Today in the PPI Holdings bankruptcy, the PPI debtors presented their bid procedures motion which sought approval of the procedures by which PPI would sell substantially all of its assets. PPI’s motion also sought approval of a break-up fee for the stalking horse bidder. In support of the break-up fee, PPI cited the Third Circuit’s decision in Calpine Corp. v. O’Brien Envtl. Energy, Inc. (In re O’Brien Envtl. Energy, Inc.), 181 F.3d 527 (3d Cir. 1999).
Given the increase in bankruptcies, break-up fees will continue to be an issue for debtors and creditors alike. The purpose of this post is to take a look at the O’Brien decision and consider when a break-up fee is appropriate, and the factors courts will consider in deciding to award such fees.
Creditors often question the logic of granting the stalking horse bidder a break-up fee when there are so few assets available in a bankruptcy estate. The Third Circuit in O’Brien looked at why break-up fees are used in bankruptcy and non-bankruptcy acquisitions. Such fees "provide a prospective acquirer with some assurance that it will be compensated for the time and expense it has spent in putting together its offer if the transaction is not completed for some reason." Additionally, the court recognized that break-up fees may encourage a bidder to do due diligence, as well as compensate the bidder for lost costs.
The Third Circuit in O’Brien considered the Bankruptcy Court’s use of nine factors the Bankruptcy Court thought were relevant in determining whether to grant a break-up. Such factors included whether the parties who negotiated the fee might be "tainted by self-dealing", whether the fee encouraged bidding, or whether the fee was reasonable relative to the purchase price. However, instead of adopting the factors identified by the Bankruptcy Court, the Third Circuit looked instead at whether the record supported the Bankruptcy Court’s decision that awarding Calpine the break-up fee was not necessary to preserve the value of the debtor’s estate. The Court’s analysis tied directly to 11 U.S.C. section 503(b)(1)(A), requiring that administrative expenses provide benefit to the debtor’s estate.
Using section 503(b) as the test, break-up fees are found to benefit the bankruptcy estate if the fee promotes more competitive bidding. The clearest of example of a fee providing benefit to the estate is where the fee induces a stalking horse bidder to bid, and the debtor can show that without such a fee, bidding on the debtor’s assets would have been reduced. Another benefit arises due to the break-up fee’s ability to motivate a stalking horse bidder to research the value of the debtor’s assets and submit a bid that serves as a minimum bid, which other bidders will exceed.
In O’Brien, the court affirmed the order of the District Court, finding that the record below supported the finding that the break-up fee to Calpine was not a necessary expense of the bankruptcy estate. In reaching its decision, the court found that bidding might have been even more competitive in the O’Brien bankruptcy had the Bankruptcy Court ruled definitively that Calpine was not entitled to a break-up fee. O’Brien is helpful for its simplicity – break-up fees are looked at using an analysis similar to a motion for allowance of administrative claim. Parties that can show how the fee preserves the value of the estate are more likely to prevail.