This month I want to talk about the business judgment rule. There are several possible standards for judging a trustee’s—or debtor in possession’s—proposed actions outside the ordinary course of business. Under the former Bankruptcy Act, courts applied a best interest of creditors test. Generally under the Bankruptcy Code (the “Code”) 111 U.S.C. §§101 et seq. the test is whether a proposed act dealing with estate property is consistent with the estate representative’s good business judgment.
One general exception to the business judgment rule in dealing with property outside the ordinary course of business is the test for approving a settlement. The Supreme Court in Anderson, dealing with a settlement that was part of a plan under former Chapter X of the Bankruptcy Act, held that the settlement, like the rest of the plan, had to be fair and equitable. 2Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson (In re TMT Trailer Ferry, Inc.), 390 U.S. 414, U.S.. The Court went on to establish the following test for the settlement:
- There can be no informed and independent judgment as to whether a proposed compromise is fair and equitable until the bankruptcy judge has apprised himself of all facts necessary for an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated. Further, the judge should form an educated estimate of the complexity, expense, and likely duration of such litigation, the possible difficulties of collecting on any judgment which might be obtained, and all other factors relevant to a full and fair assessment of the wisdom of the proposed compromise. Basic to this process in every instance, of course, is the need to compare the terms of the compromise with the likely rewards of litigation. 3Anderson, 390 U.S. at 424-25.
Since then courts have adopted and embellished upon that test for settlements proposed pursuant to Federal Rule of Bankruptcy Procedure 9019. See, e.g., Citibank, N.A. v. Baer, 651 F.2d 1341, 10th Cir. (applying “fair and equitable” test); Drexel Burnham Lambert, Inc. v. Flight Transp. Corp. (In re Flight Transp. Corp. Secs. Litig.), 730 F.2d 1128, 8th Cir. (noting that factors for approving bankruptcy settlements are the same as factors for approving settlements under Fed. R. Civ. P. 23(e)); United States v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293, 5th Cir. (applying Anderson “fair and equitable” standard). 4See also Martin v. Kane (In re A & C Props.), 784 F.2d 1377, 9th Cir. (citing Baer and Flight Transp.); LaSalle Nat’l Bank v. Holland (In re Am. Reserve Corp.), 841 F.2d 159, 7th Cir. (collecting cases); Reynolds v. Comm’r of Internal Rev., 861 F.2d 469, 6th Cir. (applying Anderson, A & C, and Am. Reserve); Motorola, Inc. v. Official Comm. of Unsec. Creds. (In re Iridium Operating LLC), 478 F.3d 452, 2d Cir. (applying Anderson and discussing shortcomings of AWECO approach); In re Brutsche, 2013 BL 284988, 500 B.R. 62, Bankr. D.N.M. (collecting cases); In re Caubble, 2014 BL 72327, 505 B.R. 857, Bankr. E.D. Ark. (same).For courts approving settlements under “fair and equitable” standard, see Boyer v. Trs. Of Ind. Univ. and Ind. Higher Ed. Telecomm. Sys. (In re Fort Wayne Telsat, Inc.), 489 B.R. 773, Bankr. N.D. Ind. (providing lengthy analysis of cases and application to facts); In re Residential Capital, LLC, 2013 BL 244457, 497 B.R. 720, Bankr. S.D.N.Y. (applying Iridium factors); In re Yellowstone Mountain Club, LLC, 2011 BL 252002, 460 B.R. 254, Bankr. D. Mont. (applying A & C factors); Cini v. Viscomi & Gersh, PLLP (In re Cini), 2013 BL 119674, 492 B.R. 291, Bankr. D. Mont. (same); In re Pac. Gas & Elec. Co., 304 B.R. 395, N.D. Cal. (same); Cory v. Leasure, 491 B.R. 476, Bankr. W.D. Ky. (applying Anderson); and In re Lehman Bros. Hldgs. Inc., 2010 BL 199267, 435 B.R. 122, Bankr. S.D.N.Y. (applying Anderson factors). For courts denying settlements under “fair and equitable” standard, see In re Nutri. Sourcing Corp., 398 B.R. 816, Bankr. D. Del. (applying Anderson); In re Lake City R.V., Inc., 226 B.R. 241, Bankr. D. Idaho (applying Anderson as quoted in A & C); In re Marples, 266 B.R. 202, Bankr. D. Idaho (citing Lake City); In re Smith, 349 B.R. 28, Bankr. D. Idaho (citing Marples); and In re West Pointe Props., L.P., 249 B.R. 273, Bankr. E.D. Tenn. (citing Reynolds).
