Stalking Horse Bidder May Be Entitled to Administrative Priority for Expenses Despite Failure to Close Bankruptcy Sale

In In re Energy Future Holdings Corp., 990 F.3d 728 (3d Cir. 2021), the U.S. Court of Appeals for the Third Circuit ruled that even though a "stalking horse" bidder failed to obtain necessary regulatory approvals to close an anticipated bankruptcy asset sale, the bidder potentially could receive an administrative claim for a break-up fee and expenses if it could demonstrate that its efforts provided value to the estate. The ruling represents an expansive view on this issue and may provide bidders with enhanced protection for their bids. In so ruling, the Third Circuit reversed lower court rulings, directing the bankruptcy court on remand to determine whether the bidder's actions conferred an actual benefit on the estate. The parties ultimately entered into a settlement that, if approved by the bankruptcy court, would result in the bidder receiving $4 million.

Allowance of Administrative Expenses in Bankruptcy

Section 503 of the Bankruptcy Code provides that, "[a]fter notice and a hearing, there shall be allowed, administrative expenses, … including—(1)(A) the actual, necessary costs and expenses of preserving the estate." 11 U.S.C. § 503(b). According to the Third Circuit, for a claim to be entitled to administrative expense status under this provision, it must "arise from a [postpetition] transaction with the debtor-in-possession," and "be beneficial to the debtor-in-possession in the operation of the business." Calpine Corp. v. O'Brien Envtl. Energy, Inc. (In re O'Brien Envtl. Energy, Inc.), 181 F.3d 527, 532–33 (3d Cir. 1999); accord In re Philadelphia Newspapers, LLC, 690 F.3d 161, 172–73 (3d Cir. 2012). The party asserting an administrative expense claim bears the burden of demonstrating that it is entitled to administrative expense status. O'Brien, 181 F.3d at 533.

The U.S. Supreme Court has ruled that postpetition tort claims may also be allowed as administrative expenses if those claims arise from actions related to the preservation of a bankruptcy estate, even if those claims have no discernable benefit to the estate. Reading Co. v. Brown, 391 U.S. 471, 477, 88 S.Ct. 1759 (1968) (holding that fire damage costs resulting from the negligent actions of a bankruptcy receiver acting in the scope of his authority are an "actual and necessary" expense of reorganization). Although Reading involved interpretation of the former Bankruptcy Act, subsequent decisions have recognized that its analysis applies to section 503(b) of the Bankruptcy Code. See, e.g., Philadelphia Newspapers, 690 F.3d at 173-74; In re B. Cohen & Sons Caterers, Inc., 143 B.R. 27 (E.D. Pa. 1992); In re Hayes Lemmerz Int'l, Inc., 340 B.R. 461 (Bankr. D. Del. 2006); In re Brooke Corp., 485 B.R. 650 (Bankr. D. Kan. 2013); In re Women First Healthcare, Inc., 332 B.R. 115 (Bankr. D. Del. 2005).

Stalking Horses and Break-Up Fees

Section 363(b)(1) of the Bankruptcy Code authorizes a bankruptcy trustee or chapter 11 debtor in possession, "after notice and a hearing," to use, sell, or lease property of the estate outside the ordinary course of business. While a sale under section 363(b)(1) is most frequently undertaken by means of a public auction, in which assets are generally sold to the highest bidder, the bankruptcy court may also approve a private sale entered into between the debtor and a purchaser.

Generally speaking, the initial bidder in a public auction held under section 363—the "stalking-horse bidder"—sets the minimum price and other terms of the transaction. Because of the time and effort expended by the stalking-horse bidder in performing due diligence and engaging in the negotiations necessary to arrive at the initial bid, bankruptcy courts generally will allow reasonable bid protections for the bidder in the event the stalking-horse bidder does not prevail at the auction. Those bid protections, which are typically the subject of extensive negotiations, often include reimbursement of expenses incurred by the bidder in connection with the transaction, a "break-up" fee equal to a specified percentage of the bidder's purchase price, auction procedures, and certain other rights related to the stalking-horse bid.

