Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

The recent late night television mess with Jay Leno and Conan O’Brien  is a great object lesson as to what contract law really is and does AND what it actually isn’t and doesn’t do.  In my last post, I highlighted some of the various legal arguments being made by Conan, NBC, and to a lesser extent Leno.  (Visit "Leno gives his side of 'Tonght Show' intrigue" for Leno's take on the events, including his guranteed payments under his contract.)    However, now that it’s over, let's look at some important points about contract disputes as they happen in "real life" well illustrated by the series of recent events.

            FIRST - Contract disputes frequently come down to the “letter of the contract” versus “spirit of the agreement” sort of dispute the Conan/NBC situation illustrates.  NBC’s initial saber rattling focused on the fact that Conan’s contract as host of The Tonight Show apparently did not specify an exact time slot.  (This is the nightmare every transactional lawyer dreads – the one thing you didn’t think of turns out to be the really crucial provision that should have been in there.)   From NBC’s perspective, this gave them the right to move The Tonight Show back a mere half hour without breaching their obligations under Conan’s contract.  Here, the LETTER OF THE CONTRACT.

Conan’s camp for their part pointed out that The Tonight Show has aired at 11:35 P.M. immediately after the local news for 60 years and essentially contended that the time slot was an “implied” term of the contract.   Here the SPIRIT OF THE AGREEMENT.  And that close cousin to “spirit” of the agreement”, namely, the “GOOD FAITH” requirement imposed in every contractual relationship.

Now, this is good stuff because it pits those careful enough (or perhaps lucky enough) to have said what they meant against those urging what might be considered a “fair” outcome built on what may well have been shared assumptions at the time the contract was made.  In a way, both sides are right, but only one’s perspective can be enforced. 

Should Conan have specified a time if that mattered so much?  Yeah, probably….. but seriously, who would think anyone would even propose moving The Tonight Show to a different slot?   Often, how a court decides to resolve this issue will do much to affect its determination of whether any breach of contract in fact occurred, and if so, what sort of damages should be awarded.  Which brings us to the second point of understanding>>>>>>

            SECOND – Resolving contract disputes OUTSIDE the court room is generally better for everyone. This three-way conflict had the potential to get really ugly really fast. Conan might have gone to Court to require NBC to keep him on at 11:35 PM until there could be a full hearing of how his contract with NBC should be interpreted. If instead Conan chose to walk away, well then there was a noncompete to deal with and the possibility of being held liable for a breach of contract by failing to continue to perform at the later time slot. The details of how Leno agreed to pass the torch to Conan in the first place (i.e. Conan’s contract was expiring and NBC needed a way to keep him at NBC) almost certainly would have been examined in graphic detail unlikely to be flattering to either NBC or Conan. Things could very well have gotten “personal” between Leno and Conan as they were already beginning to do, something which in the end was probably not going to enhance the image of either in the public eye. 

In short, long divisive publicity of this dispute was in no one’s interests. NBC decided that Leno was more valuable than Conan to it (or perhaps even more expensive proposition to jettison) and agreed to pay Conan and his crew enough to make the case go away.  And Conan got a nice severance package for himself and his staffers and, perhaps more importantly, the ability to host another show as early as September without having to deal with lawyers and lawsuits.  NBC was able to make amends to its affiliates whose unhappiness started the avalanche in the first place.  And Leno got back what he apparently never wanted to give up in the first place.

It's relatively unlikely that these three parties would all have wound up where a relatively brief period of intense negotiating got them.   And it would certainly have cost all of them A LOT more had this gone the litigation route.  Sometimes, it really isn't possible to resolve things among the parties themselves.  However,as a practical matter, it is almost always better for the parties themselves - who know and understand the situation better than any outsider could- to find their own resolution.

           THIRD - Leverage always matters.  In this case, it was the network affiliates -who were contractually obligated to run Jay Leno's 10 PM show - who really got the ball rolling.   And ultimately got exactly what they wanted...  They were losing money and they were not happy.  So even though - contractually - they didn't have a leg to stand on, none of the rest of this sordid affair would have tumbled out, but for NBC's desire to placate this important customer. Then there's Jay who was rumored to have an ironclad contract guaranteeing a hefty payment whether his show aired or not, thus perhaps presenting the economic decision for NBC that it would cost less to keep Jay than to get rid of Conan.  And Conan - well he had the ability to make the whole situation a truly horrendous mess both legally and perhaps more importantly from a PR standpoint, thus giving the impetus to NBC to pay him some money instead of insisting that he continue to perform.

In many contract disputes, there may be a well-written contract on which one party can rely from a legal perspective to enforce their position.  But that doesn't always mean that's the smart thing to do - never mind about what the "right' thing to do would be.  The point is: the law can preserve your options, but the decision must still be made in the context of the surrounding business world.

