Take-Aways from the Sears Sale Process

In fact, the UCC suggested that the sale process was manufactured by ESL/Sears as an emergency sale because Sears knew that whenever it filed Chapter 11 its business was going to be hemorrhaging money, a “melting ice cube,” facing insolvency, and subject to the usual restrictions and time constraints of a DIP order. See, UCC Objection to Sale, Dkt No. 2042. But that's the story line of most liquidations — big and small. We'll never know what would have happened with the sale if there was more time given to potential bidders, or if Sears had filed years earlier.

After the filing, the UCC and the Pension Benefit Guarantee Corporation (PBGC), a vocal UCC member, took the position that an immediate liquidation of the going concern assets was preferable to a sale to ESL because: 1) Sears faced administrative insolvency; 2) a prompt liquidation would provide the funds needed to pay pension and other priority liabilities; and 3) the releases in the ESL asset purchase agreement would interfere with the pursuit of valuable claims against ESL.

The pressure exerted by the UCC during the negotiations did result in revised and improved bids from ESL, however, including ESL's agreement during the negotiations that $17.9 million of its $120 million deposit would become non-refundable in the event ESL was not the ultimate purchaser of the assets. The UCC also persuaded ESL to eliminate its $30 million expense reimbursement request. The final purchase price included $1.4 billion in cash, $35 million for the limited release, and a $5.3 billion credit bid.

Despite obtaining valuable concessions, the UCC objected to approval of the sale to ESL. Judge Drain considered the extreme circumstances and the limited alternatives to liquidation, and ultimately approved the sale under the business judgment standard. The sale order: 1) preserves valuable claims against ESL related to the Seritage Growth transaction and the Land's End spin-off; 2) requires ESL to pay certain severance and administrative claims and assume certain liabilities; and 3) provides ESL and Lampert with only limited releases. According to some reports, accepting ESL's bid saved 45,000 jobs, but we don't know for how long.

Immediately after the announcement that ESL was the successful bidder, the UCC filed a motion seeking authority to pursue the remaining causes of action against ESL. The UCC's motion contains an extensive analysis of the law of recharacterization, equitable subordination and fraudulent transfer theories, and should be required reading for those who venture into those areas. See, Dkt. No. 1598.

Time will tell if general unsecured creditors will receive any meaningful distributions as administrative creditors are not likely to be paid in full. Before the sale to ESL, administrative claims were trading at about 55 to 70%. As of March 1, 2019, administrative claims were trading at about 85%.

Sears' View

Sears designed the auction sale process to fit the circumstances and complexities of the case, but many of the sale provisions and strategies would be useful in any case. As required in all cases, the auction rules and procedures (the Sale Rules) were designed to maximize value given the different Sears' businesses and assets, and the potential objections to the ESL credit bid and releases. See, Dkt. No. 833. The Sale Rules required the vetting of all credit bids and required ESL to pay substantial consideration for the right to credit bid. As stated above, bidders of non-cash consideration were required to calculate and explain how their bids were to be valued. Vetting the ELS credit bid presented an insurmountable task given the short time-frame and the complexities of the ESL secured claims. The parties understood that there was not enough time to litigate and resolve the disputed issues regarding the ESL credit bid, so Sears and ESL compromised and agreed on a credit bid amount for purposes of the auction.

In theory and practice, determining the cash value of credit bids provides an apples-to-apples comparison of bids, which is essential to any fair auction process. To that end, the Sale Rules took the unusual and useful step of requiring bidders to explain the non-cash value of any component of their bid, such as forgiveness of debt, a credit bid or assumption of liabilities. The Sale Rules permitted the estate to require bidders “to allocated value ascribed to a bid for a particular asset” and ask about “any significant assumptions” on which valuation assumptions are based. In other words, bidders of non-cash consideration had to explain and support their view of the value of the non-cash component of the bid. For example, if the non-cash component is the assumption of a liability, is the liability a valid debt that would have to be paid in full by the estate? These valuation issues are often overlooked in auction procedures and lead to disputes during auctions and post-auction objections. (See, “Valuing Bids in Bankruptcy Auctions,” The Bankruptcy Strategist, Vol. 33, No. 5, March 2016, http://bit.ly/2JgOqjY).

As expected, Sears designed the Sales Rules to keep the auction process on a tight time-table because Sears was on life support and subject to deadlines set forth in the DIP order. Sears responded to the UCC objection pointing out Sears' difficult cash position, the lack of better alternatives and the stringent requirements of the DIP order in the case. In the end it's difficult to second-guess the decision-making here. As the saying goes “Perfect is the enemy of the good,” and that's an apt description of this sale process, which wasn't perfect but achieved a practical, and to some a fair result.

The Sale Rules also provided a separate sale process for non-going concern assets. For example, there were separate auctions of the Sears home improvement business, intellectual property, and real estate sale. Sears received $400 million just for the sale of the “Kenmore” brand. Other Chapter 11 auctions have used the same strategy of separate auctions to maximize value and encourage bidding. In Sears, this approach was advantageous because it narrowed the disputes with ESL into one sale process and permitted the other sales to proceed without interruption or litigation.

As stated above, ESL stepped up to counter the naysayers by offering $35 million for the right to credit bid and for a limited release, as well as giving up any right to an expense reimbursement. The Sale Rules made sure that any competing bid including this extra $35 million of extra consideration so that the estate was not disadvantaged. ESL further bolstered its bid by including the assumption of certain liabilities such as section 503(b)(9) liabilities up to $139 million and certain severance obligations. See, “Material Terms of the Successful Bid,” Dkt. 1730. This consideration gave additional value to unsecured creditors by eliminating certain priority and administrative claims.

Epilogue

Since the closing of the sale, disputes have emerged regarding the asset purchase agreement. Sears filed a motion seeking to mediate disputes with ESL including whether Sears delayed payment of accounts receivable to make them post-closing obligations of ESL, and failed to properly manage its inventory which resulted in a shortfall to the detriment of ESL. This represents a significant challenge for Sears because it has acknowledged that it faces administrative insolvency and cannot afford to incur additional professional fees.

Analysis

It is my position that a credit bidder, which is subject to potential objections to its claims, and affirmative claims against it, should pay for the right to credit bid and receive a limited release. Too often, the right to credit bid and receive a general release is viewed without good reason as an inalienable right under section 363(k) and is given away for no consideration. What is ignored is the requirement that the claim underlying the credit bid be an allowed claim that is not subject to dispute.

A disputed credit bid can be resolved by the bankruptcy court before the auction, but often there is no time to do so. The practical solution of requiring a credit bidder to pay something for the right to credit bid seems to be a good way to deal with the disputes that plague many auction sales that involve credit bidders. Despite the enormous size and complexity of the Sears sale process, these valuable strategies and techniques can be used in smaller, less complicated cases.

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Adam L. Rosen is a Port Washington, NY based bankruptcy attorney who focuses his practice on corporate bankruptcy and restructuring and related litigation. He is a member of this newsletter's Board of Editors and can be reached at [email protected].