Outside of bankruptcy, a seller's decision to give such protections are typically accorded deference under the "business judgment" rule. In the bankruptcy context, however, several different approaches have been applied by courts in assessing the propriety of bid protections. See generally Collier on Bankruptcy ¶ 363.02[7] (16th ed. 2021). Some courts apply a business judgment standard to the issue, which involves the highest degree of deference to the debtor's decision to commit to the bidding protections under scrutiny. Other courts apply stricter scrutiny, requiring evidence that proposed bid protections are in the "best interests of the estate." Id.

Finally, some courts, and in particular the Third Circuit, have generally allowed or disallowed bid protections, including break-up fees, according to the standards governing the allowance of administrative expenses under section 503(b). See In re Reliant Energy Channelview LP, 594 F.3d 200 (3d Cir. 2010) (reaffirming that section 503(b) administrative expense treatment is the only appropriate standard for ruling on break-up fees); O'Brien, 181 F.3d at 535 ("[T]he allowability of break-up fees, like that of other administrative expenses, depends upon the requesting party's ability to show that the fees were actually necessary to preserve the value of the estate. Therefore, we conclude that the business judgment rule should not be applied as such in the bankruptcy context. Nonetheless, the considerations that underlie the debtor's judgment may be relevant to the Bankruptcy Court's determination on a request for break-up fees and expenses."); accord In re Acis Cap. Mgmt., L.P., 604 B.R. 484, 517 (N.D. Tex. 2019); In re President Casinos, Inc., 314 B.R. 786, 788 (Bankr. E.D. Mo. 2004).

Energy Future

Energy Future Holdings Corp. and its affiliates (collectively, "EFH") filed for chapter 11 protection on April 29, 2014, in the District of Delaware. Subject to bankruptcy court approval, EFH negotiated a merger agreement with NextEra Energy, Inc. ("NextEra") under which NextEra would pay off a significant portion of EFH's debt ($9.8 billion) in exchange for EFH's 80% indirect economic interest in Oncor Electric Delivery Company LLC ("Oncor"), Texas's largest electric power transmission and distribution company. NextEra made consummation of the merger agreement subject to the removal of a regulatory "ring fence" around Oncor put in place by the Public Utility Commission of Texas ("PUCT") in 2007. The ring fence prohibited NextEra from appointing or replacing Oncor board members and prevented Oncor from making distributions to NextEra.

The merger agreement provided that a $275 million termination fee would be payable to NextEra if EFH terminated the agreement. Specifically, under the agreement: (i) if NextEra terminated the merger following a failure to obtain PUCT approval to remove the ring fence, that would not trigger the termination fee; but (ii) if EFH terminated the merger following a failure to obtain PUCT approval, the termination fee would be payable as an administrative expense.

Section 6.7 of the merger agreement further provided for the parties to bear their own costs and expenses, as follows:

Except as otherwise provided in Section 6.3, Section 6.18, Section 6.19, Section 6.20 and Section 6.22 or any administrative expenses of [EFH's estate] addressed in the Plan of Reorganization, whether or not the Merger is consummated, all costs and expenses incurred in connection with this Agreement and the Closing Date Transactions and the other transactions contemplated by this Agreement shall be paid by the party incurring such expense.

The bankruptcy court approved the merger agreement, including the termination fee.

The PUCT ultimately denied NextEra's request to remove the ring fence. It also denied two motions filed by NextEra for reconsideration of that decision. NextEra then appealed the PUCT's decision to a Texas state court, but EFH terminated the merger agreement while the appeal was pending. Shortly afterward, the bankruptcy court approved a merger between EFH and another entity—Sempra Energy ("Sempra"). Sempra paid $9.45 billion in connection with the transaction—several hundred million dollars less than the $9.8 billion NextEra had agreed to pay—but the Sempra merger agreement contemplated that the ring fence would remain undisturbed.

Thereafter, an EFH creditor moved the bankruptcy court to reconsider its approval of the NextEra termination fee. The creditor argued that, in approving the merger agreement, the court had not realized that NextEra had no incentive to terminate the agreement if PUCT did not approve the Oncor deal. Rather, NextEra had every incentive not to terminate because doing so would mean that it would not receive the termination fee, whereas NextEra would receive the fee if it waited for EFH to terminate the agreement. NextEra opposed the creditor's motion and filed an application for payment of the fee. 

