Section 363(b) restructuring meets the sound business purpose test with bite: an opportunity to rebalance the competing interests of bankruptcy law.

AuthorUziel, Jessica

INTRODUCTION I. THE WORLD OF [section] 363 SALES: BUSINESS JUDGMENT, SUB ROSA, AND SWEET HEARTING A. The Sound Business Purpose Test 1. Unfettered Discretion 2. Business Justification and the Relevant Factors B. Evaluating the Sound Business Purpose Test Against the Goals of Chapter 11 II. GOOD FAITH IN THE BANKRUPTCY CONTEXT: IS BUSINESS JUDGMENT SUFFICIENT? A. Good Faith in Corporate Reorganizations B. Good Faith Under [section] 363 III. IN RE GULF COAST OIL CORP.: A COMPREHENSIVE FRAMEWORK FOR THE ANALYSIS OF PREPLAN ASSET SALES A. A Revised Outlook on Approval of [section] 363 Sales 1. Background 2. A Modified Approach to Authorization of [section] 363 Sales a. Factors Aimed at Efficiency and the Maximization of Value b. Creditor Protection and the Good Faith Requirement c. Preservation of the Integrity of the Bankruptcy Process 3. Application of the Gulf Coast Oil Framework B. Sound Business Purpose Test with Bite CONCLUSION INTRODUCTION

Since the economic cataclysm of the Great Depression, the rehabilitative principle underlying Chapter 11 business reorganizations has focused on the efficiency of preserving valuable assets by sustaining a business as a going concern rather than liquidation. (1) Despite this traditional model of reorganization, Chapter 11 of the Bankruptcy Code provides distressed companies with two means of selling all or substantially all of their assets: a debtor in possession may undertake an asset sale (1) pursuant to [section] 363(b) (1) of the Code (2) or (2) within a reorganization plan under [section] 1123. (3) Regardless of which statutory approach is pursued, maximization of asset value remains the ultimate goal. (4)

From an efficiency standpoint, there are several reasons why [section] 363 sales have become more advantageous vehicles than [section] 1123 reorganization plans for financially distressed companies. After the requisite notice and hearing, (5) these out-of-plan sales provide a more streamlined process because purchase agreements face only court approval, rather than the more time-consuming confirmation by several classes of creditors. (6) Thus, corporations in need of fast cash undoubtedly prefer the more expeditious [section] 363 sale. In addition to the ease of bypassing the rather burdensome creditor voting rights, [section] 363 sales are more appealing because assets are typically sold free of habilities, (7) and legally these transactions are final unless marred by bad faith. (8)

Debtors may find [section] 363 sales increasingly beneficial in the midst of recessions as a prompt means of generating "the capital needed to fund the company's reorganization and future survival." (9) As a result of the current financial crisis, Chapter 11 filings have inundated bankruptcy courts. (10) Insolvent corporations operating in various industries, most notably the automobile industry, (11) have used [section] 363 sales as the "preferred method of monetizing ... assets." (12) The recent use of [section] 363 sales as a substitute for the more traditional Chapter 11 restructuring of large global companies like General Motors, Chrysler, and Lehman Brothers (13) reflects a dramatic shift in the bankruptcy arena. This trend has crystallized the idea that traditional restructurings through reorganization plans may have become a method of the past. Today, the scope of [section] 363 has even grown to include the sale of whole companies. (14) The benefits of this tactic, however, do not come without significant costs.

Although this strategy is arguably more efficient than participating in an in-plan liquidation, [section] 363 sales have increasingly become more controversial and vulnerable to abuse. Under the current system, speed and ease beget inconsistency and a lack of transparency that jeopardize the soundness of these deals as well as the interests of creditors. (15) Debtor companies pursuing the sale of assets under [section] 363(b) obtain the advantage of circumventing the disclosure and equity requirements necessary for the approval of a reorganization plan. (16) Significant differences in the mechanics of these sales--the lack of a disclosure statement describing the terms and conditions of the plan, (17) the limited time and information provided to creditors to review the proposed sale, (18) and an absence of the requirement that the plan be in the best interest of each creditor (19)--create increasing opportunities for unfair dealing under [section] 363. (20) Thus, prospective purchasers' weak control over the terms of the transaction, (21) as well as creditors' lack of information and input, threatens creditor constituencies, endangering one of the fundamental aspects of bankruptcy law. (22)

