The Brown Publ’g Co. Liquidating Trust v. Brown Media Corp. (In re Brown Publ’g Co.), 486 B.R. 46 (Bankr. E.D.N.Y. 2013) –
A stalking horse (BMC) was the winning bidder in a section 363 bankruptcy sale. After the sale to BMC failed to close and the debtors’ assets were instead sold to a back-up bidder, BMC claimed that it was entitled to a refund of its 5% good faith deposit, while the debtors’ successor (a liquidating trust) claimed BMC defaulted and sought to retain the good faith deposit.
The debtors filed for bankruptcy on April 30, 2010 and May 1, 2010. Four days after the bankruptcy petitions were filed, the debtors filed a motion to sell substantially all of their assets to BMC as a stalking horse for $15.3 million in cash plus certain additional consideration, subject to competing bids at an auction. Under the asset purchase agreement (APA), only competing bidders were required to submit a cash good faith deposit equal to 5% of their bids. However, in reviewing the proposed sale, the court required that BMC also submit a deposit.
BMC was formed by three insiders (CEO, general counsel and CFO of the debtors), who had begun working on financing as early as February 2010 so that they could purchase the debtors’ assets for themselves, and had obtained a financing commitment for $18 million prior to the bankruptcy filings. Although BMC was relying on this commitment to fund the purchase price, the APA included a representation that it had sufficient funds available to close the sale, and there was no financing contingency.
The auction was held on July 19. BMC was the successful bidder for substantially all of the debtors’ assets with a bid of $22.4 million in cash and other consideration. The next highest bidder was a secured creditor (PNC).
At the hearing to approve the sale, it became clear that the debtors had included assets that were not identified in the APA nor disclosed to the courts (and in fact, may not even have been owned by the debtors). Among other things, the assets included three pieces of property that were listed on the debtors’ schedules as having a value of ~$550,000. In particular, one of the properties had been acquired by the debtors pursuant to an option within days before the bankruptcy petitions were filed for $375,000. BMC’s separate bid of $10,000 was the only bid for this real estate (since PNC was not interested). There were no appraisals and the properties had not been marketed or listed with a real estate broker for sale. The court concluded BMC’s bid was not reasonable and did not approve the sale of the real estate to BMC.
Accordingly, the APA was amended to exclude the real estate. In the order approving the revised sale, the court added a paragraph to its order that the debtors were authorized to proceed “but only as to those assets that the Debtors own, and have fully and publicly disclosed in their Bankruptcy Schedules or the APA.” The sale closing was scheduled for August 13, but did not occur. Among other things, BMC apparently had some concerns about whether the assets were adequately identified in light of the court’s additional paragraph.
On August 17, the court granted additional time to close with the expectation that the closing would occur no later than August 20. However, BMC lost its financing commitment, was not able to obtain backup financing, and failed to close. The court subsequently approved the sale of assets to assignees of PNC for an aggregate purchase price of $23.5 million.
BMC subsequently demanded return of its good faith deposit. In response, the liquidating trust brought an adversary proceeding against BMC claiming that it breached the APA and seeking to retain the deposit. Although the court did not agree that there was an anticipatory breach of contract in connection with the initial closing, it did find that BMC defaulted by failing to close after the August 17 hearing.
However, the court declined to allow the liquidating trust to retain the good faith deposit. Specifically, the order establishing sale procedures required that all bidders (including BMC) make a cash good faith deposit equal to 5% of their bid price. The order went on to provide:
[I]f the Successful Purchaser fails to close the Sale, the Successful Purchaser’s Good Faith Deposit shall be retained by the Debtors on accounts (sic) of damages suffered by it as a result of such failure to close, without prejudice to the Debtors’ ability to seek to recover additional damages from the Successful Purchaser.
As one would expect, the liquidating trust contended that this provision entitled it to retain the good faith deposit.
However, the court concluded that the proper question was whether the deposit provision was a valid liquidated damages provision. After reviewing applicable state law (and distinguishing cases involving real estate), the court determined that where a contract has both a liquidated damages provision and an actual damages provision, “the liquidated damages provision is read out of the contract.” In this case, since retention of the deposit was without prejudice to the right to seek additional damages, the court concluded that there was an actual damages provision, and accordingly retention of the good faith deposit as liquidated damages was not authorized.
In considering actual damages, the court noted that BMC proposed to pay $22,410,000 plus assumption of certain liabilities, while the replacement purchaser paid $23,500,000 plus cure amounts and assumption of liabilities. Thus, it was not clear to the court that the debtors suffered any actual damages, although it acknowledged that a final determination required an evaluation of the relative values of the assumed liabilities and cure amounts.
In sum, because the provision entitling the debtors to retain the good faith deposit left open the possibility that additional actual damages could be recovered, the court found that the good faith deposit provision was an invalid liquidated damages claim that it would not enforce.
That is certainly not the outcome that most people would expect. The result is perhaps even a little bit more surprising because of the hints that insider dealing was involved. Regardless, sellers should not take good faith deposits for granted, and specific consideration of state law on liquidated damages may be warranted in drafting deposit provisions.
Vicki R. Harding, Esq.