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In re Old Cold LLC

United States Court of Appeals, First Circuit

January 12, 2018

IN RE: OLD COLD LLC, f/k/a Tempnology, LLC, [*] Debtor.
OLD COLD LLC, f/k/a Tempnology, LLC and SCHLEICHER AND STEBBINS HOTELS LLC, Appellees/Cross-Appellants. MISSION PRODUCT HOLDINGS, INC., Appellant/Cross-Appellee,


          Robert J. Keach, with whom Lindsay K.Z. Milne and Bernstein, Shur, Sawyer & Nelson, P.A. were on brief, for appellant/cross-appellee.

          Christoper M. Desiderio, with whom Daniel W. Sklar and Nixon Peabody LLP were on brief, for appellee/cross-appellant Old Cold LLC.

          Christoper M. Candon, with whom Sheehan Phinney Bass & Green PA was on brief, for appellee/cross-appellant Schleicher & Stebbins Hotels LLC.

          Before Torruella, Lynch, and Kayatta, Circuit Judges.


         Chapter 11 debtor Tempnology, LLC ("Debtor") auctioned off its assets pursuant to section 363 of the Bankruptcy Code. Schleicher and Stebbins Hotels LLC ("S&S") was declared the winning bidder over Mission Product Holdings, Inc. ("Mission"). With the bankruptcy court's approval, Debtor and S&S completed the sale. On appeal, Mission now asks that we order the bankruptcy court to unwind the sale and treat Mission as the winning bidder. Because the sale to S&S was completed and S&S is a good faith purchaser entitled to protection under section 363(m), we affirm without reaching the merits of Mission's various challenges to the sale. Our explanation follows.


         Debtor made specialized products -- such as towels, socks, headbands, and other accessories -- designed to remain at low temperatures even when used during exercise. It marketed these products under the "Coolcore" and "Dr. Cool" brands. S&S is an investment holding company with its primary interest in hotels. Prior to Debtor's bankruptcy, S&S owned a majority interest in Debtor. Until just under two months before Debtor commenced this Chapter 11 proceeding, Mark Schleicher and Mark Stebbins -- S&S's two principals -- sat on Debtor's management committee.

         Almost three years before petitioning for bankruptcy, Debtor executed a Co-Marketing and Distribution Agreement with Mission. This Agreement granted Mission a nonexclusive, perpetual license to Debtor's intellectual property and an exclusive distributorship for certain of Debtor's manufactured products. The Agreement forbade Debtor from selling the covered products in Mission's exclusive territory, which included the United States.

         When the relationship between Mission and Debtor soured, Mission exercised its contractual right to terminate the Agreement without cause on June 30, 2014. This election triggered a two-year "Wind-Down Period" through July 1, 2016, during which Mission's rights remained in effect. Debtor responded by seeking to terminate the Agreement for cause, claiming as a breach Mission's hiring of Debtor's former president. Unlike Mission's election, Debtor's termination for cause, if effective, would have terminated the Agreement without a Wind-Down Period. The dispute went before an arbitrator, who found that Debtor's attempted termination for cause was improper, potentially entitling Mission to damages for Debtor's failure to abide by the Agreement leading up to arbitration. The hearing to determine the amount of these damages has been stayed pending the resolution of Debtor's bankruptcy petition.

         As the parties' relationship deteriorated, so too did Debtor's financial results. Debtor posted multi-million dollar losses in 2013, 2014, and 2015, for which it blames the Agreement with Mission. To combat its liquidity problems, Debtor took on increased debt. S&S, which had already made substantial loans to Debtor, loaned additional money, and Debtor obtained a secured line of credit with People's United Bank for approximately $350, 000. In 2014, after deciding that it would only continue lending to Debtor on a secured basis, S&S acquired People's United Bank's line of credit. S&S increased the secured loan limit, first to $4 million, and later to $5.5 million. This tactic allowed S&S to gradually convert its unsecured debt into secured debt.

         Debtor failed to improve financially. On July 13, 2015, Debtor's management committee and Stebbins met to discuss Debtor's outstanding debt. At this meeting, S&S and Debtor agreed to the outline of a forbearance agreement, which was memorialized and signed four days later. The forbearance agreement provided for an additional $1.4 million in funding for Debtor on the condition that it file for bankruptcy and sell substantially all of its assets in a section 363 sale. See 11 U.S.C. § 363(b).

         Stebbins and Schleicher both stepped down from Debtor's management committee following the July 13 meeting. Thereafter, neither had contact with Debtor's management regarding Debtor's operation or subsequent bankruptcy.

         Debtor then engaged Phoenix Capital Resources, a crisis management, investment banking, and financial services firm, to explore its options. Phoenix concluded that Debtor's best route was to be put up for sale. It then solicited approximately five companies to serve as the stalking horse bidder for Debtor's assets. In the context of a bankruptcy sale, a stalking horse bidder is an initial bidder whose due diligence and research serve to encourage future bidders, and whose bid sets a floor for subsequent bidding. See ASARCO, Inc. v. Elliott Mgmt. (In re ASARCO, L.L.C.), 650 F.3d 593, 602 n.9 (5th Cir. 2011). None of the firms solicited by Phoenix were interested in taking on the expense of this role. In August of 2015, Phoenix approached S&S, which agreed to be the stalking horse bidder.

