamental fairness. The Women First court adopted a broad interpretation of Reading. In Reading, the trustee's tortious conduct occurred in the operation of its business, not in the liquidation of the estate, as in Women First. However, the Women First court found this to be a distinction without a difference: the activity by the Debtor here was clearly in furtherance of the Debtor's case, regardless of whether it was in an operational or liquidation context, and the demands of fundamental fairness were therefore not affected.

Although the court allowed a claim predicated upon tortious conduct, the court limited Sun's administrative claim to those expenses it incurred while reasonably relying upon the Debtor's misrepresentation. To that end, the court determined that once Sun learned of Mutual's interest in the Bactrim Assets, Sun could no longer reasonably rely on the validity of the prior sale order to proceed with closing. Consequently, the Court set Oct. 5 — the day after Mutual filed its motion to reconsider the sale of the Bactrim Assets to Sun — as the cut-off date for any tort liability on the Debtor's part.

The Bankruptcy Code: 'Benefit to the Estate'

Additionally, under ' 503(b)(1)(A) of the Bankruptcy Code, the court found that Sun was entitled to recover its expenses which resulted from post-petition transactions with the debtor-in-possession and that conferred a benefit to the Debtor's estate. Because Sun entered into the stalking horse arrangement with the Debtor post-petition, it was undisputed that these transactions took place with the debtor-in-possession, meeting the first test. However, Mutual and the UST argued that Sun's preparatory activities post-auction, but pre-sale, were merely self-interested and did not “benefit the estate” at all, especially given the fact that the sale itself never actually occurred.

The court disagreed, finding that even though Sun and the Debtor never completed the transaction, the Debtor still benefited by those actions Sun took in order to quickly close the sale of the Bactrim Assets. The court found it dispositive that the Bactrim Assets were perishable, necessitating a quick sale by the estate as these pharmaceuticals had a rapidly expiring shelf-life, and thus a rapidly decreasing sale value. If Bactrim was not sold quickly, the parties recognized that it could potentially end up being completely worthless. (These factors were even recited in the initial Sun sale order.) Thus, the court considered beneficial those actions taken by Sun to ensure that the sale would be quickly concluded, despite the fact that the sale was never consummated.

As the court had already designated expenses incurred by Sun between Sept. 22 and Oct. 4 as warranting administrative priority under a tort theory of liability, the court applied the ' 503(b) analysis to those activities conducted by Sun after Oct. 5, but before the new auction was held on Nov. 10. This analysis was lengthy and heavily factually oriented, as Sun bore the burden of proving that its specific activities during that time period conferred a benefit on the estate. (Accordingly, the details are not being discussed in this article but the reader should look to the specifics for guidance should this situation apply.) Among other factors, the court noted that Sun not only engaged in steps directly necessary to the closing but also engaged in activities that were either discretionary (ie, not necessary to the closing itself but were beneficial to Sun's subsequent ownership of the assets) or directed at opposing Mutual's motion to invalidate the original auction.

An example of such an inquiry conducted here concerned a business trip taken by executives of Sun (headquartered in India) to meet with distributors and suppliers of Bactrim in the U.S. The Sun executives claimed the entire expense of the trip as an administrative expense against the Debtor. The court found though, that only one-third of the expense of the trip would be granted administrative priority, because the executives came to the U.S. to discuss three different drug assets that they had acquired from the Debtor, only one of which was the Bactrim. In short, the court spent much of the last portion of the opinion whittling down Sun's administrative claim to reflect only the work Sun had done directly in furtherance of the closing sale of the Bactrim Assets.

Currency Exchange

As is common with auctions in bankruptcy, Sun was required to post a deposit with its bid. Because Sun was a non-U.S. entity, it was required to convert rupees into dollars for the deposit. As part of its damage claim, Sun sought an administrative claim for reimbursement of currency conversion losses it sustained when the value of the Rupee dropped during the approximately 4-month period that the Debtor retained Sun's deposit. The court disallowed the claim, noting that the Debtor solicited bids for its assets in U.S. currency, and therefore the cost of conversion should not be borne by the estate. (This is consistent with ' 502, which requires claims to be handled in U.S. dollars.)

