Valuing Bids in Bankruptcy Auctions

The estate is entitled to use its broad business judgment to determine which bid is the “highest and best,” but sometimes valuing non-cash and credit bids can be fraught with subjectivity and uncertainty. Auction procedure orders usually provide estates with wide latitude to determine the operative value of bids. However, when auctions are not held in the presence of a bankruptcy judge, then there is no efficient and immediate method of resolving disputes with a sense of finality regarding the operative values of bids.

In re Financial News Network Inc.

Certainly as a result of the challenges in valuing non-cash consideration, there is greater need for flexibility in auctions involving non-cash bids. See, e.g., Consumer News and Business Channel Partnership v. Financial News Network Inc. (In re Financial News Network Inc.), 134 B.R. 737 (1991), aff'd 980 F.2d 165 (2d Cir. 1992) (FNN). In FNN, one bidder, Dow Jones submitted a bid that included $125 million in cash, a share of the business' future revenues (which it valued at $32.8 million), and assumed liabilities valued at $9.3 million.

The other bidder, CNBC, offered $135 million in cash. During the auction, which was held before the bankruptcy judge, CNBC asked the bankruptcy court to value the non-cash component of Dow's bid so that CNBC could make an informed decision with respect to its bidding strategy. The bankruptcy court refused to do so, and CNBC increased its bid to $140 million in cash, plus assumption of liabilities valued at $6.1 million. In re Financial News Network Inc., 134 B.R. at 738. At this point it was unclear which bid was best for the estate.

Bankruptcy Judge Francis G. Conrad closed the bidding and then took testimony with respect to the value of the future revenue stream, which was a component of Dow Jones' bid. Id. After the close of the testimony, the parties increased their bids. Id. The estate and the creditor's committee did not agree on which bid should be the winning bidder and the bankruptcy court did not make an immediate decision. Id. at 739.

The next day, the estate asked the bankruptcy court to delay its ruling in order to consider new evidence, namely a $17 million offer by an investment bank to purchase the future revenue stream included in Dow's bid. Id. Judge Conrad viewed the new evidence as relevant in providing a more definitive value of the future revenue stream. Id. After a conference call with the parties, Judge Conrad considered the new evidence and reopened bidding to allow both parties to again revise their bids. Id. CNBC objected, but ultimately increased its bid to $145 in million cash, and a share of the revenue stream. Dow declined to increase its bid, and Judge Conrad determined that CNBC was the successful bidder. Id. at 739-40.

Both the district court and the U.S. Court of Appeals for the Second Circuit upheld the bankruptcy court's decision to receive post-auction evidence regarding the value of the future revenue stream, which Judge Conrad determined to be critical in establishing the operative value of the future revenue stream. Id. at 738. On appeal, CNBC argued that the bankruptcy court should not have considered the additional evidence, or reopened the bidding, and that CNBC should only be required to pay the amount of its offer, rather than the increased offer made as a result of the reopened bidding. Id. The Second Circuit agreed with Judge Conrad's approach, and declined to require a refund to CNBC. FNN, 980 F.2d 165 (2d Cir. 1992).

Additionally, the district court and the Second Circuit in FNN discussed the issue of how to value non-cash auction bids. The district court agreed that the bankruptcy court acted appropriately in hearing post-auction evidence on the value of the non-cash components of bids stating:

Here, the two contending bids were structured differently and accordingly were difficult to compare. The May 7 hearing had been aimed primarily at determining the value of Dow's bid, which was uncertain because of its contingent revenue component ' [The new offer] simply was newly available evidence obtained from a third party which gave a clear answer to what at the close of the May 7 hearing appeared to be a vexing problem for the court, and was properly admitted.

FNN, 134 B.R. 737, 741-42 (S.D.N.Y. 1991).

The district court noted the need for flexibility in bankruptcy auctions, stating:

The situation was highly unusual and appears unlikely to recur frequently. In the event similar circumstances arise, bankruptcy courts retain considerable discretion to prevent manipulation or undermining of their sale procedures, an authority which the approach taken in this case has not diminished.

Id. at 743.

Although the facts in FNN were unusual, as a general proposition, we are not sure that the problem of valuing non-cash bids is so unusual, and one reason for this is the popularity and importance of credit bids.

Credit Bidding As a Non-Cash Bid

The now infamous Fisker Automotive decision may be viewed as a decision that determined the “operative value” of a credit bid for purposes of an auction. In re Fisker Automotive Holdings, Inc. , 510 B.R. 55 (Bankr. D.Del. 2014). In Fisker Automotive, the court relied on section 36(k), which provides that “unless the court for cause orders otherwise the holder of [a claim secured by the property for sale] may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.” 11 U.S.C. ' 363(k).

