There is a reason why a buyer of substantially all of a seller’s assets may want to pursue a sale via the buyer filing bankruptcy, through a bankruptcy auction. By obtaining a court order approving a sale via a bankruptcy auction, a finding of fair market value can be obtained. Such a finding can preclude a subsequent clawback by creditors and/or rescission of the sale.

The Third Circuit Court of Appeals in In re 388 Route 22 Readington Holdings, LLC, (a recent unpublished decision No. 20-2629, 2021 WL 4811409 (3d Cir. Oct. 15, 2021)), agreed with the lower courts, i.e., the bankruptcy court and the U.S. district court. There, debtor 388 Route 22 Readington Holdings, LLC owned a parcel of real property. In 2018, the Debtor filed its second Chapter 11 bankruptcy filing after having previously filed a Chapter 11 in 2011 in an effort to avoid foreclosure. The second bankruptcy was later converted to a Chapter 7 proceeding. The creditor received permission to foreclose but held off from allowing the Trustee to sell the property. Ultimately, the Trustee received an offer of $5 million that was subject to certain contingencies the Trustee found to be unreasonable. Instead, the Trustee held an auction with the winning bid being $3.2 million. This bid was sufficient to pay the Creditor in full and cover all claims against the Debtor’s bankruptcy estate, while distributing more than $100,000 to the Debtor’s sole owner, the shareholder who appealed the court order approving the sale. Notwithstanding the objection made by the shareholder arguing that the Trustee should have accepted the $5 million offer, the bankruptcy court approved the sale with the order further providing the buyer with protection under Section 363(m) of the Bankruptcy Code.

Bankruptcy Code Section 363(m) provides:

The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

11 U.S.C. §363(m).

The point of Section 363(m): when there is a finding that the property was purchased in good faith, the subsequent reversal or modification of the order on appeal will not result in the sale being set aside.

The shareholder argued that the bankruptcy court should have heard evidence in terms of whether the $5 million offer as a better offer and thus, the $3.2 million offer was not fair value. The Third Circuit Court of Appeals disagreed. Though it noted that that the results of a non-collusive auction do not conclusively establish fair value, it certainly is strong evidence of fair value.
In this case, the Third Circuit examined (a) the manner in which the auction was advertised/marketed, (b) the participants of the auction, and (c) the bidding process – and found that the auction was conducted fairly. It further noted that the $3 million offer was 40% over its previous assessed value. As a result, it found that the auction was strong evidence of fair value. The point as emphasized by the court, was not whether there was a better offer out there, but whether the current offer was for fair value.
The takeaway from this opinion is that a determination of fair value is not always a slam dunk, which is why a buyer of assets from a financially troubled debtor might want to acquire the property via a bankruptcy auction. And even then, though the buyer may not ultimately acquire the property, a well-marketed auction with active participation will help ensure that the acquisition is upheld by virtue of the property being acquired for fair value.

About the Author: Bill Siegel

William L. (Bill) Siegel is a Shareholder and Section Head of the Cowles and Thompson Bankruptcy and Creditors’ Rights Practice Group as well as a member of the Corporate and Business Practice Group.