Conclusion

Women First is a noteworthy opinion in several respects — both for those points of law that are elucidated by it, as well as for the way in which it analyzes the issue. First and foremost, in the wake of Women First, it is clear that if a successfully concluded auction is invalidated due to negligence on the part of the Debtor (such as the failure to provide sufficient notices), the estate will be held liable for those expenses incurred by the original successful bidder, in so far as those expenses stem from activities that would have conferred a benefit on the estate had the sale been consummated. This claim can be in addition to any entitlement to a break-up fee and/or expense reimbursement. Additionally, Women First expands upon the holding of Reading, making it clear that the estate will be held responsible for damage claims arising out of tortious behavior by the debtor-in-possession or the trustee, either in the administration of the estate or in a liquidation context. (The decision also favors broad notice of auctions, as the court rejected the Debtor's argument that it was not required to give Mutual, the Bactrim manufacturer, notice of the sale because its contract was not being assumed by Sun.)

Although both of these rules are clearly articulated in the opinion, the rational for their application by the Court can be less than clear. First, although it may not have been necessary to its award to Sun of an administrative claim, the court relied upon Reading to impose tort liability. However, the test articulated by the court under ' 503(b) could have addressed those same expenses incurred by Sun prior to Mutual's Oct. 4 filing date. More importantly, the court ceased any award based upon the tort claim after Mutual made it known that it was interested in bidding for the assets at a new auction. However, the existence of the prior Sun sale order, irrespective of Mutual's motion, did not cease to exist on Oct. 4. Indeed, as the court acknowledges, the Debtor was moving along a parallel track at this point, simultaneously proceeding with a closing with Sun as well as qualifying Mutual as a bidder in case the auction was reopened. Thus, arguably, Sun continued to act in reliance upon the Debtor's actions post Oct. 5 in proceeding toward consummating the sale if Mutual's motion failed. The court does not explore this situation in its decision to cut off the reach of the tort liability.

In any event, irrespective of the above nuance, under the rules of Women First Court, the estate can be held liable to bidders who act in reliance upon the debtor and a prior court order in proceeding toward a sale that may not be consummated.

The sale of a debtor's assets through a bankruptcy court supervised auction process has become more commonplace and, some theorize, under the amended law, may increase in popularity. Often, the process includes the use of a “stalking horse” agreement establishing a baseline of price and other terms for the sale of the assets. In return, the stalking horse bidder obtains certain bid protections (ie, break-up fees and/or expense reimbursements). At the close of the auction, either the stalking horse bidder either places the highest initial (or competing) bid or is outbid, maintaining a claim for the bid protections.

Although it is not common, circumstances can arise where, after the conclusion of an auction and court approval but prior to completion of the sale, the auction may be reopened due to, among other factors, a newly discovered impropriety casting doubt on the validity of the auction. If a court thereafter invalidates the results of the initial auction, what happens to the original highest bidder, which may have incurred certain expenses in preparing to consummate the previously approved sale? At least one court recently ruled that the estate may be held responsible to the initial “winner” for certain closing costs as administrative expenses.

Facts

In In re Women First Healthcare, No. 04-11278 (MFW) (Bankr. D. Del. Oct. 21, 2005), the Debtor entered into a stalking horse arrangement with Sun Pharmaceuticals Industries, Ltd. (Sun) for the sale of certain pharmaceuticals (the Bactrim Assets). The court approved the arrangement, and Sun was guaranteed a break-up fee and certain expense reimbursements in the event that it was outbid. Sun was not outbid, however. The court approved the sale order on Sept. 22, 2004, and the Debtor and Sun each began working towards the consummation of the sale.

Shortly thereafter, the Mutual Pharmaceutical Company, Inc. (Mutual) contacted the Debtor, stating that it was interested in buying the Bactrim Assets. Mutual was the exclusive manufacturer of Bactrim for the Debtor, and indicated that, as an interested party, it had not received proper notice that an auction for the Bactrim Assets would take place. Mutual filed a motion to reconsider the sale of the Bactrim Assets with the Bankruptcy Court several days later on Oct. 4, 2004.

