On July 25, 2023, the United States Court of Appeals for the Fifth Circuit issued an important opinion protecting the rights of stalking horse bidders in Section 363 sales. In the Matter of Bouchard Transportation Company, Inc. involved one of the largest petroleum shipping companies in the United States. Bouchard sought to sell a large portion of its assets, consisting of certain vessels, through a Bankruptcy Court approved auction. In anticipation of the auction, Bouchard sought, and the Bankruptcy Court entered a bidding procedures order. At the time the Bankruptcy Court approved the bidding procedures, Bouchard did not have a stalking horse bidder for its assets. However, the bid procedures included authorization to select a stalking horse bidder at a later date and provide bid protections, including a break up fee and expense reimbursement. A stalking horse bidder is an initial bidder that sets a floor for the sale price. The Bankruptcy Court set a deadline for the selection of a stalking horse bidder and limited both the break up fee and expense reimbursement.

As the deadline to select a stalking horse bidder approached, Bouchard had no offers. The Bankruptcy Court extended the deadline several times, until the deadline was less than a day prior to the auction. On the eve of the auction, Bouchard had two offers. One offer required that the debtor cancel the auction and accept its deal outright. This offer also included a financing contingency which the bidder may not have been able to secure. The other offer was from Hartree Partners, L.P. It offered $110 million for 29 of the 31 vessels and required a break up fee of three percent (3%) and a maximum expense reimbursement of $1,500,000. Both were within the permitted protections in the Bankruptcy Court’s bidding procedures order. In addition, Hartree required any overbid to be at least $500,000 more than its stalking horse bid. Bouchard accepted this offer and informed the Bankruptcy Court.

At the auction the next day, the debtor’s secured creditor, JMB Capital Partners Lending, LLC, submitted a competing bid for $115.3 million, which was the minimum necessary to pay the break up fee, expense reimbursement and overbid requirement. No parties submitted additional bids, and JMB won the auction.

Thereafter, the Official Committee of Unsecured Creditors objected to the break up fee and expense reimbursement, contending that the payments were administrative expenses subject to scrutiny under § 503(b) and did not provide an actual benefit to the estate. Bouchard took the position that the payments were governed by § 363(b) and only needed to satisfy the business judgment standard. The Bankruptcy Court approved the sale to JMB but set a later hearing to consider the bid protections. At this, the Bankruptcy Court ruled that the break up fee was appropriate and approved the expense reimbursement in the reduced amount of $1 million. The Bankruptcy Court did not decide whether § 503(b) or §363(b) applied, reasoning that under either standard, the payments should be permitted. The Committee appealed to the District Court, which affirmed the Bankruptcy Court.

The Committee appealed the matter to the Fifth Circuit. The Fifth Circuit first determined that the issue presented a mixed question of law and fact, but that due to the primacy of the factual issues, deference should be given to the Bankruptcy Court since it conducted the fact finding. The Bankruptcy Court ruled after hearing five hours of witness testimony. Accordingly, the standard utilized by the Fifth Circuit in considering the appeal was whether the Bankruptcy Court’s determinations were “plausible in light of the record.”

In considering whether the bid protections were appropriate, the Fifth Circuit noted a split in authority as to whether § 503 or § 363 governed. In fact, prior Fifth Circuit precedent gave mixed signals as to which section should be utilized. Further, this case presented somewhat unusual facts given the timing of the selection of the stalking horse bidder since a stalking horse bid is often approved before the auction. Like the Bankruptcy Court and the District Court, the Fifth Circuit declined to decide which provision was appropriate and instead determined that under either standard, the payments should be approved.

Under § 503(b), an administrative expense will be awarded if the claimant establishes that the expenses (i) were incurred post-petition as a result of actions taken by the debtor; (ii) were actual; and (iii) were “necessary costs of preserving the estate.” While the purchase agreement was clearly entered into post-petition, the Committee argued that it was not enforceable until approved by the Bankruptcy Court. The Fifth Circuit declined to adopt this reasoning, focusing instead on the post-petition nature of the agreement, the policy behind the statute – encouraging parties to do business with debtors, and the language of the statute which expressly contemplates that the debtors will incur administrative expenses prior to court approval.

The Fifth Circuit next described the benefits to the estate from the stalking horse bid. It allowed the debtor to avoid a “naked” auction thereby securing a floor price, and the fact that there was an overbid. The court rejected the Committee’s argument that the risk of a “naked” auction was overblown and that the overbid only benefitted the secured creditor. Looking at the evidentiary record, the Fifth Circuit determined that the risk was real and the debtor benefited from the bid. The Fifth Circuit also found that any benefit is sufficient to satisfy the statute, even if it only benefits the secured creditor, noting that “unsecured creditors are in the back of the line, and sometimes that comes with downsides.”

The Fifth Circuit also found that the break up fee and expense reimbursement were “necessary.” The Committee argued that Hartree could not have been induced by the break up fee and expense reimbursement because they were contingent on court approval. However, the Bankruptcy Court had pre-authorized a stalking horse bidder within limitations and the record reflected that Hartline expected they would be approved. The Committee also argued that the stalking horse bid did not induce the overbid because JMB had an incentive to bid the precise amount of $115.3 in order to satisfy certain maritime liens and administrative expenses. While the Fifth Circuit found this argument plausible, it found no reason to disturb the Bankruptcy Court’s finding that the stalking horse bid led to the overbid from JMB.

Finally, the Fifth Circuit found that under § 363, the result would be the same, finding that if expenses satisfy the standard under § 503, they “easily satisfy a deferential reasonableness standard.” The debtor evaluated all of the options on the eve of the auction, considered the alternatives with sufficient information and made a considered decision. The board minutes reflected a thorough discussion of the advantages and disadvantages of designating a stalking horse bidder and on the eve of the auction held two board meetings to consider the bid. Ultimately, the court found that the debtor acted well within the bounds of reasonable business judgment in approving the stalking horse bid.

Thus, the Fifth Circuit confirmed the benefit and value of bid protections in Section 363 sales. It also provides a road map for obtaining approval of bid protections even in less than ideal situations.