So, does all this mean lawyers and their contracts are an unnecessary evil to be dispensed with?  No - a well written contract helps set the parameters for what is open for discussion and can in some cases influence the amount of leverage one has or doesn't have.  it's simply important to understand that neither they, nor their breach, exist in a vacuum.

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So the latest brilliant (?) idea about what to do about the financial predicament GM finds itself in  - notice nobody is even talking in any meaningful way any more about resuscitating Chrysler - is to do what is known as a "363 sale" (so called because of the section of the Bankruptcy Code allowing it) in a quick two week "surgical" bankruptcy. 

How would that work?  And could it really be done in less than a fortnight?  Perhaps if you still believe in Santa Claus and the Tooth Fairy and think all those stores about Paul Bunyon are true.  But otherwise, it's one tall tale to swallow.  As Jonathon Glater recently wrote in his NYT news analysis "A Quick Bankruptcy for G.M.?  Not So Fast":

Any hope of a high-speed bankruptcy by General Motors faces a serious obstacle:   a judge -- not the Obama administration, not G.M. management and not the company's creditors -- would reign in court.  

Overview of 363 Sale Process

Leaving aside considerations of "how things actually work in the real world", what are the mechanics involved in making a 363 sale happen?  Well, reduced to the bare essentials, the debtor files a motion (or motions) seeking authorization to sell certain, or all, of its assets.  Sometimes there is a written purchase offer from a prospective purchaser (who is known in bankruptcy circles as a "stalking horse" and will often seek payment of a "break-up fee" or topping fee" to protect against other would-be purchasers) that may be described in, or attached to the Motion.  Other times the Motion seeks authorization of some sort of auction procedure or submission of sealed bids.  Depending upon the complexity and size of the case, these procedures can often be -- and most certainly would be in a GM bankruptcy -- incredibly complicated.  Then the Bankruptcy Court may or may not hear testimony and ultimately issues an order approving the sale as proposed or as modified.     

There are of course rules that govern how all of this is supposed to take place.  Section 363(b)(1) states that a debtor "after notice and a hearing, may use, sell or lease, other than in the course of ordinary business, property of the estate..."  For purposes of a 363 sale, "property of the estate" is essentially the debtor's assets, i.e. equipment, real estate, etc. 

After Notice and a Hearing,,, or Not

And it is true that "after notice and a hearing" has a rather elastic meaning and may not really require an actual hearing in all cases.  According to section 102 of the Bankruptcy Code, it

(A)  means after such notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is appropriate in the particular circumstances; but

(B) authorizes an act without an actual hearing if such notice is given properly and if --

(i)  such a hearing is not requested timely by a party in interest; or

(ii)  there is insufficient time for a hearing to be commenced before such act must be done, and the court authorizes such act.

SO, at least theoretically, a 363 sale could be authorized by the Bankruptcy Court in a matter of days in a GM bankruptcy.  

Section 363(f) - When Sale Can Occur

There are, however, some other requirements which might slow things down, even theoretically speaking.  Section 363(f) of the Bankruptcy Code will only permit the sale of the debtor's property "free and clear of any interest ,,," (which is of course the whole reason for doing a 363 sale in the first place) if and only if:

• Applicable non-bankruptcy law permits sale of such property free and clear of such interest;
• The lienholder or other party with an interest in the property consents;
• With respect to lienholders, the price at which such property is to be sold is greater than the aggregate value of all liens on the property being sold;  
• The interest is in bona fide dispute; OR
• The lienholder or other party with an interest in the property could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

Now it used to be that bankruptcy courts routinely reasoned that state foreclosure law -- and similar laws with respect to personal property going by such names as replevin or "claim and delivery") -- provided all the rationale they needed to approve a 363 sale.  After all, the end result of a foreclosure IS that lienholders get however much money is paid at the sheriff's sale in the order of their priority. If you're the third lienholder and the sale proceeds only pay 10% of your debt after the folks ahead of you get paid, that's just too bad; you can still chase the debtor of course, but the successful purchaser at the sheriff's sale now owns the property free and clear of your lien.  The Uniform Commercial Code provides for a similar result when personal property is sold by the secured creditor in a "commercially reasonable" way.

Section 363(m) - What Appeal?

And, thanks to section 363(m) of the Bankruptcy Code, once the Bankruptcy Court had "done the deed"  of authorizing a 363 sale, the reversal or modification of that Order on appeal "does not affect the validity of the sale... under such authorization to an entity that purchased... such property in good faith, whether or not such entity know of the pendency of the appeal, unless such authorization and such sale... were stayed pending appeal."  Because 363 sales were often consummated moments after the Order authorizing them was signed by the Bankruptcy Judge, disgruntled lienholders and other parties in interest often never had a chance to even seek a stay, let alone obtain one.

