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And the Auction Winner is…the Second Highest Bid! Wait…What?!

And the Auction Winner is…the Second Highest Bid! Wait…What?!

by Ryann M. Aaron

During a bankruptcy proceeding, the trustee is able to sell property of the bankruptcy estate by meeting certain conditions under the Bankruptcy Code (the “Code”). Code section 363(b) allows the trustee, after notice and a hearing, to sell property of the estate if the sale of such property is not within the ordinary course of the debtor’s business.[1] If, however, the sale is in the ordinary course of business, the trustee is permitted to sell property of the estate without notice and a hearing before the court.[2] Although not explicit in the Code, when authorizing the sale of property outside the ordinary course of business, courts have required the sale to be awarded to the bidder with the “highest and best offer.” As discussed below, the principle of the “highest and best offer” does not always correlate to the highest dollar amount but sometimes leads courts to evaluate additional factors.

Courts frequently cite to In re United Healthcare System, Inc.[3] from the District of New Jersey when evaluating additional factors other than price in an auction. In United Healthcare, Judge Nicholas Politan considered whether the Bankruptcy Court abused its discretion in voiding a pre-bankruptcy sale of United’s assets to Saint Barnabas Corporation shortly before United filed for bankruptcy.[4] The Bankruptcy Court found that if United had waited to sell its assets in the bankruptcy proceeding, “the Court would have the opportunity to take higher and better offers…”[5] Accordingly, the Bankruptcy Court voided the sale.

Reversing the Bankruptcy Court’s order, Judge Politan stated, “the Court must not only weigh the financial aspects of the transaction but also look to the countervailing consideration of a public health emergency.”[6] Politan found the Bankruptcy Court did not consider the totality of the circumstances but focused overwhelmingly on the monetary aspects of the competing bids.[7] The sound business reason for the sale was “to ensure attendance to critical public health needs.”[8] Accordingly, Politan reversed the Bankruptcy Court on the grounds that United had exercised sound business judgment in selling its assets prior to its bankruptcy filing.[9]

More recently in New Jersey after Pascack Valley Hospital (“Pascack”) filed Chapter 11 in 2007, the Bankruptcy Court considered whether it should award a sale based solely on a bidder’s  monetary offer or whether it should evaluate additional factors in making its decision. At a motion hearing to approve the sale of Pascack’s mobile intensive care unit (“MICU”),[10] Judge Rosemary Gambardella reopened the auction even though previous negotiations had already established a winning bid.[11] The previous winning bid was a joint bid by Englewood Hospital and Medical Center (“Englewood”) and Valley Hospital (“Valley) producing the highest financial offer at $240,000.[12] Gambardella referenced Judge Politan’s United Healthcare decision noting, “the Court essentially should look to the totality of circumstances, not mechanically applying bankruptcy principles of highest and best offer but weighing all the facts in the case including . . . the countervailing considerations of public health . . . .”[13]

Before Judge Gambardella reopened the bidding, Englewood and Valley tried to address her concern for public health. The two hospitals had modified the asset purchase agreement with Pascack agreeing to sell back Pascack’s assets if another purchaser wished to continue operating the MICU as a general acute care hospital.[14] This concession was made despite Englewood and Valley’s motivation for purchasing the hospital—to shut it down. Downplaying the glaring self-interest of shutting down a competitor, both hospitals argued the area already had enough hospital beds and the surrounding hospitals could take care of patients who normally would have gone to Pascack.[15] After a bidding war between Englewood/Valley and Hackensack University Medical Center (“HUMC”), Judge Gambardella ultimately awarded the MICU to HUMC with a winning bid of $3.6 million.[16]

HUMC was awarded Pascack’s MICU in November 2007 and was subsequently awarded Pascack’s real property after a hearing by Judge Gambardella on March 18, 2008.[17] However, Englewood and Valley continued to oppose Hackensack’s goal to reopen the hospital. Valley spokesperson Megan Fraser stated, “[w]e’ll continue to vigorously oppose the reopening of a hospital that will harm the health care system of Bergen County. Patients are being extremely well served by existing hospitals.”[18] Additionally, a 2009 press release by Englewood stated, “the best way we can serve all the people of Bergen County . . . is to support decisions that are based on sound public policy. The opening of a new, for-profit hospital in Westwood would compromise the quality of healthcare for all residents of Bergen County.”[19]

The Pascack bankruptcy is one example of the competing interests at stake. Should Pascack’s creditors be entitled to receive more money from a sale of assets at a higher price? Or do the people of Bergen County need the continued operation of Pascack’s MICU? One can imagine the creditors’ frustration when a Bankruptcy Court makes decisions based on factors other than maximizing recovery for the parties who have already been hurt by the debtor’s financial irresponsibility. As uncommon as the Pascack example might seem other scenarios have resulted in the approval of a sale when it did not result in the highest monetary bid.