Nevertheless, most actions by the trustee or debtor in possession under Sections 363(b)(1) or 365 of the Code will be tested under the good business judgment rule. See, e.g., Bloomberg Law: Bankruptcy Treatise, pt. I: General Provisions and Case Administration, ch. 48, § 365 (D. Michael Lynn et al. eds., 2015) (noting that the business judgment standard is the proper standard to be applied to trustees’ decisions to assume or reject under § 365). 5For cases applying the business judgment rule to Section 363(b), see, e.g., In re Borders Group, Inc., 2011 BL 111666, 453 B.R. 459, Bankr. S.D.N.Y. (“In approving a transaction conducted pursuant to section 363(b)(1), courts consider whether the debtor exercised sound business judgment.”); In re Diplomat Constr., Inc., 481 B.R. 215, Bankr. N.D. Ga. (“The business judgment test is the prevailing rubric to evaluate the proposed transaction under § 363(b)(1), although it has been articulated in a variety of ways.”); Fulton State Bank v. Schipper (In re Schipper), 933 F.2d 513, 7th Cir. (“Under section 363, the debtor in possession can sell property of the estate outside the ordinary course of business if: he has an articulated business justification…”) (citations omitted); In re ASARCO LLC, 2010 BL 313502, 441 B.R. 813, Bankr. S.D. Tex. (“Approval of § 363(b) transactions requires that the bankruptcy court find that the debtor ‘justify[ ] the proposed transaction. … there must be some articulated business justification for using, selling, or leasing the property outside the ordinary course of business.’”) (quoting Inst. Creds. of Cont’l Air Lines, Inc. v. Cont’l Air Lines, Inc. (In re Cont’l Air Lines), 780 F.2d 1223, 5th Cir., which itself cited In re Lionel Corp., 722 F.2d 1063, 2d Cir.).For cases applying the business judgment rule to Section 365, see, e.g., N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, U.S. (noting “the traditional ‘business judgment’ standard applied by the courts to authorize rejection of the ordinary executory contract.”); In re Old Carco LLC, 2009 BL 193010, 406 B.R. 180, Bankr. S.D.N.Y. (“The business judgment standard is employed by courts in determining whether to permit a debtor to assume or reject a contract.”); Lubrizol Enterps., Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers, Inc.), 756 F.2d 1043, 4th Cir. (“Courts addressing [whether contract rejection would be advantageous] must start with the proposition that the bankrupt’s decision upon it is to be accorded the deference mandated by the sound business judgment rule.”); In re MF Global Holdings Ltd., 2012 BL 61029, 466 B.R. 239, Bankr. S.D.N.Y. (“Courts routinely approve motions [under section 365] upon a showing that the debtor’s decision to take such action will benefit the debtor’s estate and is an exercise of sound business judgment.”); Moran v. City of Central Falls, 2012 BL 110070, 475 B.R. 323, D.R.I. (“The decision of a receiver to reject an executory contract is reviewed under the business-judgment rule, which consists of a determination of what is ‘in the best interest of the estate.’”) (citations omitted). There is, however, another potential exception at least under Section 365 when public policy is involved. 6See In re Pilgrim’s Pride Corp., 2009 BL 86252, 403 B.R. 413, Bankr. N.D. Tex. (citing Bildisco, 465 U.S. 513, and Mirant Corp. v. Potomac Elec. Power Co. (In re Mirant Corp.), 378 F.3d 511, 5th Cir.). See also Old Carco, 406 B.R. at 189-91 and Cal. Dept. of Water Res. v. Calpine Corp. (In re Calpine Corp.), 337 B.R. 27, S.D.N.Y.. The test when the court has a concern for public policy will be whether rejection (or perhaps assumption) of a contract 7Notably public interest-policy is recognized in railroad reorganizations in the statute. See Code §§1165 & 1169. will be:
- burden[some to] the bankrupt estates, [and whether], after careful scrutiny and giving significant weight to comments and findings of the [governmental entity] relative to the effect such a rejection would have on the public interest inherent in the [delivery of goods or services] in interstate commerce, the equities balance in favor of rejecting the [contract], and that rejection of the [contract] would further the Chapter 11 goal of permitting the successful rehabilitation of Debtors. 8Pilgrim’s Pride, 403 B.R. at 423 n. 23 (quoting Mirant, 318 B.R. at 108). For further discussion, see Bloomberg Law: Bankruptcy Treatise, pt. I: General Provisions and Case Administration, ch. 48, at § 365 (noting that in cases where the debtor operates in highly regulated industry or the contract at issue is subject to regulatory constraints, a higher standard that takes into account public policy may be applied).