The bankruptcy court granted the motion for reconsideration and modified the termination fee provision in the merger agreement to preclude NextEra from receiving it. In so ruling, the court wrote:

The Court had a fundamental misunderstanding of the critical facts when it approved the Termination Fee. Despite the Court's direct question as to whether the Termination Fee would be payable if the PUCT declined to approve the NextEra Transaction, the record is incomplete and confusing on that fundamental point. The Court simply did not understand that if the PUCT declined to approve the NextEra Transaction and the [EFH] (as opposed to NextEra) terminated the Merger Agreement the Termination Fee would be payable to NextEra…. The confusing record was critical because in combination with another fact that was not mentioned, i.e., the Merger Agreement had no time limit, the reality was that under no foreseeable circumstances would NextEra terminate the Merger Agreement if the PUCT declined to approve the NextEra Transaction. Why? Because NextEra had the ability to hold out and to pursue numerous motions for reconsideration and a fruitless appeal until [EFH was] forced by economic circumstances to terminate the Merger Agreement, which is exactly what occurred. If the Court had understood these critical facts it would not have approved this provision of the Termination Fee.

In re Energy Future Holdings Corp., 575 B.R. 616, 632-33 (Bankr. D. Del. 2017), aff'd, 904 F.3d 298 (3d Cir. 2018). However, the court held that NextEra could seek allowance of an administrative claim "on a ground other than the grounds on which the Termination Fee was denied." The Third Circuit affirmed the bankruptcy court's ruling on direct appeal. See In re Energy Future Holdings Corp., 904 F.3d 298 (3d Cir. 2018), cert. denied sub nom. NextEra Energy, Inc. v. Elliott Assocs., L.P., 139 S. Ct. 1620 (2019) ("EFH I"). NextEra's request for rehearing en banc by the Third Circuit and a petition seeking U.S. Supreme Court review were both denied.

NextEra then filed an application in the bankruptcy court under section 503(b)(1)(A) to recover costs "incurred in its efforts to complete the transaction, obtain the requisite regulatory approvals, and complete the acquisition of [EFH's] Oncor assets from the time the Merger Agreement was executed until [EFH] gave notice of termination." Certain EFH creditors objected to the application and moved to dismiss it or, in the alternative, for summary judgment.

The bankruptcy court granted the motion to dismiss NextEra's application. The court reasoned that there was no "competitive bidding process" in connection with the NextEra transaction and that EFH "eventually closed a transaction with Sempra for substantially less value." The court rejected NextEra's argument that its efforts provided a "roadmap" for the Sempra deal, emphasizing that there was no benefit to the bankruptcy estate because EFH "[was] forced … to find an alternative transaction at far less value."

The bankruptcy court also concluded that NextEra was not entitled to payment of the requested costs under the express language of the merger agreement, cited above. The district court affirmed the ruling, and NextEra appealed to the Third Circuit.

The Third Circuit's Ruling

A three-judge panel of the Third Circuit reversed and remanded the case below. The Third Circuit did reject NextEra's argument that it benefited the estate by acting as a stalking horse. NextEra's bid was the sole offer and did not attract higher offers, but in fact resulted in an alternate merger transaction with Sempra at a significantly lower price.

However, writing for the panel, District Judge Wendy Beetlestone (sitting by designation) concluded that section 6.7 of the merger agreement did not bar NextEra's request for payment of fees as an administrative expense claim. According to Judge Beetlestone:

The unambiguous meaning of Section 6.7, then, is that except as specified in certain sections of the Merger Agreement, "administrative expenses of [EFH's estate]" are allowed … if determined by the Bankruptcy Court to be expenses that were "actual and necessary" to preserving [EFH's estate] …. Only costs that do not meet the requirements of § 503(b)(1)(A) or are not otherwise enumerated in the Merger Agreement are barred by Section 6.7. Appellees' argument that NextEra waived its right to claim general administrative expenses pursuant to § 503(b)(1)(A) is contrary to the plain language of Section 6.7.

