Restructuring

We have written, at some length (see posts on September 9, 2013, September 13, 2013, March 14, 2014, and April 11, 2014), about the competing interests involved in higher post-auction bids. The United States Bankruptcy Court for the District of Delaware recently confronted a similar dynamic when it addressed the question of whether a debtor could abandon its not-yet-approved settlement agreement in favor of a higher offer from a third party in In re Filene’s Basement, LLC, Case No. 11-13511 (Bankr. D. Del. April 29, 2014).
The Lease Litigation
At the time it filed for protection under chapter 11 of the Bankruptcy Code, Syms Corp., the corporate parent of Filene’s Basement, leased real property in Secaucus, New Jersey for its headquarters. The debtors’ landlord filed two proofs of claim relating to the headquarters lease. The debtors objected to the landlord’s requests for administrative expenses and, shortly thereafter, moved to assume the headquarters lease upon a cure payment in the amount of $5,026.55. The landlord objected to the debtors’ motion, asserting that the proper cure amount was at least $3.627 million. The parties agreed to consolidate the claim objection and assumption motion into a single litigation with respect to the lease.
On the same day that the debtors emerged from chapter 11, both the landlord and the debtors filed motions for summary judgment in the lease litigation. The bankruptcy court issued a memorandum and order holding that the landlord was entitled to “Percentage Rent,” in the amount of $1.5 million, less fees and expenses, but there were outstanding issues of material fact with respect to the landlord’s claim for “Additional Rent.” The bankruptcy court reserved the issue of whether the landlord’s cure claim included attorney fees.
Potential Purchaser Appeared
Several months later, during an evidentiary hearing on the reorganized debtors’ supplemental motion to assume the lease, the reorganized debtors disclosed that they were negotiating a sale of their leasehold interest to a third-party purchaser. The reorganized debtors and the landlord continued negotiations simultaneously and, at a hearing on March 14, 2014, announced their settlement of the lease litigation and agreement to transfer, sell, and assign the reorganized debtors’ leasehold interest to a landlord-designated entity. ASG Equities Secaucus LLC, the potential third-party purchaser with which the reorganized debtors had also been negotiating, objected to the settlement and the bankruptcy court directed the reorganized debtors to file a motion for approval of the settlement under Bankruptcy Rule 9019.
ASG made another offer, but the reorganized debtors still believed the settlement to be superior and filed their motion for approval under Bankruptcy Rule 9019. A few days later, ASG increased its offer to be more than $2.5 million higher than the settlement amount with the landlord. The reorganized debtors concluded that this offer provided materially greater value to their creditors and shareholders, withdrew the motion for approval of the landlord settlement, and filed a motion to approve assumption and assignment of the lease to ASG. The landlord subsequently submitted another offer, which was again topped by ASG. Notably, ASG’s final offer included a letter of credit that would cover the reorganized debtors’ exposure with respect to the lease litigation.
Ultimately, the landlord filed a motion to enforce its not-yet-court-approved settlement with the reorganized debtors, which drew objections from the reorganized debtors, an official creditors’ representative, and (by joinder) a significant prepetition and post-emergence shareholder.
Landlord Settlement Required Bankruptcy Court Approval
The landlord argued that its settlement with the reorganized debtors did not require court approval under Bankruptcy Rule 9019 because the reorganized debtors’ ability to settle was no longer subject to the restrictions of the Bankruptcy Code and the Bankruptcy Rules. In fact, the Debtors’ plan of reorganization authorized the reorganized debtors to compromise or settle any claims “without supervision or approval by the Bankruptcy Court and free of any restrictions of the Bankruptcy Code or Bankruptcy Rules, other than those expressly imposed by the Plan or the Confirmation Order.”
