Orchids Paper Products Company – U.S. Trustee for Region 3 Continues Activist Streak, Assails “Market” Bid Protections as Blocking Devices and Excessive

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April 24, 2019 – The U.S. Trustee for Region 3 objected to the Debtors' bidding procedures motion, arguing that the proposed break-up and expense reimbursement fees "are not truly bid protections, but rather blocking devices to make it more costly for other bidders to propose a qualified bid. Approving a Break-Up Fee and Expense Reimbursement of $7,250,000 to be paid by any winning bidder other than the Lenders will chill the bidding process…" [Docket No. 79].

In recent weeks, we have seen the U.S. Trustee for Region 3 object to a number of standard motions relating to retentions, employee plans (ie KEIPs and KERPs) and even what would normally be considered a truly mundane first day motion to appoint and compensate a claims agent. These efforts have been mirrored in Region 6 as well. In each case, the U.S. Trustee has taken issue with motion practice and argument, pushing debtors' counsel to re-examine the drafting and filing of their motions.

In this instance, we see the U.S. Trustee for Region 3 push back on bid protections that have become pretty much market, ie a 3% break-up fee and an expense reimbursement fee capped at $2mn, or roughly 1% of the stalking horse bid. The U.S. Trustee has carefully considered its choice of poster child. Here the bid protections, which as usual are added to any required qualified bid of a competing bidder, total an impressive $7.25mn and are being given to a credit bidding senior lender (prepetition and DIP) who had only just purchased the relevant debt (ie they had only just completed their due diligence on the Debtors and the debt they were acquiring). The U.S. Trustee may have chosen the present Debtors because of the eye-catching output generated by market standard bid protections as applied in this singular context, but the U.S. Trustee's supporting arguments makes it clear that ALL debtors (and counsel) will have to revisit statute before reflexively relying on market practice…if they want to avoid an objection in Region 3.

The U.S. Trustee makes the following arguments:

  • "Break-up fees and expense reimbursements are intended to be incentives for a party to invest time and money to do the due diligence…" Where due diligence (as here) has been largely done…that should be reflected in any proposed  fees.
  • Break-Up and expense reimbursement must be “actually necessary to preserve the value of the estate.” Here, where the stalking horse needed no incentive, that was not the case…without an incentive, a stalking horse fails the "necessary to preserve value" test.
  • Keep an eye on other expense reimbursement commitments. Here the debtor-in-possession ("DIP") financing arrangements provide for lender fees to be covered anyway. In such circumstances, does the expense reimbursement fee have any other purpose other than to chill bids?
  • Whatever the expense reimbursement fee (the U.S. Trustee argues it should be no more than $500k…if anything at all), any incurred fees need to be documented and the U.S. Trustee argues that this requirement should be memorialized.
  • Break-Up Fee and expense reimbursement fees are not entitled to super-priority administrative claims: "Even if the Court were to approve some portion of the Break-Up Fee or Expense Reimbursement, there would be no basis under the Bankruptcy Code to have claims for such amounts treated as super-priority administrative claims."

The objection states, “By way of the stalking horse, the Lenders have made a credit bid of $175 million of the more than $187 million the Debtors stipulate was owed to the Lenders as of the petition date. The Lenders will also be credit bidding the amount of the outstanding DIP financing. The U.S. Trustee objects to those portions of the Motion that seek to pay the Lenders, if outbid at auction, (a) a Break-Up Fee of $5,250,000 (which is 3% of the credit bid), plus (b) an Expense Reimbursement with a cap of $2 million. When added together with an initial overbid of $500,000, all other interested bidders will have to bid $7,750,000 over the amount of the Lenders’ credit bid in order for their bid to be considered. Break-up fees and expense reimbursements are intended to be incentives for a party to invest time and money to do the due diligence necessary to make a stalking horse bid, knowing it might be outbid at the auction and therefore out-of-pocket for its expenses. The Lenders, who purchased the Debtors’ debt only three months before the Debtors filed for bankruptcy, did not need to undertake any additional due diligence to make a bid, did not need an incentive to make a bid, and will not need to be compensated if they are not the winning bidder at the auction. This is because, regardless of the outcome of the auction, the Lenders will benefit.

Even if the Lenders were not getting their expenses reimbursed through the DIP Financing Order, an expense reimbursement of $2million is excessive. Any such fees should be capped at no more than $500,000, and the Lenders should be required to provide support for all such expenses to the Debtors, the Committee, and the U.S. Trustee, who should have the same review and objection rights set out in the Interim DIP Financing Order for reimbursement of Lender expenses.”

The Court scheduled a hearing for May 1, 2019 to consider the objection.

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