You may have noticed that I've been using the past tense in the last couple of paragraphs.  That's because the Ninth Circuit U. S. Circuit Court of Appeals Bankruptcy Appellate  Panel recently raised some questions about the supposed invulnerability of an order authorizing a 363 sale.  In Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (B.A.P. 9th Cir. 2008), the Bankruptcy Court had authorized a 383 sale in which the ultimately successful purchaser was the bank which held the first priority lien over the objection of the junior lienholder.  The bank "credit bid" the amount that was owed to it so it did not come out of pocket and no dollars flowed into the bankruptcy estate to pay the junior lienholder which a a $2.5 million claim.  The BAP overuled the bankruptcy court with a rather intricate interpretation of section 363(m).  In addition, the case was remanded to the Bankruptcy Court for a more specific demonstration that the provisions of subsection 363(f) were being met.   

For more detail on this case and what the BAP holding may mean  in general, visit "Clear Channel Raises Troubling Issues in Section 363 Sales But Case Doesn't Spell the End of Free-and-Clear Sales" , an article by Christopher Combest and Faye B. Feinstein in the Turnaround Management Journal.

Also check out "Will Section 363 'free and Clear' Sale Orders Survive an Appeal?  A recent Appellate Decision Raises New Doubts" by Robert Eisenbach III of the In the (Red) blog.

Although technically this only affects bankruptcies in the Ninth Circuit on the West Coast  - one place we can be certain GM will not file -- bankruptcy law has long been a procduct of trends starting in one particular jurisdiction.  Thus it's entirely possible that whatever Bankruptcy Court GM winds up facing would adopt this viewpoint.  So the net result of this is that a purchaser at any 363 sale might need to wait out the 10 day appeal period (and any subsequent appeal) before consummating the sale authorized by the Bankruptcy Court.  And some sort of real record will need to be made demonstrating the satisfaction of section 363(f) - there will need to be at least a modicum of due process allowing some preparation time before the hearing.

Other Important Requirements 363 Sales Must Meet 

There's also other substantive requirements that must be met before a 363 sale can be approved.  In the United States Sixth Circuit  -- which is certainly one place a GM bankruptcy might well unfold given its headquarters in Michigan -- a sale of all of the debtor's assets (and possibly by extension, the most important assets) can only be approved "when a sound business purpose dictates such action."  Stephens Indus., Inc. v. McClung,  789 F.2d 386 (6th Cir. 1986).  To determine whether that standard has been met in a particular case, the Bankruptcy Court must look at the following factors:

• whether the terms of the proposed sale reflect the highest and best offer for the assets
• whether the negotiations were conducted at arm's length
• whether the sale is in the best interest of the estate and its creditors

There must also be a finding that the the purchaser has acted in "good faith" and that the sale itself is in "good faith".  The words of a slightly earlier case in the Sixth Circuit, Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel), 722 F.2d 1063 (6th Cir. 1983) seem particular pertinent today:

In fashioning its findings, a bankruptcy judge must not blindly follow the hue and cry of the most vocal special interest groups; rather he should consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity holders, alike.  he might, for example, look to such relevant factors as the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the liklihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and most importantly perhaps, whether the asset is increasing or decreasing in value.  This list is not exhaustivee, but merely to provide guidance to the bankruptcy judge. 

By now you're probably starting to understand how unlikely -- even in the theoretical vacuum-- it would be for GM or any other debtor to get in and out of a "surgical" aka "prenegotiated" or "prepackaged" or "controlled" (as if any bankruptcy could really be controlled once filed !). bankruptcy in two weeks, even using a 363 sale.

There's one more thing.  Section 363(b)(2) applies in situations in which antitrust law might apply to the proposed sale.  It REQUIRES a FIFTEEN DAY waiting period, which may be extended, but CANNOT be shortened.  While that might not be relevant in many situtions, it surely could become relevant in a GM bankruptcy.

So there you have it.  Whether it's a Chapter 11 case of a small business or a mega case like GM would be, this is what you have to do in order to sell assets once in bankruptcy.  The procedures also apply in a Chapter 7 liquidation bankruptcy with a bankruptcy trustee.  The emphasis is on transparency and what is "fair" and "equitable".  And that is not something that can be achieved in a "shotgun" bankruptcy, even if there really was such a beast outside of legend. 

UPDATE (6/1/09): So now it's official - GM is now in bankruptcy.  Filed in NYC, Case No. 09-50026, Judge Gerber presiding.  Check out my post GM Follows Dealership Affiliate to Obtain NYC Venue for Its Bankruptcy for all the basic filing info and press releases.

Looks like I might be wrong about the speed of approval for a sale, but in my defense (A) GM HAS actually been working pretty hard lately before filing to clean up loose ends and (B) I was naive enough to think we would actually go by real bankruptcy rules as opposed to distoring them beyond all recognition.  Nonetheless since GM doesn't actually have a third party seller like Chrysler did, it may still take longer than GM and the obama Administration are planning... even they gave up on the idea of a TWO WEEK surgical bankruptcy.

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