Recently, the Office of the United States Trustee (the “UST”) has been objecting to debtors’ motions to establish bidding procedures to sell some or all of an estate’s assets pursuant to section 363 of the Bankruptcy Code. As highlighted in three recent Delaware cases, the UST has objected to stalking horse bid protections on a number of grounds, including: (a) when such protections would be payable; (b) the proposed priority classification for such protections; (c) the scope of the bid protections; and (d) whether the debtor has demonstrated that such protections benefit the estate and are necessary to preserve estate value. Understanding the UST’s concerns is critical when negotiating with a stalking horse bidder.
Jo-Ann Stores[1]
On January 15, 2025, the Jo-Ann Stores debtors filed chapter 11 bankruptcy petitions. Alongside the petition, the debtors filed a motion to approve bidding procedures and a stalking horse agreement with Gordon Brothers Retail Partners. The proposed bid protections for the stalking horse included (a) up to $500,000 for reasonable out-of-pocket expenses and (b) up to $1.6 million for the reasonable costs incurred to acquire signage for going-out-of-business sales. On February 5, 2025, the UST objected to the bidding procedures motion and raised the following points concerning the stalking horse agreement:
- The stalking horse was an affiliate of the debtors’ prepetition lenders’ first-in-last-out (“FILO”) agent and therefore did not need to conduct significant due diligence or be induced to bid in exchange for its affiliate to be paid in full from the sale proceeds.
- The initial minimum overbid of $2.2 million was too large and would chill bidding.
- The bid protections were not eligible to receive super-priority administrative expense status because the stalking horse was not providing postpetition financing (section 364(c)(1)) and was not a secured creditor who received insufficient adequate protection for the postpetition diminution in value of their collateral (section 507(b)).
- Because the debtors’ prepetition FILO agent was an affiliate of the stalking horse, the affiliated prepetition lenders should not be a consultation party or at least should be shielded from sharing information with the stalking horse.
The bankruptcy court ultimately agreed that as an affiliate of the stalking horse bidder, the prepetition FILO agent could not be a consolidation party during the bidding process but otherwise overruled the UST’s remaining objections.
Ligado Networks[2]
On January 6, 2025, a day after filing chapter 11 bankruptcy petitions, the Ligado Networks debtors filed a bidding procedures motion, which included a stalking horse agreement with AST & Science, LLC. If consummated, the stalking horse agreement would provide the debtors with hundreds of millions of dollars through several different payment streams (e.g., common stock, convertible notes, warrants, percentage of net revenue, annual usage rights payment), the sum of which did not have a fixed value. The stalking horse agreement included a $200 million bid protection, which the debtors argued was reasonable based on the complex transaction, similar transaction fees approved in prior Delaware cases, being required by AST, and providing a material benefit to the estates. The UST objected to the bidding procedures motion and raised the following points concerning the stalking horse agreement:
- No bid protection should be paid if the transaction could not be consummated for regulatory reasons because the debtors have no control on whether regulatory approval is obtained, and regulatory denial would force the debtors to begin negotiating with alternative purchaser(s) and lose $200 million.
- Any alternative purchaser the debtors select as the successful bidder must result in not merely any transaction, but one that is a higher and better bid than AST’s.
- It would be improper to include a second-protection fee of an additional $250 million if the debtors’ $40 billion takings lawsuit against the U.S. related to the debtors’ wireless terrestrial 5G services adversely affected AST’s use of the debtors’ L-band spectrum (i.e., a range of radio frequencies used for satellite navigation, maritime and aviation safety, and radars).
- Similar to the objection in Jo-Ann Stores, the stalking horse should not be granted super-priority expense status because only sections 364(c)(1) and 507(b) authorize such a classification.
- The large $200 million bid protection should be market tested.
The debtors and UST subsequently resolved the UST’s objection by agreeing: (a) that the bid protection would be payable after a failure to receive regulatory approval only if the debtors subsequently consummated a higher or better transaction; (b) only the expense reimbursements would receive super-priority administrative expense status and all other bid protections would merely be treated as an administrative expense (although the postpetition DIP lenders voluntarily agreed to subordinate their obligations to the remaining bid protections); and (c) the request to authorize payment of the $250 million second-protection fee related to any potential impact to the L-band spectrum would be removed. The bankruptcy court entered an order approving the revised bidding procedures.
First Mode[3]
On December 15, 2024, the First Mode debtors filed chapter 11 bankruptcy petitions, and the following day filed their bidding procedures motion. The bidding procedures motion included a stalking horse asset purchase agreement with Cummins, Inc., which proposed to grant Cummins bid protections in the form of a 3% break-up fee and expense reimbursements of up to $550,000. The UST objected to the bid protections on the following grounds:
- Similar to the objections in Jo-Ann Stores and Ligado Networks, the bid protections should not prime other administrative expenses as super-priority expenses because only sections 364(c)(1) and 507(b) authorize the classification of an expense as a super-priority administrative expense status.
- Certain payment triggering scenarios, such as withdrawing the bidding procedures motion or filing a motion to convert or dismiss the case, provided no benefit to the estates as required by section 503(b) (i.e., does not promote competitive bidding or induce the stalking horse to perform diligence and set a floor price).
The debtors and UST resolved the objections by: (a) classifying the bid protections as an administrative expense claim; (b) providing the UST, debtors, and creditors’ committee five business days to review proposed expense reimbursements before such amounts are payable; and (c) slightly narrowing the circumstances that would trigger payment of the bid protections.
Takeaways
Debtors who seek approval of a stalking horse agreement in their bidding procedures motions should be prepared for the UST to object to certain aspects of the bid protections. First, the UST will most likely object if the proposed classification for the bid protections is a super-priority administrative expense claim. Although the debtors in First Mode conceded to the UST’s position, debtors could attempt to bifurcate the classification by authorizing superpriority status for expense reimbursements (Ligado Networks) or push forward with pursuing full superpriority status, which was successfully obtained in Jo-Ann Stores.
Second, debtors should be cognizant of potential objections to the triggering events for paying bid protections. It is unlikely that a debtor would be permitted to pay bid protections in the event the debtor, without demand by its secured creditor(s), files a motion to convert or dismiss its bankruptcy cases. Further, if there are significant contingencies surrounding the future value of the business (e.g., Ligado Networks’ $40 billion takings lawsuit affecting the L-band spectrum), parties may want to consider reflecting that risk in a reduced sale price or increased bid protection amount rather than as a triggering event for payment of additional protection amounts. And if the contingency is related to obtaining governmental consents before the sale can be consummated (e.g., Ligado Networks’ regulatory approval), such contingency should not likely be a triggering event unless it is succeeded by the consummation of an alternative transaction.
Third, in liquidation situations like Jo-Ann Stores where the stalking horse would incur significant expenses to wind-up the debtors’ businesses and liquidate assets, bankruptcy courts may be more lenient to grant bid protections when such expenses clearly are incurred to benefit the estates.
In conclusion, proactive negotiation with the UST concerning bid protection terms is a prudent first step for counsel of both debtors and the stalking horse bidder to pursue in order to resolve the issues the UST has recently identified in the Jo-Ann Stores, Ligado Networks, and First Mode bankruptcy cases.
[1] In re Jo Ann, Inc., Case No. 25-10068 (CTG) (Bankr. D. Del. Jan. 15, 2025).
[2] In re Ligado Networks LLC, Case No. 25-10006 (TMH) (Bankr. D. Del. Jan. 5, 2025).
[3] First Mode Holdings, Inc., Case No. 24-12794 (KBO) (Dec. 15, 2024).