Asset Sales in Bankruptcy: Public Auctions vs. Private Sales under Bankruptcy Code Section 363
We now address assets sales under Bankruptcy Code section 363. The statute allows debtors to use, sell, or lease their property in the ordinary course of business without court permission. But a debtor’s use, sale, or lease of property outside the ordinary course of business requires court approval. And courts will usually approve a debtor’s disposition of property if it reflects the debtor’s reasonable business judgment and an articulated business justification.
Property of value is often sold in bankruptcy by public auction. Debtors will try to find a so-called “stalking horse” bidder to set the base price. Procedures approved by the bankruptcy court will set bid increments above the initial one. If the stalking horse loses the auction, it will likely receive a “break-up” fee to cover its cost of due diligence. The winning bidder is the one who will have made the highest and best offer.
But debtors do not have to sell property solely by public auction. They can hold private sales as well. But assume a debtor notices and starts a public auction. Can the debtor switch in mid-stream to a private sale and ignore other bidders?
This issue arose recently in a case in Florida. In re Royal Palm, LLC, No. 9:19-cv-80343, 2019 U.S. Dist. LEXIS 61611 (S.D. Fla. Apr. 10, 2019). In August 2018, the owner of a hotel that was under construction filed chapter 11. The debtor retained a national real estate firm to market the property. A stalking horse bidder was identified, the base price was set at $32 million, the court approved bidding procedures, and an auction was scheduled for November 2018.
But these plans got sidetracked by litigation involving the debtor, a former owner of the hotel, and foreign investors. In addition, the former owner sought to credit bid a claim it held against the debtor’s estate at the auction and have that claim estimated.[i] While motion practice on these two issues moved forward, the auction was adjourned a month. Discovery on the motions caused more delay. Over four days in early 2019, the bankruptcy court heard the credit-bid and estimation motions. Then, in early February 2019, the bid deadline and auction were rescheduled again, for March 2019.
That’s where the matter stood in late February 2019 when the debtor changed its plans. It made a motion to sell the hotel in a private sale to an entity that would pay $39.6 million. No one else but the stalking horse would be allowed to bid. The public auction bidding procedures would be withdrawn.
The bankruptcy court approved the new procedures. In mid-March 2019, the court approved a sale to the new bidder (not the stalking horse) free of all liens, claims, and encumbrances. After the private sale was approved, the former owner (who had been shut out of the bidding) appealed to the federal district court. The former owner challenged the withdrawal of the public auction procedures, the approval of the private auction procedures, and the bankruptcy court’s approval of the private sale.
Less than a month after the appeal was filed, the district court ruled for the debtor on all issues. The court said there was “nothing in the record to overcome the deference that is owed to the Debtor’s business judgment and the Bankruptcy Court’s findings of fact.” 2019 U.S. Dist. LEXIS 61611, *13. District Judge Robin L. Rosenberg added that the “record reveals that the Debtor had actively marketed the property, employed an international real estate broker to help sell the property, and had been continuously working towards that sale since as early as October 2018.” Id., *14. In addition, Judge Rosenberg noted, “[i]n particular, the Bankruptcy Court did not clearly err in crediting the Debtor’s manager’s . . . testimony regarding the Debtor’s ‘extensive marketing’ of the property and his conclusion that the [private sale] offer was worthy of pursuit.” Id. Significantly, the court said, “private sales are not unheard of in bankruptcy and in fact are expressly contemplated by the rules. See Fed. R. Bankr. P. 6004(f)(1).” Id., *16.
The former hotel owner said it would have offered $1 million more than the private-sale bid. But the court noted that the highest bid isn’t necessarily the best. Id., *20. The elimination of other bids “was subject to the Debtor’s business judgment.” The private sale gave the debtor “finality [and] certainty” with a higher price than the stalking horse bid. Id. *16. “[T]o force the Debtor to forgo the [accepted private-sale] offer and subject itself to a public auction would require this Court to use its own business judgment in place of the Debtor’s, which this Court will not do.” Id., *22.
Thus, on these facts, both the bankruptcy court and the district court ruled that the debtor could abandon a public auction in favor of a private sale and still satisfy the requirements of Bankruptcy Code section 363. We will watch to see if the district court’s decision is appealed to the Court of Appeals and, if so, report on future developments.
[i] Credit bidding is a secured creditor’s right to bid the amount owed to it rather than pay with cash.