Stalking “Ponies” – Are Break Up Fees A Thing Of The Past?

Stalking “Ponies” – Are Break Up Fees A Thing Of The Past?

The "Stalking Horse" is a term of art often used in the bankruptcy court to describe the initial bidder for a bankrupt company's assets.   Typically, a company in bankruptcy will reach a deal with an outside bidder that wants to acquire all or substantially all of its assets.   Prior to filing a motion with the court to approve the sale, the company will enter into a purchase and sale agreement with the bidder that is often contingent upon, among other things, bankruptcy court approval.   These agreements will also afford "stalking horse status" to the proposed buyer, which means that the company will not sell for a lower offer, period, and will not accept a higher offer unless it pay the stalking horse bidder's expenses as well as a "break up fee."  The calculation of the fee can vary, but it is typically based on a percentage of the value of the assets (which can range from 1 to 4 percent).

The break-up fee can be a double-edged sword.  On the one hand, it can operate as an incredible "icebreaker" to get the bidding process rolling.  To explain, it takes significant time and resources to put together a purchase agreement and conduct due diligence (particularly on a bankrupt company).   Many acquirers need to justify the acquisition to their own stakeholders and directors as a sound business decision, which makes a thorough analysis imperative.    At the same time, one of the primary policy objectives of a bankruptcy proceeding is to maximize the value of the estate for the benefit of all creditors.  Thus a court (and the creditors) want to ensure that the debtor gets the highest and best offer (not necessarily the first or quickest) for its assets.  This policy, by nature, lends itself to the requirement of a robust (arms-length) auction process before approving a motion to sale all of the debtor's assets.  The break-up fee is, therefore, intended to balance these competing interests.  It protects the initial bidder who takes the initiative of "opening the auction" from getting outbid by a nominal dollar amount, while at the same time fostering a competitive auction environment (with the floor set by the stalking horse bid).

In some cases, however, the break-up fee can have a chilling effect, because it is not necessary to encourage or initiate an auction for the debtor's assets (e.g. in cases where there is already a competitive market for the debtors assets exists before the initial bid is submitted).  In those cases, a break up fee might actually deter bidders who would have otherwise been interested in the assets.   Further, the estate would be disadvantaged because a portion of the consideration (on a higher offer) would be diverted (perhaps wastefully) to the initial bidder.

Thus, you have the conundrum before a bankruptcy court when presented with a sale motion to a stalking horse bidder where the underlying purchase agreement contains a break up-fee stipulation.     Like most bankruptcy issues, the analysis of these provisions will vary to some extent depending upon which federal circuit you are in. The 3rd Circuit Court of Appeals, for example, has been increasingly chilly towards the allowance of break-up fees.    In contrast to some of the more liberal standards of other federal districts, the 3rd Circuit views these fees under the very stringent "administrative expense" standard under 11 U.S.C. § 303(b).   That is, whether the fee is "actually necessary" in benefitting and preserving the debtors estate.   See, Reliant Energy Channelview LP, 594 F.3d 200 (3d. Cir. 2010)  [enhanced version available to lexis.com subscribers / unenhanced version available from lexisONE Free Case Law]

District and appellate courts in other circuits follow a 3-part "business judgment" rule test, while others follow a "best of interest of the estate" standard.  Nonetheless, it is very important to know the law of your jurisdiction before opening up a bid on the debtor's assets as the stalking horse.    In many cases, it is wise to require court approval of the break-up fee in your purchase agreement (as opposed to a requirement that the debtor simply "seek" court approval).  This shows the court that you would not be bidding but for the break-up fee provision.  Thus, it is "necessary" to preserve a competitive interest in the debtor's assets.

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