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Fifth Circuit Affirms Reimbursement of Potential Bidder's Due Diligence Expenses as a Proper Exercise of Debtor's Business Judgment

Wednesday, September 7, 2011
Asarco, Inc. v. Elliott Mgmt. (In re Asarco LLC), No. 40930, 2011 BL 213002 (5th Cir. Aug. 16, 2011) The United States Court of Appeals for the Fifth Circuit affirmed a bankruptcy court’s ruling authorizing a debtor to reimburse qualified bidders for expenses incurred in connection with the sale of a substantial asset of the debtor’s estate as a proper exercise of "business judgment" under 11 U.S.C. § 363(b). While the debtor’s parent, which had since regained control of the debtor, argued on appeal that the proposed reimbursement should be governed by the more stringent standard applicable to administrative expenses under 11 U.S.C. § 503(b), the Fifth Circuit disagreed and held that § 363(b) was the appropriate statutory provision given that the debtor sought authorization to make discretionary use of the estate’s funds, rather than approval of fees already incurred.

Debtor’s Judgment against AMC for Fraudulent Transfer of the SCC Stock

In 1999, prior to its bankruptcy filing, ASARCO LLC ("Debtor"), a mining conglomerate, was purchased by Grupo Mexico, S.A.B. de C.V. ("Grupo Mexico"). At the time, Debtor was a controlling shareholder in Southern Peru Copper Company ("SCC"). Once Debtor started having financial problems, Grupo Mexico decided to sell the SCC shares to its wholly owned subsidiary, Americas Mining Corporation ("AMC"), which, along with ASARCO Inc., served as Debtor’s parent company (together, "Parent"). Notwithstanding the transfer, however, Debtor continued to have financial problems and, in 2005, filed a petition for chapter 11 bankruptcy protection. During its bankruptcy, Debtor commenced an action in district court, alleging that AMC had wrongfully caused Debtor to transfer the SCC shares. Following a trial on the matter in 2008, the district court found AMC liable for actual fraudulent transfer, aiding and abetting a breach of fiduciary duty and conspiracy. As such, in April 2009, the district court entered a judgment ("SCC Judgment"), requiring AMC to transfer approximately 260 million shares of SCC common stock to Debtor and pay approximately $1.4 billion in damages.

Bankruptcy Court Grants Debtor’s Motion to Reimburse Bidder’s Due Diligence Expenses

In the meantime, Debtor and the Parent each filed separate plans of reorganization in Debtor’s bankruptcy proceeding. Under Debtor’s plan, the reorganization was to be partially funded by the sale of the SCC Judgment through a two-part bid solicitation process. In July 2009, during the first phase of the bid solicitation process, Debtor filed a motion requesting authorization to reimburse certain due diligence expenses incurred by bidders invited to proceed to the second phase of the bid process ("Reimbursement Motion"). In its motion, Debtor explained it had decided to proceed with a select group of bidders to continue to the next phase of the process, during which time they would be able to conduct additional due diligence related to the SCC Judgment, which would be very costly to value. Thus, in order to entice bidders to go forward in the due diligence process, Debtor determined that it was necessary to reimburse qualified bidders for their expenses incurred, and therefore, sought authorization under § 363 to make such payments Ultimately, the bankruptcy court granted the Reimbursement Motion ("Reimbursement Order"), finding that Debtor had demonstrated a "compelling and sound business justification" for authorization under § 363(b). The Parent subsequently appealed the Reimbursement Order to the district court and successfully moved for a stay pending appeal. While the appeal was pending, the district court confirmed the Parent’s plan of reorganization, by which the Parent regained control of Debtor and obtained a release from the SCC Judgment upon the plan’s effective date. Soon thereafter, the district court affirmed the Reimbursement Order issued by the bankruptcy court. The Parent, which had since regained control of Debtor pursuant to its confirmed plan, then appealed the district court’s ruling to the Fifth Circuit.