Energy Future, 990 F.3d at 740. Next, Judge Beetlestone determined that NextEra "plausibly alleged" that its expenses conferred an actual benefit on the estate "by providing valuable information, and accepting certain risks, that paved the way for the later Sempra deal." In reversing the lower courts on this point, she explained that, in the context of a motion to dismiss, the inquiry "is not whether NextEra actually benefitted the estate, but whether it plausibly alleged that it did so." Id. at 747. 

According to Judge Beetlestone, benefit to the estate "does not have to be substantial" and "less readily calculable benefits, such as the ability to conduct business as usual, can qualify." She further noted that promoting more competitive bidding by inducing an initial bid, along with encouraging prospective bidders to do their due diligence and "research[ing] the value of the debtor and convert[ing] that value to a dollar figure on which other bidders can rely" can qualify as a "benefit." Id. at 742 (citations and internal quotation marks omitted).

Judge Beetlestone agreed that NextEra plausibly alleged that its efforts in drafting the merger agreement and the chapter 11 plan, settling creditor objections to the proposed merger, and "proving to future bidders that [EFH's] interest would necessarily have the [ring fence] attached saved [EFH] from reinventing the wheel even after the deal with NextEra fell through." Id. at 745. Even though the Sempra merger involved a substantially lower price, the Sempra bid "was for Oncor with the undesirable ring fence intact and was, therefore, a bid on a different bag of goods." Id. at 744. Moreover, NextEra's unsuccessful efforts toward consummating the merger without the ring fence "provided future bidders with the necessary information to place informed bids, with the understanding that the ring fence would remain." Id. at 745.

The Third Circuit concluded that NextEra plausibly alleged it benefited the estate through its "due diligence" attempting to obtain PUCT approval of the transaction without the ring fence because NextEra's actions "'increase[d] the likelihood that the price at which the debtor['s asset] is sold will reflect its true worth.'" Id. (quoting O'Brien, 181 F.3d at 535, 537). It accordingly reversed the lower courts' dismissal of NextEra's application and remanded the case below.


Because Energy Future involved reversal of an order granting a motion to dismiss, the Third Circuit directed the bankruptcy court to consider whether NextEra's efforts "actually benefitted" the estate. On remand, the Third Circuit wrote, the bankruptcy court should "consider the equities to NextEra as part of its balancing of the benefit and costs to the estate," including "the fairness—or lack thereof—of NextEra being induced by the assurance of a Termination Fee to make the substantial outlays it did, only, when all was said and done, to lose out not only on the deal but also on the Termination Fee." Id. at 742 n.8.

However, the Third Circuit cautioned, because Termination Fees are "meant to account for the risk of mergers rather than be an accurate valuation of merger-related services, … the size of the Termination Fee is not, absent more, an appropriate guide to the value of the benefits to the estate." Id. at 746 n.13. It also emphasized that the question of "whether [a] Termination Fee, if correctly understood at the time it was approved, produced a benefit to the estate" does not govern the bankruptcy court's inquiry on remand. Rather, the bankruptcy court must determine whether actions taken by NextEra to consummate the merger "provided a benefit worthy of administrative expense reimbursement wholly apart from any Termination Fee." Id. at 743 n.9.

On September 1, 2021, NextEra, EFH, and certain other parties reached a settlement regarding NextEra's application for the allowance of an administrative expense claim. Under the proposed settlement, which is subject to bankruptcy court approval, NextEra's administrative expense claim would be allowed in the amount of $15 million, but NextEra would be paid only $4 million on that claim with funds contributed by a third party, the parties would grant mutual releases, and the litigation would be dismissed.

Despite its complicated and unusual procedural posture, Energy Future is significant. The Third Circuit adopted a potentially broad view of what can qualify as a plausible administrative expense claim under section 503(b)(1)(A) of the Bankruptcy Code in the context of a proposed transaction under section 363(b) of the Bankruptcy Code. Under this ruling, even unsuccessful efforts to consummate a transaction can potentially benefit the estate and render related expenses eligible for administrative claim status. As a result, parties documenting bidding protections may wish to include language specifically identifying the scope of recoverable administrative expense claims or specific waivers of the right to cover such expenses from the estate in the event of an unsuccessful bid.

A version of this article is being published in Lexis Practical Guidance. It has been published here with permission.

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