This exception is narrow but would be applicable to other acts by the trustee or debtor in possession. For example, in Midlantic, the Supreme Court held hazardous waste could not be abandoned by a trustee. 9Midlantic Nat’l Bank v. N.J. Dept. of Envtl. Prot., 474 U.S. 494, U.S.. Similarly, it is questionable that a sale of property that would seriously frustrate the public interest—say a sale of the only local health clinic to a bar owner—would be approved absent a greater showing than the business judgment rule requires.
The business judgment rule as generally applied grants substantial deference to the trustee or debtor in possession. One court has said that unless the estate representative is acting in “bad faith, or [upon] whim or caprice” the decision should be approved. 10Wheeling-Pittsburgh Steel Corp. v. West Penn Power Co., 72 B.R. 845, Bankr. W.D. Pa.. This is not to say that the court is just a rubber-stamp for the trustee or debtor in possession. In Orion
11Orion Pictures Corp. v. Showtime Networks, Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, 2d Cir.). the Court of Appeals for the Fifth Circuit said “[i]n reviewing a trustee’s or debtor-in-possession’s decision to assume an executory contract … a bankruptcy court sits as an overseer of the wisdom with which the bankruptcy estate is being managed by the trustee or debtor-in-possession. . . .” 12Id. at 1099
Interpreting Minges, 13Control Data Corp. v. Zelman (In re Minges), 602 F.2d 38, 2d Cir.. the Court of Appeals for the Second Circuit suggested the bankruptcy court was to put itself in the trustee’s place and, accepting his or her assumptions and projections, test that decision-maker’s exercise of business judgment. 14Orion, 4 F.3d at 1099. The Court of Appeals for the Fifth Circuit in Richmond Leasing opined that the bankruptcy court should consider “the risks of the proposed transaction, the available alternatives, and the danger of prejudice” to any party objecting. 15Richmond Leasing Co. v. Capital Bank, N.A. (In re Richmond Leasing Co.), 762 F.2d 1303, 5th Cir..
In Pilgrim’s Pride I held that the choice to reject a contract had to be justified in a rational fashion. 16Pilgrim’s Pride, 403 B.R. at 427. That is, the estate representative could not use a method for choosing to reject that did not effect a logical solution. 17Id. For example, at least in most cases, the decision had to be made based on weighing risks and alternatives as suggested in Richmond Leasing, 18Richmond
Leasing, 762 F.2d at 1312 n.11. not through the use of prayer or some other non-logic based methodology. 19Pilgrim’s Pride, 403 B.R. at 427 (applying Richmond Leasing). The same rule would apply to sales or abandonment of estate property. Thus when exercising business judgment the trustee or debtor in possession must use as a decision-making method a rational process that takes into account all reasonable options and selects from those options on a rational basis that which is best in the decision-maker’s objective opinion.
