Bankruptcy Sale Offers: Highest Is Not Always Best

In re Diplomat Construction, Inc., 481 B.R. 215 (Bankr. N.D. Ga. 2012) –

Is there an obligation to sell to the highest bidder in a bankruptcy sale?  In Diplomat Construction, the court approved a sale to a bidder that offered less than half of the offer of the highest bidder.  Under normal circumstances, cash is king and the highest bidder is automatically selected as the winning purchaser.  However, as illustrated by this case, occasionally there are exceptions.

A Chapter 7 trustee proposed to sell a debtor’s interest under a ground lease to Khushal Hospitality, LLP (Khushal) for $22,500.  At the hearing on the proposed sale, two additional parties made higher offers.  In particular, World Debt Acquisition, LLC (World Debt) made a final offer of $125,000, which purported to be a cash offer with no contingencies on an “as is where is” basis.  The hearing was adjourned to allow World Debt to deposit $125,000 into the trustee’s escrow account and to allow the trustee to prepare evidence that the World Debt offer was the highest and best offer.  However, at the adjourned hearing, the trustee again proposed to sell to Khushal, this time at a price of $55,000.

As background:

  • The debtor owned and operated a Red Roof Inn near the Atlanta Airport.  It leased the real estate from the City of Atlanta under a long-term lease.  The court previously approved the debtor’s assumption of the ground lease, which included four parcels.
  • The debtor’s interests were subject to liens of the State Bank of Texas.  The bank obtained relief from the automatic stay and foreclosed on two of the four parcels under the ground lease.  Khushal purchased the two foreclosed parcels, which it operated as a hotel with some parking.  The bank, which asserted a five million dollar deficiency claim, was only willing to consent to a sale of the remaining two parcels to Khushal.
  • Ruby Tuesday, Inc. asserted an interest in the sale based on the fact that the court had previously approved a settlement allowing it to use the parking lot governed by the ground lease, which initially it contended would not be adequately protected under the proposed sale.
  • The City of Atlanta also chimed in, arguing that the ground lease covering the four parcels was an agreement with one lessee.  It claimed that performance under the ground lease for the remaining two parcels was impossible unless the hotel owner (now Khushal) was the party that assumed the ground lease.

The trustee argued that the sale to Khushal provided the best result for the bankruptcy estate since it would minimize further litigation with both the City regarding its contention that the lease agreement could not be split and with Ruby Tuesday regarding the parking issue.

In addition, since the bank would consent to allowing the sale free and clear of liens only if Khushal was the buyer, the higher offer would be subject to the bank’s liens and would not realize any net benefit to the other creditors.

As a procedural matter, the court ruled that the unsuccessful competing bidders were not parties in interest, and thus did not have standing to oppose the trustee’s motion to sell to Khushal.

With respect to the proposed sale, the court held that it should be evaluated using the business judgment test.  The trustee was required to establish that there were sound business reasons for the proposal.  But once the trustee met this burden, his judgment was “entitled to respect and deference from the Court.”  The court went on to reiterate that, although the trustee’s discretion is not without limit, his judgment as to which bid to accept was to be “afforded great judicial deference.”  In this case, the court was persuaded by the trustee’s arguments and approved the sale.

As noted above, there is a lot of pressure on a debtor or trustee to maximize value for the estate – typically meaning as much cash as possible.  As this case illustrates, the highest dollar bid may not necessarily be the best offer.  However, notwithstanding the language in this case to the effect that a decision to go with a lower offer will be given “great” deference, as a general rule the expectation is that there will have to be compelling reasons to select a lower offer.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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