In Re America West Airlines, Inc.
166 B.R. 908, 31 Collier Bankr. Cas. 2d 27, 1994 Bankr. LEXIS 668 (1994)
Rule of Law:
In bankruptcy proceedings, break-up fees associated with asset sales are not subject to the business judgment rule but must be scrutinized under the 'best interests of the estate' standard pursuant to 11 U.S.C. § 363(b) and cannot be granted as administrative expenses under 11 U.S.C. § 503(b) if they constitute liquidated damages unrelated to actual, beneficial costs to the estate.
Facts:
- On December 8, 1993, the Bankruptcy Court entered an Investment Procedure Order stating that if the Lead Plan Proposal selected by America West (the Debtor) was made by a third party, that party would be entitled to reasonable bidding protections, which could include topping fees, break-up fees, and reimbursement of expenses.
- On February 24, 1994, America West selected a proposal submitted by AmWest Partners, L.P. ('AmWest') as its Lead Plan Proposal.
- America West and AmWest negotiated an Interim Procedures Agreement that included a provision for a $4 million break-up fee if America West breached the agreement prior to approval of a disclosure statement, and a possible $4-8 million break-up fee under certain contingencies after disclosure statement approval.
- America West, with the assistance of investment bankers Donaldson, Lufkin & Jenrette and Salomon Brothers, had 'thoroughly marketed' itself to approximately 100 potential bidders from the airline industry and other major corporations, resulting in four bids from which AmWest's was chosen.
- The proposed break-up fee was viewed by the parties as liquidated damages in the event the Debtor breached its agreement with AmWest.
- America West had been profitable over the last three quarters and was on the verge of profitability at the time of the proposed agreement.
- The Interim Procedures Agreement also called for reimbursement of AmWest's expenses up to $250,000 per month, capped at $3 million, subject to court approval.
Procedural Posture:
- America West (the Debtor) filed a Motion for Approval of the Interim Procedures Agreement in the United States Bankruptcy Court for the District of Arizona.
- An objection was filed against the Debtor's motion.
- The Bankruptcy Court held a hearing on America West's motion on March 16, 1994, which was subsequently continued to March 28, 1994.
- At the March 28, 1994 hearing, the Bankruptcy Court set an evidentiary hearing for April 12, 1994, on the Interim Procedures Agreement and the specific issue of break-up fees.
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Issue:
Does the business judgment rule apply to determine the validity of break-up fees in bankruptcy asset sales, or must such fees be scrutinized under a 'best interests of the estate' standard in accordance with 11 U.S.C. § 363(b)?
Opinions:
Majority - Robert G. Mooreman, Chief Judge
No, the business judgment rule does not apply to determine the validity of break-up fees in bankruptcy asset sales; instead, such fees must be scrutinized under a 'best interests of the estate' standard in accordance with 11 U.S.C. § 363(b). The court found that the acquisition of an ongoing business in bankruptcy is fundamentally different from an acquisition outside of bankruptcy, which means a wholesale adoption of non-bankruptcy procedures, including the business judgment rule for break-up fees, is inappropriate. Unlike non-bankruptcy contexts where such fees primarily affect shareholders, in bankruptcy, they impact the debtor, creditors, and equity holders alike, necessitating careful scrutiny. The court rejected the application of the business judgment rule used in `In re Integrated Resources, Inc.`, arguing that `Integrated` failed to adequately address 11 U.S.C. § 363(b) and the unique distinctions of a debtor-in-possession. The correct standard, the court explained, is not whether a break-up fee is within the debtor's business judgment, but whether the transaction will 'further the diverse interests of the debtor, creditors and equity holders, alike' as established in `In re Lionel Corp.` The court concluded that the proposed break-up fee, in any amount, was not in the best interest of the estate, its creditors, or equity holders. This was because America West had already been 'thoroughly marketed,' rendering the fee unnecessary as an inducement for further bidding and serving to chill rather than encourage competition. Furthermore, the court held that the proposed break-up fee, functioning as liquidated damages and not correlated to actual transactional costs or expenses incurred and beneficial to the estate, could not be paid as an administrative expense under 11 U.S.C. § 503(b). While denying the break-up fees, the court approved the sections of the Interim Procedures Agreement allowing for reimbursement of AmWest's expenses, deeming them reasonable and in the best interest of the estate.
Analysis:
This case represents a significant departure from earlier bankruptcy court tendencies to apply the 'business judgment rule' to break-up fees, establishing a stricter 'best interests of the estate' standard for such arrangements. By rejecting a wholesale adoption of non-bankruptcy corporate acquisition practices, the court underscored the unique protective role of bankruptcy courts under 11 U.S.C. § 363(b) for all stakeholders. This ruling made it more difficult for debtors to secure break-up fees by imposing a higher standard of justification, thereby promoting estate preservation and fostering more competitive bidding environments in distressed asset sales. It also clarified the limits of administrative expense treatment for break-up fees, ensuring such fees are actual, beneficial costs rather than mere liquidated damages.
