Saturday, August 20, 2011

Bidders Reimbursed For Auction Which Never Occurred: The Fifth Circuit's ASARCO Opinion

The Fifth Circuit has ruled that, under the facts of the specific case, that bidders could recover their costs without a showing of direct benefit to the estate. Matter of ASARCO LLC, No. 10-40930 (5th Cir. 8/16/11). The specific holding was that reimbursement of costs incurred in submitting a bid were governed by the business judgment standard under 11 U.S.C. Sec. 363(b) rather than the benefit to the estate standard under 11 U.S.C. Sec. 503(b). You can find the opinion here.

A Billion Dollar Judgment And An Auction That Wasn't

This was a case about a big judgment and a unique procedure to auction off that judgment. In 1999, Grupo Mexico S.A.B. de C.V. (Grupo Mexico) purchased ASARCO. ASARCO owned 260 million shares of Southern Peru Copper Company (SCC). Through a series of transfers, the SCC shares were transferred from ASARCO to a subsidiary of Grupo Mexico. After ASARCO filed for chapter 11 relief in 2005, it sued the transferee, which was a subsidiary of Grupo Mexico. ASARCO won big. It obtained a judgment for actual fraudulent transfer, aiding and abetting a breach of fiduciary duty and conspiracy. ASARCO LLC v. Americas Mining Corp., 396 B.R. 278 (S.D. Tex. 2008). Not only did it get the shares back, but it also recovered a judgment for $1.4 billion. ASARCO LLC v. Americas Mining Corp., 404 B.R. 150 (S.D. Tex. 2009). (I have included the citations here because they are informative opinions for fraudulent transfer litigation).

Having a valuable asset in hand, ASARCO proposed a plan of reorganization. Its plan was to be funded in part by selling the SCC Judgment. It proposed a two-stage bid solicitation process. In the first stage, its financial adviser identified potential bidders for the judgment. In a variant on the typical auction process, ASARCO invited a select group of bidders to proceed to the second phase of the process. In order to entice the bidders to perform the expensive legal due diligence necessary to evaluate the asset, ASARCO sought and obtained an order from the Bankruptcy Court authorizing it to reimburse qualified bidders for their due diligence expenses. The Bankruptcy Court granted the motion finding that ASARCO had demonstrated a "compelling and sound business justification" for the order.

Grupo Mexico appealed the reimbursement order which was stayed. Meanwhile Grupo Mexico confirmed a plan of reorganization which paid all creditors in full, released the judgment and gave it control of ASARCO. Since Grupo Mexico now controlled ASARCO, ASARCO was not interested in defending the appeal. However, two of the bidders were granted leave to intervene and defend the order.

The Appeal

On appeal, the Appellants argued that because the sale was never concluded, there was not a benefit to the estate and the bidders expenses could not be reimbursed under Sec. 503(b). The bidders argued that the Bankruptcy Court could authorize the payment under the business judgment standard of Sec. 363(b). The business judgment test was a lower bar since it looked at whether the order was reasonable at the time it was sought; on the other hand, the benefit to the estate standard would have analyzed the benefit in hindsight.

The Fifth Circuit distinguished two Third Circuit cases which had disallowed break-up fees. While the Third Circuit had rejected break-up fees on the ground that they chilled the bidding, here the Fifth Circuit found that the reimbursement order sought to increase competition and was offered to all bidders invited to the second round. The Fifth Circuit also distinguished the break-up fee cases on the basis that the auction involved a "very unique and very valuable but possibly worthless asset."

The Ruling

In upholding the order, the Fifth Circuit wrote:
On this record, we conclude that the business judgment standard is the better fit for assessing ASARCO’s reimbursement motion. Section 363 addresses the debtor’s use of the estate property, and in its motion ASARCO sought authorization to make discretionary use of the estate’s funds. Section 503, in contrast, generally applies to third parties that have already incurred expenses in connection to the debtor’s estate. The unsuccessful bidders in O’Brien and Reliant Energy sought payment for expenses incurred without the court’s preapproval for reimbursement, and thus section 503 was the proper channel for requesting payment. In ASARCO’s case, however, the bankruptcy court issued the Reimbursement Order before any potential qualified bidders, including the Intervenors, had incurred due diligence and work fees. In this context, application of the business judgment standard is appropriate.
Opinion, pp. 11-12. Having concluded that the business judgment standard applied, the court had no difficulty finding that the standard had been satisfied.

In a final footnote, the Court hinted that it would have upheld the award under the benefit to the estate standard as well, noting that the District Court had found that the auction process "was perhaps the final impetus needed to encourage the Parent to file its plan which pays creditors in full."

Why It Matters

This case is important for two reasons. One is that large bankruptcy cases are increasingly being resolved by Sec. 363 sales. There are not many circuit level opinions on 363 sales, since most appeals are rendered moot by the sale closing. As a result, any opinion which explains the Sec. 363 process is useful.

Second, this particular opinion, while very fact specific, provides some useful pointers. First, reimbursement orders should be obtained before any due diligence expenses are incurred. Second, the complexity of the asset will influence the advisability of reimbursing due diligence costs. There is a big difference between a tract of raw land and a billion dollar judgment. Finally, and perhaps most importantly, reimbursement orders are justifiable when they will increase competition. In the typical case, a stalking horse bidder is granted reimbursement if it is outbid. This encourages the stalking horse to invest in the due diligence necessary to submit a bid. Conversely, it can be used to tilt the auction procedures in favor of the stalking horse. Here, the unique aspect of the process was that all bidders invited to the second round were granted a right of reimbursement. Thus, the process was even-handed and fostered competition rather than inhibiting it.

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