OPINION AND ORDER
Appellant, a committee of subordinated bondholders, appeals from an order and memorandum decision of the United States Bankruptcy Court for the Southern District of New York (Blackshear, J.), approving a break-up fee arrangement among appel-lees, the debtor and a prospective purchaser. For the reasons set forth below, the challenged order is affirmed.
I.
Appellees are Integrated Resources, Inc. (“Integrated”) and Bankers Trust New York Corporation (“BT”). On February 13, 1990, Integrated filed a voluntary petition for relief under chapter 11 of Title 11 of the United States Code, 11 U.S.C. §§ 101,
et seq.
(the “Bankruptcy Code”).
See In re Integrated Resources,
On November 8, 1991, Integrated, the Senior Committees, and BT entered into a letter agreement (the “BT Proposal”), whereby BT offered to fund a plan to reorganize Integrated with $565 million in cash, conditioned upon the bankruptcy court’s approval by November 25, 1991. The BT Proposal provided for an expense reimbursement and break-up fee arrangement (the “Break-up Fee”) in favor of BT. A break-up fee, or more appropriately a termination fee, is an incentive payment to a prospective purchaser with which a company fails to consummate a transaction.
Integrated sought approval of the BT Proposal and Break-up Fee on November 12, 1991. At a conference the next day, the bankruptcy court rejected the claim by the Sub-Debt Committee, not a party to the BT Proposal, that it needed discovery on the broad issue of which, if any, third-party offer was the highest or best. The -court refused to reschedule the hearing and limited discovery to the narrow question to be heard on November 25, 1991: whether it should approve the BT Proposal.
Between November 13, 1991 and November 24, 1991, the Sub-Debt Committee conducted document discovery and took the depositions of representatives of Integrated, BT, and the two Senior Committees. On November 25, 1991, Judge Blackshear, after a lengthy hearing, approved the Break-up Fee, as modified. He rejected the Sub-Debt Committee’s argument that the process which led to the BT Proposal was tainted by the self-dealing of Integrated’s management.
In re Integrated Resources,
II.
Integrated is primarily a holding company that owns numerous operating entities whose prepetition business included operating life insurance companies; organizing, managing, and selling direct participation investment programs; providing investment counseling and money management services for private accounts and mutual funds sponsored by Integrated; equipment leasing; operating media properties; and managing certain contractual rights and obligations. Since filing its petition, Integrated has continued to manage, as debtor-in-possession pursuant to §§ 1107 and 1108 of the Bankruptcy Code, its partnership-related businesses, equipment leasing busi
Initially, Integrated tried to develop an internally funded plan of reorganization. However, Integrated and the Senior Committees disagreed about Integrated’s ability to confirm and consummate such a plan. As a result, since June 1991, Integrated has pursued third-party funding in an effort to resolve key issues dividing itself and the Senior Committees, and has contacted numerous parties in an effort to locate a buyer. Integrated entered into confidentiality agreements with those entities that showed serious interest, in order to permit those entities to conduct the detailed investigations necessary to informed decisions about acquisition — often referred to as “due diligence” — while at the same time safeguarding Integrated’s confidential information.
In January 1991, BT prompted Integrated to establish a data room and began to examine Integrated in earnest. On or about January 23, 1991, Integrated entered into a confidentiality agreement with BT. Importantly, it was the Senior Committees, sophisticated investors with approximately $1.5 billion in claims, not Integrated management, who led the negotiations with BT. BT and the other prospective bidders have used the data room since early 1991. (We-inroth Dep. at 66, 208)
Because BT expressed serious interest in funding a plan, Integrated filed a motion for authorization to enter into an agreement to reimburse BT’s expenses. However, the Creditors’ Committees strenuously objected and Integrated withdrew the motion. Nonetheless, BT continued its investigation without such reimbursement.
