The Restructuring Report

In 2019, the Eighth Circuit Court of Appeals upheld the finality of an asset sale previously approved by the bankruptcy court, providing valuable precedent in support of this core aspect of Chapter 11 practice. Fulmer v. Fifth Third Equip. Fin. Co. et al. (In re Veg Liquidation, Inc.), 931 F.3d 730 (8th Cir. 2019)

The debtor Allens, Inc., a food canning company, filed a Chapter 11 case and moved to sell all of its assets under a court-approved sale process. As part of the sale process, Seneca Foods Corporation was selected as a “Stalking Horse” bidder, whose $148 million asset purchase agreement served as the opening bid at the auction.

At the auction, the debtor’s financial advisor valued the Stalking Horse bid at a $117 million “net value.” To reach this value, the debtor’s financial advisor subtracted a working capital adjustment, assumption of various debts and the funding of an escrow. Auction Transcript, In re Veg Liquidation, Inc., No. 5:13-bk-73597 (Bankr. W.D. Ark., Feb. 10, 2014), ECF No. 587.

The prevailing bid at the auction was a $125 million bid by a group of second lienholders, which was valued by the debtor’s financial advisor at a $160 million “net value.” Importantly, as is often the case when a bidder intends to continue the business of the debtor, the competing bid included the purchase of non-insider avoidance actions and a covenant not to pursue them. No purchaser wants its suppliers to be subject to claw back lawsuits arising from the business it just purchased, so it is common practice for a bid to include those avoidance actions for the purpose of burying them.

The debtor selected the competing bid and requested court approval of the sale. The bankruptcy court did so, and in an order approving the sale, the court found that the auction was “a competitive and good faith bidding process” and that the successful bid was “the highest or otherwise best offer” for the assets.

With no further operations, the debtor converted the case to Chapter 7. A trustee was appointed who then sued the members of the unsecured creditors committee, the debtor’s financial advisor and the purchaser. The trustee argued that the purchaser won the auction with an overvalued bid that included an undisclosed agreement between the purchaser and an unsecured creditor. One of the members of the unsecured creditors’ committee had an agreement to do business with the purchaser if it was the successful bidder. The trustee argued that the estate was entitled to damages, rescission and reformation.

In affirming the dismissal of the complaint, the Eighth Circuit held that the trustee’s complaint was an impermissible collateral attack on the validity of the sale order. In order to sustain the claims, a court would be required to contradict the bankruptcy court’s determinations that the auction was conducted in good faith and that the successful bid was the best available offer for the assets.

A contrary decision would have severely impacted Chapter 11 practice. Fewer buyers would be willing to participate in a Chapter 11 sale process if the result could be unwound years later by a trustee who was not present during the process. Furthermore, from the outside there does not appear to have been anything unusual about this case. It is common for the debtor and its professionals to value bids at something other than their “top line” purchase price.

As much as they attempt to make sure bids are “apples to apples,” that is rarely the case in practice. The debtor’s professionals described on the record at the auction how each bid was valued and how various qualitative factors would be considered, such as ability to close and limited conditions precedent. Auction Transcript, In re Veg Liquidation, Inc., No. 5:13-bk-73597 (Bankr. W.D. Ark., Feb. 10, 2014), ECF No. 587.

And it is also common for creditors to support bids from parties with whom they will do business in the future. Creditors often have multiple interests – a bid might include the assumption of leases or contracts, bury avoidance actions or promise an ongoing business relationship – and it is legitimate for those creditors to take those issue into consideration in determining whether to support a bid.

In addition to dodging a bullet that was aimed at a key aspect of Chapter 11 practice, this case provides two key practice points for estate professionals conducting a sale process: Ensure that there is transparency regarding how the bids are valued and include applicable findings in the sale order.

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