The prominence of [section] 363 sales, the amplified speed of the process, and the use of this provision as an alternative to reorganization in unprecedented ways intensify these concerns over potential abuses. As a result of the shockingly speedy General Motors and Chrysler sales, where both companies exited from bankruptcy within forty-five days, (23) critics are now duly alarmed that such hasty timelines will become more common, adversely affecting creditors' ability to negotiate throughout the process. (24) Furthermore, experts in the field criticize these recent [section] 363 sales as "sham sales," setting the precedent that a debtor can design "pretend" sales of its key assets to a new entity set up by the debtor with the objective of avoiding interference by creditors and shareholders. (25) Critics argue that such sales are "artificial" because they do not provide for the proper auction process that [section] 363 calls for--conferring power to one bidder rather than stimulating multi-party bargaining among other interested parties and creditors--and that they have the potential to violate the priority rules installed by the Code. (26) Regardless of whether these innovative uses of asset sales are a product of government involvement or a reaction to the unique circumstances of the financial crisis, (27) this precedent has now opened the door for smaller, private businesses to use [section] 363 sales to restructure their entire business. (28)

No matter the cause, the exploitation of [section] 363 has jeopardized the soundness of these transactions. That creditors will likely fail to find sanctuary in bankruptcy courts' treatment of [section] 363 sales augments such concerns. The prevalent standard for court approval of [section] 363 asset sales, articulated by the Second Circuit in In re Lionel Corp., requires only a motion, a hearing, and a court's determination that the debtor has a sound business purpose for selling its assets. (29) This test is designed to strike a balance between judicial discretion and creditor protection. (30)

As this Comment demonstrates, the "sound business purpose" test is applied inconsistently throughout the nation. Courts approach these cases using a variety of factors, which produces a large degree of variance in the weight given to each of these considerations. (31) Perhaps a more troubling observation, in light of the escalating and evolving criticism of [section] 363 sales, is that despite underlying congressional intent (32) and frequent judicial language indicating that good faith is one such salient factor to be considered, bankruptcy courts typically examine good faith only as a faint afterthought. (33) With the growing likelihood of abuse of [section] 363 sales to the detriment of creditors, it is disconcerting that an analysis of good faith in these transactions has been subordinated to a very liberal application of the business purpose test.

In reaction to the current criticism of large companies' abuses of [section] 363 sales, the change in the bankruptcy "landscape," and inconsistent treatment by bankruptcy courts, the Bankruptcy Court for the Southern District of Texas in In re Gulf Coast Oil Corp. enumerated thirteen factors to be weighed in determining whether to approve such a transaction. (34) This Comment argues that bankruptcy judges should follow the Gulf Coast Oil factors as a model. This test, which modifies previously recognized considerations and adds several new elements, strikes a sound balance between judicial discretion and adherence to the goals of bankruptcy law while also giving the sound business purpose test teeth to address recent concerns of abuse. By providing a more focused legal analysis, which pointedly implies a good faith requirement within its enumerated factors, this approach ensures an analysis of good faith as a potential remedy to ameliorate misuse of the Bankruptcy Code.

Part I of this Comment provides a brief overview and evaluation of the sound business purpose test that courts employ in approving [section] 363 sales. Part II examines the significance of good faith in the bankruptcy context by analyzing the differences between the meaning of good faith in Chapter 11 reorganizations and in the [section] 363 approval process. Additionally, this examination will illustrate the ramifications of ignoring whether a transaction is pursued in good faith. Finally, Part III analyzes Gulf Coast Oil and the framework that the court articulated. For the reasons outlined above, this Comment argues that this framework provides a preferable model for evaluating [section] 363 proposals. Because [section] 363 sales are so prominent across the nation, courts should reevaluate the broad discretion that the Bankruptcy Code confers upon them in order to guarantee that these sales promote creditor protection, an underlying principle of bankruptcy law, (35) by ensuring that parties enter into these deals in good faith.

  1. THE WORLD OF [section] 363 SALES: BUSINESS JUDGMENT, SUB ROSA, AND SWEETHEARTING

    The increasing popularity of [section] 363 sales as a substitute for true reorganizations reflects a growing conflict between the underlying themes of corporate reorganization under Chapter 11 and the cursory...

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