A case from Georgia represents an example in the real estate industry. In In re Diplomat Construction, Inc.,[20] the Bankruptcy Court for the Northern District of Georgia applied the business judgment test[21] and approved the sale of the debtor’s interest in a ground lease to Khushal Hospitality, LLP (“Khushal”) for $55,000 despite the existence of higher bids up to $125,000. In the opinion, Judge Mary Grace Diehl stated, “[t]he highest bid does not always equate to the best bid for the estate.”[22] Judge Diehl found no reason to interfere with the trustee’s business judgment in selling the lease to Khushal having a sound rational to maximize the return to the estate.[23]

Another example arises from the professional sports industry. Discussing the inherent conflicts between professional sports leagues and the Code, attorney Lawrence Kotler noted the approval in 2009 of the NHL’s $140 million purchase of the Phoenix Coyotes “was at least $72.5 million less than that of [the other competing bidder].”[24] Another case involving the Texas Rangers brought speculation as to whether the highest bidder would be awarded the purchase because the ultimate decision was subject to MLB approval.[25] In 2010, a local news agency posted a Q&A regarding the auction. Answering the question “Will the highest bidder win?” the news agency stated, “[n]ot necessarily. Final approval rests with Major League Baseball, which can select the second-highest bidder . . . .”[26]

As all of these cases show, bankruptcy sales do not always go to the highest bidder at an auction. Indeed, this seems odd considering bankruptcy’s goal of maximizing creditor recovery. However, as discussed above, the trustee of the estate may be able to argue sound business reasons for selling assets to lower bidders (for instance, if the lower bid ultimately allows the trustee to sell other assets at a higher price, as was the case in Diplomat Construction). Additionally, in the area of health care, the trustee can make arguments regarding the public health showing adequate concerns to award a sale to a purchaser other than the highest bidder. With these available arguments both trustees and potential buyers should consider the options at their disposal when their goals may not be accomplished strictly by accepting/making the highest monetary offer.

[1] 11 U.S.C. §363(b)(1).

[2] 11 U.S.C. §363(c)(1). For instance, if a debtor is a retailer, the debtor does not have to receive court approval to continue selling merchandise since the sale of these assets occurs in the ordinary course of the debtor’s business. However, if the debtor-retailer wants to sell an entire store or certain equipment, such sales would likely not be considered sales in the ordinary course of the debtor’s business.

[3] 1997 U.S. Dist LEXIS 5090, at *9 (D.N.J. Mar. 26, 1997).

[4] Id. at *9.

[5] Id. at *8.

[6] Id. at *17.

[7] Id. at *19.

[8] Id. at *17.

[9] In re United Healthcare Sys., 1997 U.S. Dist LEXIS 5090, at *20 (D.N.J. Mar. 26, 1997).

[10] An MICU generally consists of paramedics and emergency responders able to provide emergency care after dispatching ambulances or other rescue vehicles.

[11] Transcript of Hearing at 24, 51, In re Pascack Valley Hosp. Ass’n., No. 07-23686 (RG) (Bankr. D.N.J. Nov. 14, 2007).

[12] Id.

[13] Id. at 46.

[14] Id. at 41.

[15] Jason Braff, HUMC Revives Plan to Reopen Pascack Valley Hospital, The Ridgewood News, Dec. 24, 2010, available at http://www.northjersey.com/news/humc-revives-plan-to-reopen-hospital-1.237573.

[16] Transcript of Hearing at 62-69, In re Pascack Valley Hosp. Ass’n., No. 07-23686 (RG) (Bankr. D.N.J. Nov. 14, 2007).

[17] Lindy Washburn, Pascack Valley Hospital Auction Put Off for Month, The Record, Feb. 5, 2008, available at http://www.northjersey.com/story-archives/hospital-auction-put-off-for-month-1.1207389.

[18] Braff, supra note 12.

[19] Englewood Hospital and Medical Center, 2009 Press Release, https://www.englewoodhospital.com/about_news_press_09_24.asp (last visited Mar. 31, 2016).

[20] 481 B.R. 215 (Bankr. N.D. Ga. 2012).

[21] Under the business judgment test, the trustee has the burden to establish sound business reasons for the terms of the proposed sale. See In re Diplomat Constr., Inc., 481 B.R. 215, 219 (Bankr. N.D. Ga. 2012).

[22] Id. at 219 (citing In re Gulf States Steel, Inc. of Alabama, 285 B.R. 497, 51 (Bankr. N.D. Ala. 2002)).

[23] Id. at 221 (Kushal’s offer was the only offer that would allow the trustee to sell assets free and clear of liens because the lienholder would only consent to Kushal’s offer).

[24] Lawrence J. Kotler, Column, Code to Code, Rangers’, Coyotes’ Asset-Purchase Agreements: Trumping Bankruptcy’s Fundamental Goals?, 29-7 American Bankruptcy Institute Journal 26, 71 (Sept. 2010).

[25] Id. at 70.

[26] WFAA, Aug. 4, 2010, http://legacy.wfaa.com/story/sports/mlb/rangers/2014/08/09/13607442/ (last visited Apr. 3, 2016).