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The Delaware Bankruptcy Insider is a premier blog designed to bring its readers a comprehensive analysis of the latest Delaware corporate bankruptcy news and rulings. Brought to you by Ashby & Geddes, P.A.
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Third Circuit Upholds Bankruptcy Court’s Reconsideration Order Described by Dissent as “Troubling – If Not Dangerous – Precedent”
In this precedential Opinion, the United States Court of Appeals for the Third Circuit (the “Third Circuit”) upheld the decision of the Delaware Bankruptcy Court reconsidering, and thereby denying, a previously approved $275 million termination fee (the “Termination Fee”) to a potential purchaser (NextEra Energy, Inc. (“NextEra”)) in the chapter 11 bankruptcy cases of Energy Future Holdings Corp. and its affiliated debtors (the “Debtors”). In doing so, the majority of a three-judge panel of the Third Circuit held that the Bankruptcy Court did not abuse its discretion in determining that it fundamentally misunderstood the facts and thus committed a clear or manifest error of law in rendering its initial approval order. In a dissent, however, Judge Marjorie O. Rendell described the Bankruptcy Court’s reconsideration “troubling” and “dangerous.” NextEra has stated its intention to petition a rehearing by the Third Circuit en banc.
The Termination Fee dispute between NextEra and the Debtors arose in connection with a merger agreement entered into between the parties (the “Merger Agreement”) during the Debtors’ bankruptcy proceedings pursuant to which NextEra sought to purchase the Debtors’ economic interest in Oncor Electric Delivery Co. LLC. The deal, with an approximately $18.7 million enterprise value, was subject to the approval of the Bankruptcy Court as well as the Public Utility Commission of Texas (“PUCT”).
The Debtors filed a motion seeking the Bankruptcy Court’s approval of the Merger Agreement and the Termination Fee (the “Approval Motion”). The Termination Fee provision was detailed and gave rise to questions of the Bankruptcy Court as to what circumstances gave rise to payment. The parties conveyed that the Termination Fee would become payable if, among other things, the PUCT did not approve the Merger Agreement and the Debtors entered into another transaction. However, the record was not made clear that the Termination Fee would become payable in that circumstance only if it was the Debtors that terminated the Merger Agreement and, critically, there was no deadline by which regulatory approval of the Merger Agreement had to be obtained. In other words, the Merger Agreement provided for a scenario that, if the PUCT did not approve the Merger Agreement, NextEra was free to pursue indefinitely regulatory approval until the Debtors chose to terminate the agreement and pay NextEra the Termination Fee.
On the record before it, the Bankruptcy Court ultimately approved (the “Approval Order”) the Termination Fee under the governing “actual and necessary” 11 U.S.C. § 503(b)(1)(A) standard of Calpine Corp. v. O’Brien Envtl. Energy, Inc. (In re O’Brien Envtl. Energy, Inc.), 181 F.3d 527 (3d Cir. 1999), holding that the Termination Fee was necessary to induce NextEra to bid and move forward with the Merger Agreement and that it was reasonable in amount given the value of the deal. However, following NextEra’s unwillingness to abandon certain elements of the merger, the PUCT rejected it citing various “fundamental defects” with respect to the transaction. NextEra vigorously appealed the decision and, ultimately, the Debtors terminated the Merger Agreement and entered into a less favorable alternative deal. Accordingly, the Termination Fee arose under the very scenario unappreciated by the Bankruptcy Court. Shortly thereafter, a creditor of the Debtors (but not the Debtors) sought reconsideration of the Approval Order.
In reconsidering the Approval Order, the Bankruptcy Court noted that it “misapprehended the facts as to when the Termination Fee would be payable” due in part to the parties’ incomplete presentations as well as its own failure of comprehension. Op. at **2, 11. What was unclear to the Bankruptcy Court, based on an “incomplete and confusing” record was “the fundamental point” that if the PUCT rejected the transaction and the Debtors (as opposed to NextEra) were forced to terminate the Merger Agreement, the Termination Fee would be triggered. The Bankruptcy Court concluded that its misapprehension of these critical facts led to a legal error as “[p]ayment of a termination or break-up fee when a court (or regulatory body) declines to approve the related transaction cannot provide an actual benefit to a debtor’s estate sufficient to satisfy the O’Brien standard.” Id. at **13-14.
NextEra appealed the Bankruptcy Court’s reconsideration, and, in a split 2-1 decision, the Third Circuit affirmed. With respect to the Bankruptcy Court’s finding that it misapprehended the facts, the Third Circuit explained that it “must accept the Bankruptcy Court’s factual conclusions regarding its own subjective understanding unless they are clearly erroneous.” Id. at 28. Here, based on the record (and lack thereof) giving rise to the Approval Order, the Third Circuit did not see a reason to “second-guess” the Bankruptcy Court’s determination that it “initially failed to recognize the absence of a deadline for PUCT approval . . . .” Id. at *28.
Moreover, the Third Circuit held that the Bankruptcy Court did not abuse its discretion when it held that its factual misunderstanding gave rise to a clear legal error in its application of the O’Brien standard. More specifically, in this particular case, the majority did not find problematic the Bankruptcy Court’s weighing of the various then-understood considerations and its determination that the potential benefits of the Termination Fee by inducing NextEra’s bid were outweighed by the substantial risks of harm that could result therefrom if regulatory approval was not obtained and the Debtors were left with either no deal or an inferior one. The Third Circuit agreed that the Termination Fee could have provided a “large benefit to the estates,” however, it also realized that it carried the risk of being “disastrous.” Id.
Interestingly, Judge Rendell dissented, albeit reluctantly. Acknowledging that the Bankruptcy Court “carefully considered its decision,” Her Honor found that the Bankruptcy Court’s reconsideration “sets a troubling – if not dangerous – precedent.” Id. at 6. Her Honor stated that, while the Bankruptcy Court “fail[ed] to appreciate a particular set of potential consequences,” “hindsight cannot justify nullifying a material term of the deal that was struck with all of the facts on the table.” Id. at 2. According to Judge Rendell, the Bankruptcy Court thoughtfully assessed the Termination Fee and its importance to the NextEra bid, held it appropriate, and then inappropriately conducted a second analysis based on the occurrence of after-the-fact events.
While these proceedings have proven to be interesting, they are unique. And while some might argue that the Third Circuit implicitly approved the Bankruptcy Court’s sweeping opinion that a termination or break-up fee can never provide a benefit to a debtor’s estate sufficient to satisfy the O’Brien standard if it arises when a court or regulatory body declines to approve a transaction, the Third Circuit specifically declined to do so. And as suggested by the dissent, such a rule may not be appropriate given that applicable Third Circuit precedent has examined, among other things, the benefits that bids can provide in progressing a sale process and valuing assets regardless of their later success or lack thereof. Indeed, as suggested by Judge Rendell, the outcome here might have been different if the Debtors entered into a higher and better offer following the denial of the NextEra deal.