The bankruptcy court, however, rejected the landlord’s argument, observing that, (i) the settlement parties specifically made court approval a condition of the settlement, (ii) the settlement included resolution of the pre-confirmation assumption motion, which was explicitly noted in the confirmation order, and (iii) as part of the settlement, the landlord had required an order prohibiting certain parties from asserting against the landlord any non-contractual indemnity or contribution claims arising out of the claims being settled, and such an order could not be granted by the bankruptcy court without notice and a hearing.
Bankruptcy Court Denied Approval of Landlord Settlement
The bankruptcy court then turned to Third Circuit precedent for guidance on how to resolve the conflict between the reorganized debtors’ duties of good faith and fair dealing with respect to one creditor (i.e., the landlord) and its fiduciary duty to maximize the value of the estate for all creditors. Citing, Myers v. Martin, the bankruptcy court observed that a debtor is not required to continue to support a motion for approval of a settlement if circumstances change such that the debtor no longer believes that settlement is in the best interests of the estate. If this is the case, the debtor should advise the bankruptcy court of the changed circumstances and the bankruptcy court will determine whether it should approve the settlement. Although the landlord argued that ASG’s higher offer should be disregarded because the settlement was not subject to higher offers, the bankruptcy court rejected that argument as the settlement was silent on the issue despite the landlord’s knowledge of the ASG negotiations and participation in continued bidding.
Considering the factors articulated in Martin, namely(i) the probability of success in litigation, (ii) the likely difficulties in collection, (iii) the complexity of the litigation involved, and the expense, inconvenience, and delay necessarily attending it, and (iv) the paramount interests of the creditors, the bankruptcy court denied the landlord’s motion to enforce the settlement. To start, the bankruptcy court noted that the “Percentage Rent” issue was the “main piece” of the lease litigation and it was already decided. Accordingly, the bankruptcy court believed that the remaining issues “should not involve a great expense for the Reorganized Debtors.” Moreover, the letter of credit included in ASG’s final offer eliminated the reorganized debtors’ exposure to the lease litigation. Finally, ASG’s final offer was more than $5 million higher than the original settlement amount with the landlord and $2 million higher than the landlord’s increased offer. In light of these facts, the bankruptcy court would not approve the landlord settlement under Bankruptcy Rule 9019.
Bankruptcy Court Approved Assumption and Assignment to ASG
Having determined that the landlord settlement should not be approved, the bankruptcy court considered whether it should approve assumption and assignment of the headquarters lease to ASG on the terms of its final offer.
First, the bankruptcy court addressed the landlord’s objection that the headquarters lease had terminated because the debtors’ motion to assume that lease was still pending when the deadline under section 365(d)(4) elapsed. An upcoming post will examine this portion of the bankruptcy court’s decision.
Next, the bankruptcy court concluded that the reorganized debtors could meet the requirements for assumption and assignment under section 365(b)(1) and section 365(f)(2) because the significant value the reorganized debtors would receive from assuming and assigning the lease provided a sound business purpose for doing so and adequate assurance could be provided by (i) payment of the determined amount of “Percentage Rent” to the landlord and (ii) execution of the ASG letter of credit.
Finally, the bankruptcy court concluded that the motion to assume and assign the lease to ASG should be approved under section 363(b)(1) because ASG’s offer was the highest received, the price of that offer was the product of a competitive process, the letter of credit eliminated the reorganized debtors’ exposure to the lease litigation, and creditor and shareholder support demonstrated the reasonableness of ASG’s offer. Additionally, the bankruptcy court rejected the landlord’s argument that the ASG deal was not reached in good faith because “The record before me shows two parties interested in obtaining the Leasehold Interests and the reorganized debtors engaging in arms-length negotiations with those parties.”
Lessons Learned
Prior to approval by the bankruptcy court, settlement agreements may remain subject to higher or better offers from third parties. While the Filene’s Basement decision may be limited to its specific facts (e.g., the procedural posture of the lease litigation and the landlord’s requirement of an injunction as part of its settlement), it demonstrates that courts are likely to favor the result of a competitive process that maximizes the value of the estate for all creditors unless there are compelling reasons not to do so.