On January 22, 2013, the US Bankruptcy Court for the Eastern District of New York held in In re Brown Publishing Co. that a debtor may not retain the good faith deposit of a successful bidder in a section 363 sale who ultimately fails to close the transaction, if the sale procedures provide that the debtor may seek additional actual damages, but no actual damages were incurred.

Four days after The Brown Publishing Company and its affiliates (Debtors) filed for Chapter 11 bankruptcy relief, they filed a motion to sell substantially all of their assets free and clear of any interests, claims or liens to Brown Media Corporation (BMC) as the stalking horse bidder in a section 363 sale. The Court authorized the Debtors to conduct an auction and approved the sales procedures, which provided in part that:

BMC was the successful bidder at the auction and PNC Bank, N.A., a secured creditor of the Debtors, was the next successful bidder. However, BMC failed to close the transaction in violation of the asset purchase agreement. Therefore, the Debtors sold the assets to PNC's assignee and to ISIS Ventures Partners LLC in a sale which yielded a higher purchase price than BMC's winning bid.

BMC filed a demand requesting the return of its good faith deposit. The Brown Publishing Company Liquidating Trust (Trust) in turn commenced an adversary proceeding against BMC for breach of contract and sought a declaratory judgment that the Trust is entitled to keep BMC's good faith deposit together with any accrued interest as liquidated damages as a result of BMC's breach. In response, BMC filed a cross-motion for summary judgment asserting, among other things, that it did not breach the asset purchase agreement and that the Debtors did not sustain any actual damages.

After determining that BMC breached the asset purchase agreement, the primary issue before the Court was to decide which party is entitled to the good faith deposit made by BMC in connection with its proposed purchase of the Debtors' assets.

The Trust argued that under Maxton Builders Inc. v. LoGalbo, the seller may always keep a good faith deposit when the buyer defaults. However, the Court noted that Maxton Builders cannot be applied blindly without examining the specific contract at issue. Maxton Builders involved a real estate transaction, where the actual damages would be difficult to determine in the event of a breach. In real estate cases, a liquidated damages provision may be a practical estimate of the amount of actual damages.

The Court contrasted real estate transactions with auction sales. In an auction sale, the parties know that they will be bound by their bids. In the rare event that the successful bidder fails to close, there is generally a next successful bidder whose bid is already known. The uncertainty present in remarketing a property in an ordinary real estate transaction is missing in the auction sale context. The actual damages are easy to calculate as the difference between the original successful bid and the final purchase price.

In analyzing the asset purchase agreement, the Court noted that the agreement did not mention damages regarding the good faith deposit. Rather, the sale procedures contained both:

To obtain actual damages, the Trust would have to show that the Debtors suffered damages greater than the amount of the good faith deposit.

The Court held that where a contract contains both a liquidated damages provision and an actual damages provision, the liquidated damages provision should be read out of the contract because then the contract does not fix or limit damages recoverable by the non-breaching party in advance. Therefore, the Court held that the Trust is entitled only to actual damages because the sale procedures included both types of damages.

The Trust argued that this interpretation in the section 363 context would open the flood gates to successful bidders who may fail to close and then argue for the return of their good faith deposit at the debtor's expense. The Court rejected this argument, noting that it is rare that the next successful bid would be higher than the original winning bid, resulting in no actual damages. Also, if sellers at a section 363 sale want to have a liquidated damages provision, the contract should clearly state that the damages are limited to a fixed amount or percentage and not provide the ability to also seek actual damages that exceed that amount or percentage. This puts bidders on notice that they will forfeit their good faith deposit if they fail to close.

The Court denied the Trust's motion for summary judgment because the Trust had not proved that the Debtors sustained any actual damages. On its face, the ultimate purchase price was higher than what the Debtors would have received if BMC had closed on the asset sale. Because the determination of the actual amount of damages allegedly sustained by the Debtors is an issue of material fact, the Court declined to rule at this time on which party is entitled to keep the good faith deposit.

This case highlights the importance of clearly drafting provisions to properly provide the protections the seller needs. As the Court noted, the seller could have specifically required that any successful bidder that fails to close would only forfeit the good faith deposit as liquidated damages. Alternatively, if the seller is not concerned with securing a particular amount, it could require only actual damages, which would protect itself up to the amount of any difference between the original successful bid and the next successful bid.

For more on asset sales and purchase agreements under section 363 of the Bankruptcy Code, see: