Bankruptcy Law Update: Kelson Channelview LLC v. Reliant Energy Channelview LP

January 25, 2010

Publication| Bankruptcy & Corporate Restructuring

In Kelson Channelview LLC v. Reliant Energy Channelview LP (In re Reliant Energy Channelview LP), No. 09-2074 (3d Cir. Jan. 15, 2010), the Third Circuit Court of Appeals reaffirmed (and potentially relaxed) the standard governing break-up fees in bankruptcy. The Reliant opinion is noteworthy not only because it is the Third Circuit’s first published opinion on break-up fees since the seminal decision in Calpine Corp. v. O’Brien Envtl. Energy, Inc. (In re O’Brien Envtl. Energy, Inc.), 181 F.3d 527 (3d Cir. 1999), but also because the Third Circuit may have given bankruptcy courts more leeway to award break-up fees.

O’Brien held that a break-up fee could be approved only under Section 503(b) of the Bankruptcy Code, which requires that the break-up fee be an “actual, necessary cost … of preserving the estate.” To satisfy this exacting standard, the break-up fee must be necessary to provide a benefit to the estate. In the O’Brien Court’s words, “in some cases a potential bidder will bid whether or not break-up fees are offered…. In such cases, the award of a break-up fee cannot be characterized as necessary to preserve the value of the estate.” 181 F.3d at 535. Many practitioners interpreted O’Brien to mean that a bankruptcy court only could approve a break-up fee if approval of the break-up fee was a condition to the bid. But in Reliant, the Third Circuit suggested that there are other circumstances where a bankruptcy court may approve a break-up fee.

In Reliant, two debtors (collectively, “Debtors”) conducted a lengthy sale process for their principal assets. Ultimately two leading bidders emerged, Fortistar, LLC (“Fortistar”) and Kelson Channelview LLC (“Kelson”). Kelson submitted a $468 million bid, and, after Fortistar’s financing faltered, the Debtors entered into an Asset Purchase Agreement (“APA”) with Kelson.

The APA required the Debtors to seek bankruptcy court approval thereof as well as of certain bid protections, including a $15 million break-up fee. Notably, the APA did not require (and was not conditioned on) court approval of the break-up fee; rather, the Debtors simply were required to seek approval of the fee. At the hearing on the break-up fee, Fortistar reemerged, representing that it was willing to top Kelson’s bid and asserting that the $15 million break-up fee could deter its higher bid and served no purpose. Under the circumstances, the Bankruptcy Court denied the break-up fee. Fortistar ultimately topped Kelson’s bid by $32 million. After the sale to Fortistar closed, Kelson appealed the denial of the break-up fee. The District Court affirmed the Bankruptcy Court’s ruling.

The Third Circuit likewise affirmed. In its Opinion, the Third Circuit stated that a break-up fee can satisfy Section 503(b) in one of two ways:  (1) where the break-up fee is necessary to induce the bidder to make its bid, or (2) where the break-up fee is necessary to preserve the bid. Kelson could not meet the first requirement because its bid was not conditioned upon approval of the break-up fee. This fact was dispositive: “[T]here is no escape from the fact that Kelson did make its bid without the assurance of a break-up fee, and this fact destroys Kelson’s argument that the fee was needed to induce it to bid.” Slip op. at 15.

The Third Circuit’s analysis of the second requirement was more nuanced and fact intensive. The record indicated that, although the break-up fee was not necessary to induce Kelson’s bid, the fee could have served a useful purpose by assuring that Kelson adhered to its bid rather than abandoning its attempt to purchase the Debtors’ assets. Thus, it was appropriate for the Bankruptcy Court to balance the potential benefit of preserving Kelson’s bid against the possibility that the break-up fee would deter other purchasers, such as Fortistar. The Third Circuit was very deferential to the Bankruptcy Court’s balancing of these competing interests,  and held that the Bankruptcy Court’s denial of the break-up fee was not an abuse of discretion.

Reliant thus reaffirms O’Brien, but also appears to afford bankruptcy courts greater discretion to award break-up fees. Reliant suggests that even if a break-up fee is not a condition to a bid, a bankruptcy court still may approve a break-up the fee where the possible benefits of the fee outweigh the potential harm it may cause, thus requiring a fact-intensive balancing of competing interests. Only time will tell whether Reliant truly has relaxed the break-up fee standard or merely restated it.

Richards, Layton & Finger acted as Debtors’ counsel in the case.

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