Among other issues Judge Gross had with the validity of the credit bid in Fisker, part of what he decided was that limiting the operative value of the credit bid was justified, at least in part, because it was unclear what portion of the bidder's claim was a valid secured claim. See In re Fisker Automotive Holdings, Inc., 510 B.R. at 61 (“The law leaves no doubt that the holder of a lien the validity of which has not been determined, as here, may not bid its lien.” (citing In re Dau fuskie Isl. Props., LLC, 441 B.R. 60 (Bankr. S.D.C. 2010)). Judge Gross' decision was based on the established principle that the disputed portion of a secured claim cannot be used to credit bid. See, e.g., In re RML Development, Inc., 528 B.R. 150, 155 (Bankr. W.D. Tenn. 2014) (holding that secured creditor may credit bid the uncontested portion of its allowed secured claim but not the contested portion).

Other Examples of Non- Cash Consideration

Sometimes the operative value of a bid is affected by considerations such as the risk of a delayed closing, or the risk of no closing. Also, the views of affected parties, like landlords and other contract parties whose views are relevant to the sale process should affect the operative value of a bid. Or, litigation concerns might affect the value of an offer. Or, public policy concerns like continuation of the work of a not for profit organization. See, e.g., In re United Healthcare System, Inc., 1997 WL 176574 (D.N.J. March 26, 1997) (“When analyzing an articulated business reason for the sale, the bankruptcy court must also take into consideration the fact that a debtor is a charitable institution.”) (citing In the Matter of Brethren Care of South Bend, Inc., 98 B.R. 927, 935 (N.D. Ind. 1989) (“[C]ontinuing satisfaction and ongoing beneficial treatment of the residence of the St. Paul's [retirement and nursing] facility is a good business reason for the sale of [its] assets as scheduled.”).

But, should the estate be required to provide its value of non-cash components of a bid in order to encourage competitive bidding? Certainly, estates should do so with respect to stalking horse bids that contain significant non-cash components. Perhaps fewer auctions would be cancelled due to a lack of interest if potentially interested bidders were able to determine the operative value of non-cash components of an offer. There are many recent examples of cancelled auctions. In re Kior, Inc., Case No. 14-12514 (CSS) (Bankr. D.Del.) (ECF Doc. No. 196); In re Cold Holding Company LLC, 15-11296 (LSS) (Bankr. D.Del.) (ECF Doc. No. 607); In re Grubb & Ellis Company' Case No. 12-10685 (MG) (Bankr. S.D.N.Y.) (ECF Doc. No. 720).

Often, complex auctions drag on for hours or days because, at least in part, there are disagreements regarding the valuation of non-cash components of bids. In some cases with sophisticated financial advisers, these questions are resolved at the auction, but in many cases the operative value of non-cash bids remains a gray area, which makes bankruptcy auctions less attractive to potential competing bidders.

The Bankruptcy Court's Role

Conducting the auction in the presence of a bankruptcy judge certainly is a good practice in these circumstances. Bankruptcy courts recognize that non-cash components of a bid are a part of determining the highest and best bid. See, e.g., In re After Six, Inc., 154 B.R. 876, 882 (Bankr. E.D.Pa. 1993) (stating in dicta that in appropriate circumstances non-cash components of a bid might justifiably cause an estate to choose a “lower” bid as the winning bidder). For example, if a bid contains a waiver of claims against the estate, and those claims are unlikely to be paid in full then the operative value of the bid should reflect that fact. Id. at 883.

Courts understandably are hesitant to substitute their own business judgment for the estate's judgment. See, e.g., In re Diplomat Construction, Inc., 481 B.R. 215 (Bankr. N.D. Ga. 2012) (holding trustee's selection of second highest bidder as successful bidder was a reasonable exercise of business judgment, because “the [t]rustee is afforded great judicial deference in deciding which bid to accept as the best and highest bid. Even though the discretion is not without limit, the Court should not step in and assume a role and responsibility properly placed in the hands of the [t]rustee under these facts”) (citations omitted).

On Dec. 1, 2015, the Bankruptcy Division of the District Court of the Virgin Islands approved a sale of assets after an auction involving substantial non-cash consideration. See In re Hovensa, L.L.C., Case No. 15-10003 (MFW) (ECF Doc. No. 394). The declarations filed with the court by the Government for the Virgin Islands, and the estate's financial adviser, demonstrate that the estate made an effort to determine the cash value of certain tax concession agreements with the Government for the Virgin Islands. Ultimately, the stalking-horse bidder was selected, due in part to the substantial value attributed to the non-cash consideration offered (a negotiated agreement with the Government, and certainty as to allocation of sale proceeds between the Government and the estate).

Reopening Auctions

When courts do intervene in auctions, that decision and the results are often controversial. For example, whether to reopen an auction to consider a new bid, which is always dependent on the facts of the case.