The business judgment rule is applicable in all Chapters. 20Except Chapter 9. It is central to liquidation of an estate 21Subject to the rare exception of Section 721 of the Code. or a debtor’s restructuring to rehabilitate. Although a debtor may operate his or her business in the ordinary course 22See Code §§1107, 1203 & 1304(b). and use, sell or lease estate property in the ordinary course, 23See Code §362(c)(1). it will be necessary to the reorganization, if not the operation, of the business to use property of the estate outside the ordinary course. That brings Section 363(b)(1) of the Code into play. For almost any act outside the ordinary course, from financing to replacing major equipment, the business judgment rule will be implicated or even control the court’s decision whether to approve the debtor’s proposed course of action. While under Section 363 if a proposed act is not objected to the estate representative may proceed without a court order, an order is necessary to assume or reject a contract under Section 365. See
Bloomberg Law: Bankruptcy Treatise, pt. I: General Provisions and Case Administration, ch. 46, at § 363 (noting that § 363(b)(1) does not mention or require a court order so that if there are no objections, the trustee does not need a court order to effectuate the sale) and ch. 48, at § 365 (noting that assumption and rejection require an order from the court). 24For cases where a trustee proceeded under §363 without a court order, see, e.g., In re Wolfe, 362 B.R. 844, Bankr. N.D. Ohio (“In the absence of an objection filed to such ’notice,’ no hearing or order of the court is necessary or appropriate. The action prayed for in the ’notice’ is automatically allowed by administrative operation without a hearing or an order of the court”); In re HLC Properties, Inc., 55 B.R. 685, Bankr. N.D. Tex. (finding that a trustee has authority to sell real property in ordinary course of business and there is no need to further burden court’s docket or staff with superfluous order declaring that debtor is authorized to sell property merely to comfort title company); In re Snyder, 74 B.R. 872, Bankr. E.D. Pa. (explaining that normally, when there is no objection, a trustee need not obtain a court order to sell property under § 363(b)(1) (citing
Collier on Bankruptcy ¶ 363.03 (15th ed. 1987)); In re Burd, 202 B.R. 590, Bankr. N.D. Ohio (concluding that a trustee need not obtain a court order authorizing a sale free and clear of liens where trustee has provided proper notice and no opposition to such motion has been filed); In re Livore, 473 B.R. 864, Bankr. D.N.J. (quoting In re Roth Am. Inc., 975 F.2d 949, 3d Cir., to explain that the framework of § 363 is designed to allow a trustee (or debtor-in-possession) the flexibility to engage in ordinary transactions without unnecessary creditor and bankruptcy court oversight, while protecting creditors by giving them an opportunity to be heard when transactions are not ordinary”).For cases under § 365 where an order is required, see, e.g., Mason v. Official Comm. of Unsecured Creditors (In re FBI Distrib.Corp.), 330 F.3d 36, 1st Cir. (“an executory contract cannot be assumed by unilateral acts of the debtor-in-possession during the reorganization of the business” but rather only with express approval of the court); Thinking Machs. Corp. v. Mellon Fin. Servs. Corp. (In re Thinking Machs. Corp.), 67 F.3d 1021, 1st Cir. (holding that court approval is a condition precedent); South Street Seaport Ltd. P’ship v. Burger Boys, Inc. (In re Burger Boys, Inc.), 94 F.3d 755, 2d Cir. (“assumption of a lease must be done, as suggested by the Bankruptcy Rules, through a formal motion to the court”); Sea Harvest Corp. v. Riviera Land Co., 868 F.2d 1077, 9th Cir. (“rules plainly specify that a debtor in possession must file a formal motion”); ReGen Capital I, Inc. v. UAL Corp. (In re UAL Corp.), 635 F.3d 312, 7th Cir. (citing the Code, a trustee or debtor-in-possession may assume any executory contract “subject to the court’s approval”). For cases where contract cannot be implied because of an absence of a proper court order, see Stumpf v. McGee (In re O’Connor), 258 F.3d 392, 5th Cir. (citing In re Swallen’s, Inc., 210 B.R. 120, Bankr. S.D. Ohio) (holding that because assumption of executory contract requires court approval, executory contract “can only be expressly assumed”)); In re Cole, 189 B.R. 40, Bankr. S.D.N.Y. (boilerplate plan language purporting to assume all executory contracts not expressly rejected prior to confirmation ineffective to assume leases because it would allow circumvention of section 365’s requirement of judicial approval).
