By: Sean Cork, E.D.A. Law.
The National Law Journal published an excellent piece recently titled Blockchain – Not Bitcoin – In Bankruptcy, by Joanne Lee Molinaro at Foley & Lardner LLP. This is a unique and thought-provoking piece that I encourage anyone interested in blockchain technology to read. The article can be found here: https://www.natlawreview.com/article/blockchain-not-bitcoin-bankruptcy
In summary, this article proposes that blockchain technology can help automate several time-consuming chores in chapter 11 bankruptcies by eliminating the need for middlemen performing these tasks, specifically vote tabulation, claims administration, and auctions. Yet after reading and reflecting on this piece for a bit, I found myself agreeing with Meatloaf: two out of three ain’t bad.
The benefits of the blockchain are apparent concerning vote tabulations and claims administration. I do not think, however, that blockchain can or will eliminate the need for estate professionals to review and evaluate competing bids for a debtor’s assets. In fact, assessing such bids is not only one of the most crucial components of any chapter 11 auction, but is one that requires careful discernment by experienced professionals.
A bit of background for the uninitiated. Many chapter 11 bankruptcies involve a 363 auction sale, so called because section 363 of the Bankruptcy Code authorizes a court to court to sell a debtor’s assets free and clear of liens and claims. Technically an auction is not required for a 363 sale, but bankruptcy judges almost always require them to ensure that the debtor is getting the highest and best price for the asset(s) sold. When that asset happens to be an entire business or substantially all of the debtor’s assets, it is common practice for the debtor to negotiate a tentative sale with a “stalking horse bidder” subject to higher and better offers. The stalking horse makes the first, public bid for the asset, typically conditioned on the debtor obtaining approval of certain auction procedures designed to ensure that other bids are comparable to that of the stalking horse, and to compensate the stalking horse for its out-of-pocket expenses if it is not the highest bidder at auction. While bid procedures may differ, they always define a set of conditions that a bid must meet to be considered a “qualified bid” and thus be entitled to bid at the auction.
On its face, this seems like a straightforward process. Determining whether a bid meets a minimum set of defined criteria seems perfectly designed to be handled by an automated process. The reality, however, is usually far different. A brief illustration will highlight this reality.
Imagine a chapter 11 business debtor that has two main operations: a factory that produces widgets, and a storefront where the widgets are sold. Both operations are in separate cities, and each location has 50 full-time employees. The debtor wants to sell its business to a stalking horse that will continue to operate the business and keep the labor force intact. The stalking horse bid for all of the debtor’s assets is $100 in cash. The court approves bidding procedures that require any competing bids to be in writing and to be for a minimum of $101.
The following bids are received by the debtor’s lawyers. Which, if any, are qualified bids? Which is the highest and best bid for the assets?
-Bid A offers to buy all of the assets for $101, of which $25 is cash with the balance paid by a 30-year note secured by a senior lien on all the assets and bearing a below-market rate of interest.
-Bid B offers to buy only the manufacturing business for $90 in cash but is otherwise the same as the stalking horse.
-Bid C offers to buy all of the assets for $102 in cash but provides that all employees will be fired and replaced with robots.
-Bid D offers to buy all of the assets for $50 in cash plus its waiver of over $1,000 in unsecured claims it holds against the debtor’s estate.
-Bid E offers to buy only certain patents and intellectual property owned by the debtor (and integral to running its business) for $75 in cash.
The core issue in evaluating competing bids at a 363 sale is ensuring that the evaluator is comparing apples to apples. Our hypothetical auction is filled with apples, oranges, bananas, and more. Identifying the highest and best bid (let alone qualified bids) in this circumstance cannot be done by merely running a few numbers in an excel sheet. Evaluating which of these bids is the highest and best requires real effort. Moreover, it may be that the bid with the highest dollar value is not the highest and best. Bid C, for instance, will pay the most cash for the assets but will put 100 people out of work. Is the elimination of 100 full-time paying jobs worth an additional two dollars? Couldn’t (indeed, shouldn’t) the debtor decide that $100 plus retention of all employees is a better deal than $102 and elimination of all employees?
This example shows why the blockchain cannot be applied to every aspect of chapter 11 estate administration. The blockchain can be helpful for purely administrative tasks such as calculating votes and determining if documents are timely filed. But it cannot provide a substitute for real discernment, such as comparing apples-to-oranges. Handling this and similar issues will still require the efforts of middlemen for some time to come.