Bankruptcy courts generally will not reopen an auction “simply because one of the parties who participated ' now wants to make a higher offer.” In re Bigler, LP, 443 B.R. 101, 102, 109 (Bankr. S.D.Tex. 2010) (declining to reopen auction based upon U.S. Court of Appeals for the First Circuit precedent that it is important to instill “public confidence in the regularity of judicial sales” absent something unusual about the auction or some other circumstance warranting reopening the auction as a matter of equity) (quoting In re Gil Bern Industries, Inc., 526 F.2d 627, 629 (1st Cir. 1975)).

But, where a higher offer is made after the close of the auction, only if “the price [accepted at the auction] is so grossly inadequate as to shock the conscience,” then some courts will consider reopening the bidding, or even invalidating the sale. See, e.g., First Nat'l Bank v. M/V Lightning Power, 776 F.2d 1258, 1259 (5th Cir. 1985) (voiding sale where party was unable to bid because it did not have the required documents demonstrating its financial wherewithal, enabling the bank to successfully bid $5,000 for a vessel valued at $900,000); In re Family Christian, LLC, 533 B.R. 600 (Bankr. W.D. Mich. 2015) (holding that auction was flawed because, among other reasons, the sale to the high bidder included releases of potential estate claims against insiders which had not been accounted for in valuing the bid).

Courts may even consider reopening an auction without a showing that the “initial bids were grossly inadequate or that the original bidding was tainted by fraud or some other irregularity,” where a late bid is submitted prior to entry of a sale order, and it “would not unduly frustrate the reasonable expectations of the participants or compromise the integrity of the process,” but rather, would result in a financial gain for the estate and its creditors. See Corporate Assets, Inc. v. Paloian, 368 F.3d 761 (7th Cir. 2004) (affirming district court and bankruptcy court decisions to reopen auction to consider new bid that was 9% higher based on a flaw in the auction process concerning the debtor's failure to communicate certain information to all parties during the auction) (citing FNN, 980 F.2d at 170; In re Food Barn Stores, Inc., 107 F.3d 558, 565 (8th Cir. 1997)).

Another reason to reopen an auction is to hear evidence concerning the value of non-cash components of a bid. FNN, 134 B.R. 737, 742 (S.D.N.Y. 1991) (holding bankruptcy court appropriately reopened bidding, especially where earlier proceeding “had seen considerable 'ebb and flow” which suggest[ed] that both parties understood that the proceeding was not constrained by rigid procedural requirements”).

In FNN, the Second Circuit supported the reopening of the auction, holding that:

[T]he involved and somewhat speculative nature of the assets being sold required the bankruptcy court to adopt a fluid bidding process that allowed both parties at various times to amend their offers in an attempt to arrive at a fair valuation of the assets. There was, according to the bankruptcy court, an 'ebb and flow' throughout the auction, which 'required each participant to tack with the change of the wind.' In [the Second Circuit's] view, this process best balanced the competing considerations of finality in the bidding process and fairness to the bidders against the interests of creditors in securing the highest sales price. There are cases where the bankruptcy court's discretion must be sufficiently broad so that in making its decision it can compass these competing considerations as best it can.

In re Financial News Network Inc., 980 F.2d 165, 170 (2d Cir. 1992).

Even though it would be helpful to bidders, “there is no requirement that competing purchasers be given precise valuations of the non-dollar components of their bids.” In re Bakalis, 220 B.R. 525 (Bankr. E.D.N.Y. 1998) (citing In re Financial News Network Inc., 134 B.R. 737 (S.D.N.Y. 1991), aff'd 980 F.2d 165 (2d Cir. 1992)).

Practice Tips

In cases where bids include significant non-cash consideration or a disputed secured claim, the estate should consider conducting the auction in the presence of the bankruptcy judge, or seek pre-auction direction from the court to ensure auction participants understand the operative value of bids, and bid terms. See, e.g., In re Bigler, LP, 443 B.R. 101, 116 (Bankr. S.D.Tex. 2010) (suggesting “that the most appropriate approach to maximizing value for the estate ' and also the soundest method of maintaining confidence in the system ' is to hold auctions in the courtroom, on the record, with the [c]ourt serving as auctioneer”). This allows competing bidders to bid on an “apples to apples” basis. It also encourages bidders to participate in auctions because it increases transparency and valuation consistency.

Bidders should also consider raising valuation issues before the auction procedures are approved, or during the auction, whether or not the auction is held before the court. In the end, bankruptcy judges want to bring value into the estate, and will use their equitable powers to do so where appropriate and justifiable.

Adam L. Rosen is a partner and Sheryl P. Giugliano is an associate with Diamond McCarthy LLP in New York City. They can be reached at [email protected]'and [email protected], respectively.