In re Integrated Resources,
Integrated successfully used BT’s bid both as a bid comparison to spur existing bidders and as a magnet to attract additional bidders. By summer 1991, Integrated had contacted approximately 30 potential bidders. (11/25/91 Hr’g Tr. at 50) The Hailwood Group Incorporatеd (“Hall-wood”), which previously had considered purchasing certain limited assets from Integrated, began investigating a bid for Integrated’s entire business in April 1991, but when BT temporarily withdrew in August 1991, “the Hailwood offer was substantially lower.” (11/25/91 Hr’g Tr. at 66) Integrated Chairman Stephen Wein-roth showed documents to Hailwood that compared the values in the BT Proposal and in Hailwood’s bid. (Weinroth Dep. at 193) Following the BT Proposal, another group, Penguin Realty Associates Limited Partnership (“Penguin”), which had expressed interest in funding a plan and had investigated Integrated’s assets, raised its tentative offer.
In re Integrated Resources,
However, none of the prospective buyers has been willing to sign a binding agreement, because a plan to reorganize Integrated would entail a commitment of hundreds of millions of dollars and considerable risk. The bid preparation required extensive investigation. Integrated’s assets were, and still are, complicated and not easily valued. These assets include so-called deferred origination contract rights, which represent future rights to payment in connection with real estate limited partnerships Integrated sponsored throughout the country. (11/25/92 Hr’g Tr. at 154-57)
Not surprisingly, BT and the other bidders incurred substantial out-of-pocket expenses and opportunity costs in trying to understand and evaluate Integrated’s finances. To sustain the bidders’ interest and ensure the maximum value of their estate, Integrated and the Senior Committees considered proposals for break-up fees and expense reimbursement from
all
the bidders, not only from BT. An earlier proposal by Hailwood had provided for a $4
The Break-up Fee which appellants challenge is a component of the BT Proposal and a condition precedent to funding a plan of reorganization. The Break-up Fee would be payable to BT if (1) Integrated sells to anyone other than BT any material assets proposed to be acquired by BT or enters into a transaction that otherwise is materially inconsistent with the BT Proposal (an "Alternative Transaction”); (2) a plan of reorganization based on the BT proposal or a subsequent definitive agreement with BT (a “Definitive Agreement”) is abandoned; or (3) the creditors of Integrated receive a material divided or distribution respecting their claims. By contrast, the Break-up Fee would not be payable if BT abandons its proposal because of a material adverse change, is unable to obtain any necessary regulatory approvals, or materially breaches the BT Proposal or a Definitive Agreement.
The Break-up Fee originally provided for the following amounts to be paid to BT: (1) $500,000 if the BT Proposal is abandoned because Integrated and the Senior Committees find unacceptable the list of Integrated subsidiaries that BT requires to file bankruptcy petitions (a condition of the plan funding proposal); (2) $2 million if Integrated and the Senior Committees elect to terminate (“Termination Election”) negotiations with BT by February 15, 1992, and do not agree to pursue an Alternative Transaction with another party; (3) $4 million if, by February 15, 1992, Integrated has not made a Termination Election, and has neither agreed to an Alternative Transaction nor executed a Definitive Agreеment with BT; and (4) $9 million if Integrated fails to consummate the transaction after the Definitive Agreement has been executed.
In re Integrated Resources,
The BT Proposal also included a “window shop” clause. A window shop clause is a promise not to solicit a later, better offer, but which permits a board to look at such an offer, provide information to the offeror, and, under appropriate circumstances, accept the offer. Dennis J. Block, Nancy E. Barton and Stephen A. Radin, The Business Judgment Rule 226 (3d ed. 1991). The BT Proposal provided that upon execution of a Definitive Agreement, Integrated and the Senior Committees agreed not to solicit or initiate the submission of offers to pursue an Alternative Transaction. However, Integrated and the Senior Committees would retain the right to discuss or negotiate a plan with any parties who initiate, or with whom they are currently having, negotiations. The parties could then proceed with an Alternative Transaction after a Definitive Agreement, without being obligated to pay a break-up fee, only if the consideration paid to Integrated pursuant to any Alternative Transaction exceeds the cash portion of the BT funding proposal by no less than $20 million. Integrated and BT agreed аt the November 25, 1991 hearing to lower this amount to $15 million. 1
III.