At this point, the Debtor began to proceed along a parallel track, simultaneously preparing to close the sale with Sun in order to ensure that the sale would go forward if Mutual's motion was denied, while also working with Mutual to qualify it as a bidder should Mutual's motion be granted and the auction reopened. Ultimately, over Sun's objection, the Court granted Mutual's motion, vacated the initial Sun sale order, and set Nov. 10 as the date for the a new auction of the Bactrim Assets.

Mutual prevailed at the Nov. 10 auction, and Sun subsequently filed an administrative claim against the estate for approximately $300,000 — the amount it claimed to have spent in preparing to consummate the sale of the Bactrim Assets, from the now-vacated Sept. 22 sale order through the new auction ordered by the court on Nov. 10. Mutual and the U.S. Trustee (UST) objected to the claim. As discussed below, the court allowed the claim in part and denied it in part, setting forth certain general guidelines for when the estate can be held liable to the bidder who relied upon a prior court order.

Legal Analysis

As a threshold matter, the court declined to adopt Sun's general equitable argument under ' 105(a) of the Bankruptcy Code. The court reasoned that although ' 105(a) grants courts broad authority to issue any order “necessary or appropriate” to carry out the Code's provisions, ' 105(a) does not create substantive rights that would otherwise be unavailable under the Code. Section 105(a) creates no independent basis for allowance of the expense claim. However, the court found that Sun was entitled to recovery of a portion of its expenses under two separate legal theories: 1) tort; and 2) ' 503(b)(1)(A).

Tort

The court concluded that Sun was entitled to an administrative claim covering those costs it incurred due to the Debtor's tortious conduct. Specifically, the court found that by failing to provide Mutual with notice of the asset sale, but still representing to Sun that it had notified all potentially interested parties, the Debtor had committed the tort of negligent misrepresentation to Sun. Thus, any activities in which Sun engaged in reasonable reliance on that misrepresentation gave rise to a valid administrative claim.

Notably, the court relied upon Reading Co. v. Brown , 391 U.S. 417, 477 (1986), in which the Supreme Court held that a party that had incurred damages as a result of the tortious conduct of the debtor-in-possession (or trustee) was entitled to an administrative claim for reasons of fundamental fairness. The Women First court adopted a broad interpretation of Reading. In Reading, the trustee's tortious conduct occurred in the operation of its business, not in the liquidation of the estate, as in Women First. However, the Women First court found this to be a distinction without a difference: the activity by the Debtor here was clearly in furtherance of the Debtor's case, regardless of whether it was in an operational or liquidation context, and the demands of fundamental fairness were therefore not affected.

Although the court allowed a claim predicated upon tortious conduct, the court limited Sun's administrative claim to those expenses it incurred while reasonably relying upon the Debtor's misrepresentation. To that end, the court determined that once Sun learned of Mutual's interest in the Bactrim Assets, Sun could no longer reasonably rely on the validity of the prior sale order to proceed with closing. Consequently, the Court set Oct. 5 — the day after Mutual filed its motion to reconsider the sale of the Bactrim Assets to Sun — as the cut-off date for any tort liability on the Debtor's part.

The Bankruptcy Code: 'Benefit to the Estate'

Additionally, under ' 503(b)(1)(A) of the Bankruptcy Code, the court found that Sun was entitled to recover its expenses which resulted from post-petition transactions with the debtor-in-possession and that conferred a benefit to the Debtor's estate. Because Sun entered into the stalking horse arrangement with the Debtor post-petition, it was undisputed that these transactions took place with the debtor-in-possession, meeting the first test. However, Mutual and the UST argued that Sun's preparatory activities post-auction, but pre-sale, were merely self-interested and did not “benefit the estate” at all, especially given the fact that the sale itself never actually occurred.

The court disagreed, finding that even though Sun and the Debtor never completed the transaction, the Debtor still benefited by those actions Sun took in order to quickly close the sale of the Bactrim Assets. The court found it dispositive that the Bactrim Assets were perishable, necessitating a quick sale by the estate as these pharmaceuticals had a rapidly expiring shelf-life, and thus a rapidly decreasing sale value. If Bactrim was not sold quickly, the parties recognized that it could potentially end up being completely worthless. (These factors were even recited in the initial Sun sale order.) Thus, the court considered beneficial those actions taken by Sun to ensure that the sale would be quickly concluded, despite the fact that the sale was never consummated.