Fifth Circuit Declares Jurisdiction over the Parent’s Appeal

Rendering its decision on appeal, the Fifth Circuit began by rejecting the Parent’s argument that the court lacked jurisdiction because the Reimbursement Order was not a final, appealable order. Noting that it was obligated to examine the issue even though it was not raised before the district court, In re Cortez, 457 F.3d 448, 453 (5th Cir. 2006), the Fifth Circuit declined to apply the Second Circuit’s decision in In re Integrated Resources, Inc., 3 F.3d 49, 51 (2d Cir. 1993) relied upon by the Parent, in which the court concluded that because a bankruptcy court’s order that approved a "break-up fee" was contingent upon future events, it was not final and therefore, not appealable. Citing its previous rejection of the Second Circuit’s "rigid rule of finality," see Bartee v. Tara Colony Homeowners Assoc. (In re Bartee), 212 F.3d 277, 282 n. 6 (5th Cir. 2000), the Fifth Circuit instead adopted a more flexible approach pursuant to which a bankruptcy order is considered final if it "constitutes either a final determination of the rights of the parties to secure the rights they seek, or a final disposition of a discrete dispute within the larger bankruptcy case." In re Kizzee-Jordan, 626 F.3d 239, 242 (5th Cir. 2010). Applying this rule, the Fifth Circuit determined that the Reimbursement Order constituted a final disposition of a discrete dispute within Debtor’s bankruptcy case, given that it settled whether Debtor was permitted to reimburse potential bidders of due diligence expenses related to the proposed sale of the SCC Judgment. Accordingly, the Fifth Circuit declared that it had jurisdiction over the Parent’s appeal.

Fifth Circuit Rules "Business Judgment" Standard Applied to the Reimbursement Motion

Turning to the merits of the appeal, the Fifth Circuit declined to accept the Parent’s assertion that the bankruptcy court should have considered the Reimbursement Motion under the more stringent standard for "actual and necessary costs of expenses of preserving the estate" applicable to administrative expenses under § 503(b), rather than under the flexible "business judgment" standard under § 363(b). Specifically, the Fifth Circuit was persuaded by the fact that while § 363(b) addresses the debtor’s use of property of the estate, In re Cont’l Air Lines, Inc., 780 F.2d 1223, 1226 (5th Cir. 1986), § 503 generally only applies to transactions with third parties who lend goods or services necessary to the successful reorganization of the debtor’s estate. In re Jack/Wade Drilling, Inc., 258 F.3d 385, 387 (5th Cir. 2001). In this regard, the Fifth Circuit distinguished In re Reliance Energy Channelview LP, 594 F.3d 200 (3d Cir. 2010), and In re O’Brien Envtl. Energy, Inc., 181 F.3d 527 (3d Cir. 1999), relied upon by the Parent, in which the Third Circuit applied § 503 to requests for break-up fees. Declining to follow these cases, the Fifth Circuit found it to be determinative that, unlike the break-up fees at issue in Reliance and O’Brien, the prospective bidders in the present case were to be reimbursed regardless of whether they were successful and there was no concern about chilling the competitive bidding process given that Debtor sought to increase competition by providing bidders an incentive to undertake the expensive and lengthy due diligence process. O’Brien, 181 F.3d at 529; In re Reliance, 594 F.3d at 204. As such, the Fifth Circuit concluded that the "business judgment" standard in § 363(b) was more appropriate for assessing the Reimbursement Motion given that Debtor sought to make discretionary use of estate funds, rather than the approval of fees which had already incurred as addressed under § 503(b).

Fifth Circuit Concludes Reimbursement Motion Satisfied the "Business Judgment" Test

Lastly, applying the "business judgment" standard of § 363(b), the Fifth Circuit ruled that the bankruptcy court did not commit clear error in finding that Debtor’s proposed reimbursement of expenses furthered Debtor's intent in maximizing the value of its estate, and was fair, reasonable, and appropriate and in the best interest of Debtor and its estate. Likewise, the Fifth Circuit determined that the district court had appropriately concluded that the Reimbursement Motion satisfied the "business judgment" standard because there was no evidence of self-dealing or manipulation, the Motion facilitated, rather than chilled, the auction process, and the approved maximum amount of the reimbursed fees was reasonable compared to the amount of the SCC Judgment. Consequently, the Fifth Circuit affirmed the bankruptcy court’s approval of the Reimbursement Motion.

Fifth Circuit Affirms Lower Courts’ Rulings

Ultimately affirming the lower courts’ rulings, the Fifth Circuit held that the "business judgment" standard in § 363 applied to the Reimbursement Motion and that the Reimbursement Motion satisfied this standard because the proposed reimbursement of expenses was designed to maximize the value of Debtor’s estate and was fair and reasonable. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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