         On September 1, 2015, Debtor filed a petition for Chapter 11 bankruptcy. On the same day, S&S formally became the stalking horse bidder by signing an agreement to purchase Debtor's assets for $6.95 million, composed almost entirely of forgiven pre-petition debt owed by Debtor to S&S. This strategy of offsetting a purchase price with the value of a secured lien is called credit bidding, and it is permitted in a section 363 sale "unless the court for cause orders otherwise." 11 U.S.C. § 363(k). A provision in the Agreement also left Debtor able to back out in favor of a superior bid at the auction.

         The next day, Debtor moved for approval of its proposed asset sale procedures. It also moved to reject a number of its executory contracts, including the Mission Agreement. The bankruptcy court ultimately granted that motion, and Mission's challenge to that order is the subject of our separate opinion issued this date in appeal No. 16-9016.

         Because the stalking horse bidder -- S&S -- was an insider of Debtor, both the United States Trustee and Mission sought the appointment of an independent examiner to evaluate the proposed sale and bidding procedures. Although Debtor initially resisted, it ultimately concurred in the recommendation. The court agreed, and appointed an examiner.

         On October 8, the bankruptcy court held a hearing on the sale motion. In light of a concern raised in the examiner's interim report and echoed by the court about S&S's pre-petition credit bid, S&S agreed at the hearing to change the composition of its stalking horse bid and to lower its value from approximately $7 million to just over $1 million. Its revised bid consisted of $750, 000 in post-petition debt and the assumption of about $300, 000 in pre-petition liabilities. As the bankruptcy court concluded, this agreement was a concession intended to defer to a later day a possible fight over S&S's credit-bidding rights.

         The bankruptcy court approved the sale procedures on October 8, after which Phoenix sent 164 emails to companies that Phoenix determined might be interested in bidding for Debtor's assets. Included with its standard email was a confidentiality agreement and an invitation to visit a data room, in which Phoenix had deposited Debtor's confidential business information. Despite conducting 112 follow-up calls, and a few visits by interested companies to the data room, Phoenix failed to secure any party -- other than Mission and S&S -- willing to bid at the auction. Potential bidders were deterred by, among other things, Debtor's poor financial track record, its dispute with Mission, the size of the market opportunity, and S&S's ability to credit bid. Debtor had also given Phoenix a list of parties not to contact, comprised of Debtor's customers. Debtor believed that these customers would be less likely to continue their relationship with Debtor if they knew that Debtor was undergoing an asset sale, and that their withdrawal would further threaten Debtor's already precarious financial viability.

         Through an affiliate, S&S continued to lend to Debtor during the run-up to the auction. S&S included the full amount of this disbursed and imminent loan -- $750, 000 -- as post-petition debt in a revised stalking horse bid, submitted at the beginning of October.

         On November 2, 2015, Mission placed a qualifying overbid of $1.3 million, entitling the company to bid at auction. Three days later, on November 5, Debtor's counsel held an auction for Debtor's assets, at which S&S and Mission were the only bidders. The bid procedures allowed negotiations to be conducted off the record. Although S&S had revised its stalking horse bid to exclude forgiven pre-petition debt, its first bid at auction -- for a total of $1.4 million -- included such a credit bid. Mission then asserted that S&S had no right to credit bid pre-petition debt, and announced that it would bid under protest for the remainder of the auction. The next opportunity to bid went to Mission. To beat S&S's proposal, Mission increased the value of its previous bid, to the apparent confusion of some present, by agreeing to leave in the estate $200, 000 in cash, thus increasing the total value of its bid to $1.5 million. Bidding continued to proceed in this fashion: S&S increased its bid using credit, and Mission agreed to leave additional assets in the estate, including Debtor's finished goods inventory and accounts receivable. Given Mission's bidding structure, Debtor then revalued its accounts receivable and inventory to reflect their liquidation value as opposed to their book value. This revaluation reduced the bidding value of the accounts receivable by twenty percent, to $80, 000, and the bidding value of the inventory by ninety percent, to $120, 000. Mission's counsel, after being informed that Debtor would recalculate the inventory value, responded that "[a]s long as it's apples to apples, I don't care." Mission's counsel did not object to the new figures after Debtor announced them.

         The parties then broke for lunch. Back on the record, Debtor's counsel informed those present that, after a negotiation between Debtor's counsel and S&S off the record, S&S intended to adopt Mission's bid structure by leaving assets in the estate. In its next bid, S&S credit bid only its post-petition debt, assumed all pre-petition liabilities other than rejection damages and disputed liabilities, assumed post-petition accounts payable, and left in the estate all accounts receivable, inventory, and cash. In subsequent bidding, S&S increased its bid by credit bidding pre-petition debt, and Mission increased its bid with cash. Mission soon ceased to bid and declined to be designated the backup bidder, ending the auction. S&S's winning bid, for a total value of $2.7 million, consisted of forgiven pre-petition debt, forgiven post-petition debt, the assumption of post-petition accounts payable, the assumption of certain pre-petition unsecured debt, ...

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