The bankruptcy court’s fact determinations are binding unless clearly erroneous, and its conclusions of law are reviewable
de novo. In re Ionosphere Clubs, Inc.,
In this case, the bankruptcy court ruled that the business judgment rule applied to Integrated’s approval of the BT Proposal. The court recognized that “the business judgment of the Debtor is the standard applied under the law in this district.”
In re Integrated Resources,
The business judgment rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”
Smith v. Van Gorkom,
Courts are loath to interfere with corporate decisions absent a showing of bad faith, self-interest, or gross negligence.
Van Gorkom,
However, few courts have addressed the validity of break-up fees in bankruptcy.
See, e.g., In re Integrated Resources,
These decisions suggest three questions for courts to consider in assessing break-up fees: (1) is the relationship of the parties who negotiated the break-up fee tainted by self-dealing or manipulation; (2) does the fee hamper, rather than encourage, bidding; (3) is the amount of the fee unreasonable relative to the proposed purchase price? The bankruptcy court answered “no” to each of these questions. For thе reasons set forth below, those answers are affirmed.
A.
The first question is whether the relationship between BT and Integrated’s management was tainted by self-dealing and manipulation. A court will uphold a decision by the board of directors if the decision was safeguarded by the scrutiny of disinterested directors or by other such means.
See In re 995 Fifth Ave. Assoc.,
Most important, the Senior Committees closely scrutinized the decisions of Integrated’s board of directors. The Senior Committees acted as principal negotiators on the BT Proposal. Integrated’s decision to pursue third-party funding was based on resolving disputes with the Senior Committees; the BT Proposal reflects a consensus resolution of those disputes. A break-up fee has been upheld where, as here, the creditors’ committee closely scrutinized the fеe, the fee was not unreasonable in relation to the size of the sale, and the work and expense involved in negotiating the transaction were significant. Id.
In his decision below, Judge Blackshear explained that he had hesitated to approve the fee solely because of its initial amount, not because of the Sub-Debt Committee’s allegations of a “sweetheart deal” between Integrated’s management and BT.
In re Integrated Resources,
The business judgment rule is available whеn a majority of a corporation’s independent and disinterested outside directors have approved a transaction.
See, e.g., Tomczak v. Morton Thiokol, Inc.,
[1990 Transfer Binder] Fed.Sec.L.Rep. (CCH) 95,327,
Generally, a court will assess itself the merits or fairness of business decisions only “when a transaction is one involving a predominantly interested board with financial interests in the transaction adverse to the corporation.”
AC Acquisitions Corp. v. Anderson, Clayton & Co.,
The court below found that thе discussions between Integrated and BT were not tainted by self-dealing so as to remove the protection of the business judgment rule.
In re Integrated Resources,
Appellant further asserts that the Break-up Fee is inappropriate because the directors and management of Integrated breached certain fiduciary duties. The board did not breach its duty of care. The standard under which a director’s duty of care is to be scrutinized is “gross negligence.”
Aronson v. Lewis,
When it becomes clear that a company is for sale and a takeover becomes inevitable, the board of directors is under a further duty, when conducting an auction, to deal fairly with the bidders.
Revlon,
In the non-bankruptcy takeover cases, management’s fiduciary duties run primarily to the corporation’s shareholders.
See Revlon Inc. v. MacAndrews & Forbes Holdings Inc.,
For example, the bankruptcy court in
Crowthers
upheld a break-up fee and window shop provision that prevented the company from soliciting offers, because any outside party could obtain access to the debtor’s books and records.
In re Crowthers McCall Pattern, Inc.,
This reasoning applies equаlly well to the BT Proposal, which also included both a break-up fee and a window shop provision. Bidders other than BT, including Penguin and Hailwood, have been, and will continue to be, able to investigate Integrated’s assets. Admittedly, the BT Proposal may have deterred some bidding, but such deterrence must be weighed against the value of securing BT’s commitment to a plan of reorganization for Integrated. The bankruptcy court found that Integrated properly balanced these conflicting concerns.
