Buyer Beware: Stalking Horse Purchase Deposits at Risk

Pachulski Bulletin No. 12
March 2013


A recently published decision from a New York bankruptcy court reinforces the importance for both buyers and sellers in section 363 sales of paying close attention to all the terms of court-approved sale procedures. If they fail to do so, buyers could lose their purchase deposits – even where a sale closes at a higher price – and sellers risk not being able to keep these deposits as “liquidated damages” upon a buyer’s default. Litigating over these matters can lead to prolonged sale proceedings and unnecessary delay and expense. See In re Brown Publishing Co., 2013 WL 231103 (Bankr. E.D.N.Y. Jan. 22, 2013).


In Brown, the debtor entered into an asset purchase agreement (“APA”) for the sale of substantially all of the debtor’s assets to a stalking horse buyer controlled by the debtor’s insiders. Although the APA did not require a good-faith deposit, the proposed sale procedures did call for a deposit from any other potential bidder. During court proceedings to consider the sale procedures, the court required the stalking horse to advance a $760,000 good-faith deposit in order to place the stalking horse on equal footing with other potential bidders. An auction followed that increased the proposed purchase price. The stalking horse ultimately failed to secure financing from its equity sponsor in an amount sufficient to close the transaction at the higher price and defaulted. This left the debtor to close a sale to the next highest bidder for an amount that substantially exceeded the initial stalking horse bid.


The liquidating trust formed to represent the debtor’s interests after the asset liquidation sought to retain the stalking horse’s deposit even though the ultimate sale generated more than the initial bid plus the deposit. The stalking horse sought the return of its good-faith deposit via a “substantial contribution” motion, arguing, among other things, that the liquidating trust had not sustained any actual damages given the higher price achieved.


The court agreed with the liquidating trust that “[buyer] defaulted…by (a) breaching its representation…that it has sufficient funds to consummate the transactions and (b) failing to [timely] close on the sale….” The court’s sales procedure order provided “that if the successful purchaser fails to close the Sale, the successful purchaser’s good faith deposit ‘shall be retained by the Debtors on account of damages suffered by it as a result of such failure to close, without prejudice to the Debtors’ ability to seek to recover additional damages.’” 


The critical lesson for buyers is that even where a sale closes at a higher price than initially agreed to in the stalking-horse transaction, a failure to close can lead to loss of a deposit. However, fortunately for the buyer, the court refused to simply award the deposit to the seller on summary judgment and required further fact-finding to determine whether the seller suffered actual damages, particularly given the higher price paid by the ultimate purchaser. The wording of the APA’s damages provision was critical to the court’s decision. The court found that the relevant damages provision of the APA was an “actual damages” provision since it did not limit damages to the good-faith deposit. Noting that there are many situations where a deposit in a section 363 sale context does not serve as a measure of damages but rather to ensure buyer participation in good faith, the court found that if a debtor seeks to treat a deposit as liquidated damages, it must be “clear and up-front” and limit recovery only to the fixed amount or percentage without entering further proceedings to argue for actual damages if actual damages exceed the good faith deposit. Here, given that the deposit was in the nature of a partial payment rather than estimated damages, the court ruled that additional fact-finding was needed to determine which party was entitled to all or part of the deposit. 

Please contact Jeff Pomerantz or Jeffrey Dulberg at Pachulski Stang Ziehl & Jones LLP with any questions regarding Brown Publishing Co.

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