Restructuring

Contributed by Eric Kasenetz
We previously reported here and here that a completed auction under section 363(b) of the Bankruptcy Code does not necessarily result in the sale of the property to the winning bidder.  Even if the debtor conducts an auction pursuant to bid procedures previously approved by the court, the debtor must still be prepared to prove the business justifications and defend the terms of the proposed sale.  In In re Gregg, the Bankruptcy Court for the District of South Carolina echoed these principles and stressed that a 363 sale must be in the best interests of the estate and the estate’s creditors, regardless of the completion of auction procedures and the emergence of a winning bidder.
Background
On February 1, 2013, William Maxwell Gregg, II filed a voluntary chapter 11 petition with the United States Bankruptcy Court for the District of South Carolina.  The debtor’s primary assets consisted of various pieces of real property, including 38.6 acres in Mount Pleasant, South Carolina.  The debtor valued the “Mount Pleasant Tract” at $30 million.
The debtor owed Jupiter Capital, LLC between $8.2 million and $9.4 million, and such debt was secured by a lien on the Mount Pleasant Tract.  The debtor, looking to realize more value from the Mount Pleasant Tract than the amount owed to Jupiter, entered into an agreement with CK Multifamily Acquisitions pursuant to which CK agreed to act as the stalking horse bidder with an opening bid of $11.5 million.  The court entered a bid procedures order setting forth the auction’s deadlines, hearing date, and other details.
The Auction
At several hearings prior to the date of the auction, the debtor expressed optimism that there would be competing bidders on the Mount Pleasant Tract.  Moreover, although CK’s contract was subject to a number of conditions, the debtor also expressed confidence that some of those conditions would be eliminated through the competitive bidding process.
Despite the debtor’s optimism, the debtor did not receive any competing bids for the Mount Pleasant Tract.  As a result, the debtor requested court approval of the sale to the stalking horse bidder, CK, for $11.5 million, upon the terms and conditions contained in the contract with CK.
The CK Contract
The CK contract was subject to the satisfaction of various terms and conditions, including the following:

• CK obtaining several government zoning and permit approvals;
• CK acquiring four additional parcels, each of which was owned by a person other than the debtor, that were adjacent to the Mount Pleasant Tract; and
• receipt of necessary approvals, upon terms and conditions acceptable to CK, to remove a pond and redirect storm water.

CK also had the right to terminate the contract and receive a refund of its deposit if CK determined that any of the conditions were not going to be satisfied on or before the closing date.
At the sale hearing, the debtor was unable to respond to several creditors’ questions relating to the CK contract.  For example, prepetition, the debtor had agreed to sell the Mount Pleasant Tract to a developer, but the developer failed to obtain the zoning approval that was required under the contract.  That contract was substantially similar to the CK contract, particularly with respect to zoning approvals, yet, at the hearing, the debtor could not describe the resistance to or reason behind the failure of the developer to obtain the zoning approval.
The Court’s Opinion
The court applied the “sound business test” in determining whether to approve an asset sale prior to plan confirmation and considered whether the sale would be in the best interests of the estate and its creditors.  Under the sound business test, the debtor must show (i) a sound business reason or emergency justifies a pre-confirmation sale; (ii) the sale has been proposed in good faith; (iii) adequate and reasonable notice of the sale has been provided to interested parties; and (iv) the purchase price is fair and reasonable.  In re Gregg, Case No. 13-00665, at 6 (internal citations omitted).  The court held that the debtor had not met his burden of passing the sound business test and that the sale would not be in the best interests of the estate and the estate’s creditors.
In the decision, the court explained, first, that the debtor could not answer several questions at the hearing, and the debtor lacked sufficient knowledge of the terms of the contract with CK; this was, as the court put it, “not indicative of a debtor-in-possession who takes his fiduciary duties to his creditors seriously.”  Second, because the debtor was unable to testify as to the developer’s previous attempted rezoning efforts and the opposition that the developer had faced, the current acquisition of zoning and permit approvals was suspect.  Third, the sale was contingent on CK’s purchase of four additional parcels, each of which was subject to the “whims” of four different owners.  Fourth, at the time of the decision, the debtor had not filed a viable disclosure statement or plan of reorganization, and the debtor’s second-most valuable asset (i.e., the Mount Pleasant Tract) would be tied up for the remainder of the year under a contract that might never close; given the number of directions the debtor’s case could go, the court did not wish to tie up the property under such uncertain circumstances.
Conclusion
As was evident in In re Gregg, a sale pursuant to section 363(b) is always subject to final court approval.  This fact is crucial and must be taken seriously by any debtor looking to auction off property of the estate.  While auctions can, and often do, maximize value for the estate and produce purchasers that are ready, willing, and able to close, the auction itself does not necessarily equate to a sale of the property to the highest (or only) bidder.  The debtor must, among other things, be able to defend and justify the business reasons for and the terms of the sale.