By Michael L. Temin and Martha B. Chovanes
In an issue of first impression, in In re Energy Future Holdings Corp., 2021 U.S. App. LEXIS 7400 (3d Cir. Mar. 15, 2021), the Third Circuit addressed the question whether an initial bidder whose break-up fee was disallowed could receive a portion of its costs as an administrative expense claim even if the ultimate sale price was below the amount of the initial bid? The Third Circuit answered this question in the affirmative.
In Calpine Corp. v. O’Brien Env’t Energy, Inc. (In re O’Brien Env’t Energy, Inc.), 181 F.3d 527 (3d Cir. 1999), the Third Circuit concluded that break-up fees could be authorized under Bankruptcy Code § 503(b), which permits payment of post-petition administrative expenses, for “actual, necessary costs and expenses of preserving the estate,” to induce an initial bid.
NextEra entered into an agreement (the “Merger Agreement”) with the Debtors to purchase the Debtors’ interest in Oncor, a large electric and power distribution company, subject to PUCT approval. The Merger Agreement provided for a termination fee of $275 million to be paid to NextEra if the Merger Agreement was terminated. Ultimately, the Bankruptcy Court disallowed the payment of a termination fee if the PUCT did not approve the merger as contemplated.
Eventually, the Debtors sold their interest in Oncor for $ 350 million less than the amount NextEra had agreed to pay. NextEra filed an administrative expense application pursuant to 503(b)(1)(A) to recover its out-of-pocket expenses and other costs incurred in its efforts to complete the transaction and obtain the requisite PUCT approval, for the period from execution of the Merger Agreement until notice of termination of the Merger Agreement. The Bankruptcy Court and the District Court denied NextEra’s administrative expense application.
The Court’s Opinion:
On appeal, the Third Circuit found that the terms of the Merger Agreement did not preclude NextEra’s application for administrative expenses. The Court noted:
An administrative expense claim is entitled to priority under Section 503(b)(1)(A) if (1) there was a “post-petition transaction between the claimant and the estate,” and (2) those expenses yielded a “benefit to the estate.”
The Merger Agreement was a post-petition transaction. As noted by the Court,
“The word ‘benefit’ . . . functions as ‘merely a way of testing whether a particular expense was truly ‘necessary’ to the estate: If it was of no ‘benefit,’ it cannot have been ‘necessary’ within the meaning of § 503(b)(1)(A). ”
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In O’Brien, we elucidated the concept of “benefit” under Section 503(b)(1)(A) in describing a framework for evaluating the possible beneficial acts that could justify a termination fee, e.g., (1) “promot[ing] more competitive bidding” by “inducing an initial bid” or “inducing a bid that otherwise would not have been made and without which bidding would have been limited”; and (2) “encourage[ing] a prospective bidder to do the due diligence” to “research the value of the debtor and convert that value to a dollar figure on which other bidders can rely . . . [which] increase[es] the likelihood that the price at which the debtor is sold will reflect its true worth.”
NextEra argued that by (i) negotiating the Merger Agreement, (ii) settling objections with creditors and (iii) providing further due diligence, it created guideposts that directly facilitated the merger that ultimately took place.
The Court concluded,
With respect to the motion to dismiss the question before us is not whether NextEra actually benefitted the estate, but whether it plausibly alleged that it did so.
On this basis, the Court reversed the lower courts’ dismissal of the motion for administrative expenses and remanded to give NextEra the opportunity to present facts relevant to its request for an administrative expense claim in its attempt to recoup some of its costs in the failed acquisition.