Appellant wrongly equates general principles of bankruptcy law with the fiduciary rules that apply in corporate control eases outside bankruptcy. “It is a well-established principle of bankruptcy law that the objective of bankruptcy rules and the [Debtor’s] duty with respect to such sales is to obtain the highest price or greatest overall benefit possible for the estаte.”
In re Atlanta Packaging Products, Inc.,
The BT Proposal did not generate heightened fiduciary obligations, because it did not constitute an auction. The enhanced fiduciary duties invoked by appellant relate only to the proper conduct of an auction. In an auction, the officers and directors of Integrated would have a duty, analogous to the duty in Revlon, to attract the highest price for the estate. However, an auction of Integrated has not yet begun, and there is no evidence in the record to show that Integrated will not be able to achieve the highest price when, and if, an auction begins.
The officers and directors satisfied even a heightened fiduciary duty, because they discussed with all of the bidders, including Hailwood and Pénguin, aspects of other bids “in order to move the bidding process to higher levels.” (11/25/91 Hr’g Tr. at 55) Similarly, they provided to Penguin information which they did not provide to BT. The Bankruptcy Court was unimpressed by and rejected the Sub-Debt Committee’s arguments that Integrated limited the access of other bidders to information. The record does not disclose evidence of any self-dealing. Therefore, the Break-up Fee likely would survive even a test of heightened scrutiny.
B.
The second question is whether the Break-up Fee hampered, rather than encouraged, bidding. By design, “[a] ‘breakup fee’ is an incentive payment to an unsuccessful bidder who placed the estate property in a sales configuration mode ... to attract other bidders to the auction.”
In re Financial News Network,
Outside bankrhptcy, the business judgment rule normally applies to the board’s use of a defensive strategy, such as a break-up fee.
See, e.g., Revlon, Inc.
v..
MacAndrews & Forbes Holdings,
Appellant asserts that the “enhanced duty” standard should apply to the BT Proposal. However, the “enhanced duty” analysis has been limited to cases involving hostile tender offers.
See
The Business Judgment Rule at 117-177. In contrast, the bankruptcy courts generally presume that the board's decision to agree to a break-up fee was a valid exercise of its business judgment.
In re Integrated Resources,
Further, the business judgment rule does not become inapplicable simply because a court decides a break-up fee is too largе. One bankruptcy court has asserted that “if such a fee is too large ... the fee is not protected by the business judgment rule ... and is thus subject to court review.”
In re 995 Fifth Ave. Assoc.,
In assessing the incentive effect of the Break-up Fee, a court should determine whether the dollar amount of the fee is so substantial that it has a “chilling effect” on other prospective bidders.
See CRTF Corp. v. Federated Dep’t Stores, Inc.,
The bankruptcy court found that the Break-up Fee would “enhance rather than detract from the bidding process.”
In re Integrated Resources,
A break-up fee may also ensure that a bidder does not retract its bid.
See Samjens Partners,
Pursuant to the BT Proposal, if BT fails to proceed in good faith or unreasonably abandons its proposal, it will not receive a fee. If, on the other hand, the fee ultimately becomes payable because a higher bidder than BT prevails, then in all probability BT will have attracted that bidder and thus earned its fee. The fee structure is graduated so that any amounts paid will be significantly lower absent a binding agreement between BT and Integrated. In these ways, the BT Proposal properly balances the Sub-debt Committee’s concern that the fee is excessive against .Integrated’s concern that BT might withdraw from bidding.
In attempting to define the proper boundaries of a break-up fee and to describe the function of its recipient, the parties have exploited the pastoral metaphor of the “stalking horse.” According to Webster’s, a “stalking horse” is “a horse or figure like a horse behind which a hunter stalks game [or] something used to cover up a secret project, mask, pretense.” Webster’s Third New International Dictionary, Unabridged 2221 (1986). Appellant argues that the Break-up Fee was improper because BT was not a "stalking horse.”
See
Appellant’s Br. at 32. Appellees argue the opposite.
See
Appellee Integrated’s Br. at 36, Appellee BT’s Br. at 9. Even the bankruptcy court noted that break-up fees “may encourage the making of what is colloquially referred to as a ‘stalking horse’ offer.”