As the court had already designated expenses incurred by Sun between Sept. 22 and Oct. 4 as warranting administrative priority under a tort theory of liability, the court applied the ' 503(b) analysis to those activities conducted by Sun after Oct. 5, but before the new auction was held on Nov. 10. This analysis was lengthy and heavily factually oriented, as Sun bore the burden of proving that its specific activities during that time period conferred a benefit on the estate. (Accordingly, the details are not being discussed in this article but the reader should look to the specifics for guidance should this situation apply.) Among other factors, the court noted that Sun not only engaged in steps directly necessary to the closing but also engaged in activities that were either discretionary (ie, not necessary to the closing itself but were beneficial to Sun's subsequent ownership of the assets) or directed at opposing Mutual's motion to invalidate the original auction.

An example of such an inquiry conducted here concerned a business trip taken by executives of Sun (headquartered in India) to meet with distributors and suppliers of Bactrim in the U.S. The Sun executives claimed the entire expense of the trip as an administrative expense against the Debtor. The court found though, that only one-third of the expense of the trip would be granted administrative priority, because the executives came to the U.S. to discuss three different drug assets that they had acquired from the Debtor, only one of which was the Bactrim. In short, the court spent much of the last portion of the opinion whittling down Sun's administrative claim to reflect only the work Sun had done directly in furtherance of the closing sale of the Bactrim Assets.

Currency Exchange

As is common with auctions in bankruptcy, Sun was required to post a deposit with its bid. Because Sun was a non-U.S. entity, it was required to convert rupees into dollars for the deposit. As part of its damage claim, Sun sought an administrative claim for reimbursement of currency conversion losses it sustained when the value of the Rupee dropped during the approximately 4-month period that the Debtor retained Sun's deposit. The court disallowed the claim, noting that the Debtor solicited bids for its assets in U.S. currency, and therefore the cost of conversion should not be borne by the estate. (This is consistent with ' 502, which requires claims to be handled in U.S. dollars.)

Conclusion

Women First is a noteworthy opinion in several respects — both for those points of law that are elucidated by it, as well as for the way in which it analyzes the issue. First and foremost, in the wake of Women First, it is clear that if a successfully concluded auction is invalidated due to negligence on the part of the Debtor (such as the failure to provide sufficient notices), the estate will be held liable for those expenses incurred by the original successful bidder, in so far as those expenses stem from activities that would have conferred a benefit on the estate had the sale been consummated. This claim can be in addition to any entitlement to a break-up fee and/or expense reimbursement. Additionally, Women First expands upon the holding of Reading, making it clear that the estate will be held responsible for damage claims arising out of tortious behavior by the debtor-in-possession or the trustee, either in the administration of the estate or in a liquidation context. (The decision also favors broad notice of auctions, as the court rejected the Debtor's argument that it was not required to give Mutual, the Bactrim manufacturer, notice of the sale because its contract was not being assumed by Sun.)

Although both of these rules are clearly articulated in the opinion, the rational for their application by the Court can be less than clear. First, although it may not have been necessary to its award to Sun of an administrative claim, the court relied upon Reading to impose tort liability. However, the test articulated by the court under ' 503(b) could have addressed those same expenses incurred by Sun prior to Mutual's Oct. 4 filing date. More importantly, the court ceased any award based upon the tort claim after Mutual made it known that it was interested in bidding for the assets at a new auction. However, the existence of the prior Sun sale order, irrespective of Mutual's motion, did not cease to exist on Oct. 4. Indeed, as the court acknowledges, the Debtor was moving along a parallel track at this point, simultaneously proceeding with a closing with Sun as well as qualifying Mutual as a bidder in case the auction was reopened. Thus, arguably, Sun continued to act in reliance upon the Debtor's actions post Oct. 5 in proceeding toward consummating the sale if Mutual's motion failed. The court does not explore this situation in its decision to cut off the reach of the tort liability.

In any event, irrespective of the above nuance, under the rules of Women First Court, the estate can be held liable to bidders who act in reliance upon the debtor and a prior court order in proceeding toward a sale that may not be consummated.