In re Integrated Resources,
The term “stalking horse” is not merely colloquial; it is also both underin-clusive and misleading as a purported justification for a break-up fee. Presumably, a “stalking horse” bidder would submit an early phony bid to absorb the initial costs and consequences of bidding, while acting in behalf of another party. BT did not play such a role. Therefore, when the parties question whether BT served as a “stalking horse,” they ask the wrong question.
2
The
C.
The third question is whether the amount of the Break-up Fee was unreasonable relative to the proposed purchase price. Appellant claims that the fee was unreasonably high, given BT’s limited risk. Appellant’s Br. at 35-38. A break-up fee should constitute a fair and reasonable percentage of the proposed purchase price, and should be reasonably related to the risk, effort, and expenses of the prospective purchaser. “When reasonable in relation to the bidder’s efforts and to the magnitude of the transaction, break-up fees are generally permissible.”
In re 995 Fifth Ave. Assoc.,
During the November 25, 1991 hearing, Judge Blackshear expressed concern about the size of the Break-up Fee. He suggested that the parties reduce the fee to the scale of break-up fees which courts had authorized in the past. BT, Integrated, ánd the Senior Committees followed his advice. They met during a short recess and agreed to reduce the fee by approximately one-third.
In re Integrated Resources,
In its final form, the Break-up Fee ranged from $6 million to zero. At its maximum, the fee was only 1.6 percent of the proposed purchase price of $565 million, or 3.2 percent of BT’s “out-of-pocket” expenses (excluding Integrated’s expected cash on hand). See id. at 752. Appellant’s own expert testified that the average break-up fee in the industry is 3.3 percent, nearly the same percentage as the fee in the modified BT Proposal. (11/25/91 Hr’g Tr. at 202) These calculations result from exceedingly complex determinations of fact, and the bankruptcy court found that the percentage fee was in accord with industry averages.
Furthermore, the Break-up Fee is reasonable in relation to the risk and expenses BT assumed. A court should consider the prospective buyer’s investment of both time and money when determining whether a break-up fee is reasonable. In general, a break-up fee is permissible if reasonably related to the bidder’s efforts
Appellant argues that the Break-up Fee is premature and unreasonable because BT had not entered into a binding agreement to purchase Integrated at the time of the BT Proposal. As a result, BT could receive the Break-up Fee as a windfall, and thereby waste Integrated’s assets. Appellant claims that, as a rule, the courts award break-up fees only to bidders who have signed binding agreements.
Although the cases do not directly support break-up fees in the absence of a binding agreement, neither do they ban such an arrangement. Furthermore, there is some judicial support for break-up fees even when a prospective purchaser has signed only a letter of intent, not a binding agreement. In another case, Judge Black-shear, the bankruptcy judge below, approved payment of a $250,000 break-up fee which was provided for in letter of intent to purchase certain assets of the debtor subject to execution of a binding agreement.
In re Rosemar Silver Co., Inc.,
No. 89-B-12171 (Bankr.S.D.N.Y. Apr. 25, 1990). A Colorado bankruptcy court recently approved an agreement which provided that a company would pay $100,000 to a prospective bidder if the company sold certain assets to a higher bidder, even though the bidder had signed only a letter of intent, not a binding agreement.
In re Twenver, Inc.,
No. 90-11846 (Bankr.D.Colo. Apr. 15, 1991). In contrast, an Ohio court denied a debtor’s motion to enter into a letter of intent to sell assets, including a break-up fee agreement, stressing that the brеak-up fee was to be paid “independent of any transactional costs to be incurred" by the prospective purchaser.
In re Hupp Industries, Inc.,
No court other than a federal bankruptcy court has ruled on this issue. That few bankruptcy courts have upheld break-up fees without a binding acquisition agreement reflects only that this particular type of fee is rare. Furthermore, a rule that a break-up fee may not be awarded unless the debtor and the prospective purchaser have signed a binding agreement is toothless. A prospective bidder could easily circumvent such a rule with the following strategy: sign a “definitive agreement” to acquire Integrated for a peppercorn, an option voidable at Integrated’s discretion, and include a provision for a break-up fee in case the bidder is outbid. To avoid such perverse incentives, the better approach, and the one followed below, is to weigh the reasonableness of the break-up fee, considering the bidder’s expenditures and the transaction’s complexity.
Viewed as a whole, the BT Proposal contains many of the principal terms of a binding agreement. It was the culmination of almost a full year of inquiry, investigation, and negotiation. Integrated’s assets and the structure of the transaction were both highly complex. Of course, a court may decline to approve a break-up fee if that fee seems to be part of a plan to thwart the efforts of an unwanted suitor for reasons unrelated to the maximization of shareholder profit.
See, e.g., Revlon v. MacAndrews & Forbes Holdings,
IV.
Appellant argues that the bankruptcy court abused its discretion by denying both the Sub-Debt Committee’s November 13, 1991 request for an adjournment and the
The standard of review of a bankruptcy court determination concerning the scope of discovery and admission of deposition transcripts at a hearing is whether the bankruptcy court abused its discretion.
See In re Int’l Distrib. Centers, Inc.,
The issue for the November 25, 1991 hearing was narrow: should the bankruptcy court approve the Break-up Agreement? In addition, the Sub-Debt Committee had ample opportunity during the previous months to conduct discovery regarding the plan negotiations generally. Therefore, the bankruptcy court was entitled to limit discovery.
Because discovery was ample, the bankruptcy court did not violate а substantial right or cause any fundamental unfairness. During the week before the hearing, the Sub-Debt Committee deposed four witnesses for the equivalent of a day each, and thousands of pages of documents were produced. In fact, the Sub-Debt Committee presented a fully developed case at the November 25, 1991 hearing, which encompassed many hours of testimony and documentary evidence, and generated over 260 pages of transcript.
In re Integrated Resources,
Appellants also claim that the bankruptcy court abused its discretion in not admitting into evidence the full deposition transcripts of the principals of Integrated and BT. The bankruptcy court admitted only those portions of the transcripts specifically published at the hearing. “The use of a deposition at trial is a matter of discretion for the trial court and will not be overturned except for an abuse of that discretion.”
In re Union Bank of The Middle East, Ltd.,
The transcripts at issue are each over 200 pages long. Counsel did not articulate any reason why the portions of these transcripts that were not used at the hearing were anything but cumulative. The bankruptcy court did not prevent the Sub-Debt Committee from publishing any specific portion of the testimony that was relevant to its case. Accordingly, the bankruptcy court justifiably exercised its discretion to limit discovery and to exclude cumulative evidence.
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For the reasons stated above, the bankruptcy court’s order is affirmed.
SO ORDERED.
Notes
. Like "break-up fee," the term “window shop” is misleading. To "window shop” is "to look at the displays in store windows without going inside the stores to make purchases.” Webster’s Third New International Dictionary, Unabridged 2620 (1986). The BT Proposal does not confine Integrated to "window shopping." By сontrast, a "window shopper” bound by the type of provisions in the BT Proposal could enter and make purchases at those stores where he had previously shopped and at those stores which invited him inside, but only if he spent a minimum amount; however, he could not enter any store for the first time uninvited.
. The Supreme Court has warned that "[cjatch words and labels ... are subject to the dangers that lurk in metaphors and symbols, and must be watched with circumspection lest they put us off guard.”
United States v. Ron Pair Enterprises, Inc.,
Bankruptcy cases teem with other mixed and maltreated metaphors.
See, e.g., United States v. Nelson,
Food-related metaphors are common.
See, e.g., In re Central Ice Cream Co.,
Zoological metaphors abound.
See, e.g., In re Financial News Network,
The reference to Orwell is particularly jarring because that author, a master of the language, warned against the use of stale metaphors as a substitute for clearly expressed thought. IV The Collected Essays, Journalism and Letters of George Orwell 127-40, esp. 130 (Sonia Orwell and Ian Angus, eds. 1968).