On May 23, 2014, the US Bankruptcy Court for the Southern District of New York held, in Berlin & Denmar Distributors, Inc. v. Goldstein Development Corp. (In re Berlin & Denmar Distributors, Inc.), that a successful bidder in a bankruptcy auction may be liable for ordinary contract damages if it fails to close the sale and does not limit its damages to forfeiture of the deposit (No. 10-15519, (Bankr. S.D.N.Y. May 23, 2014)).

Berlin & Denmar Distributors, Inc. (Debtor) operated a food distribution business from its cooperative units located at the Hunts Point Cooperative Market (Hunts Point). On October 21, 2010, Berlin filed a Chapter 11 case and subsequently entered into a contract for the sale of three of its cooperative units (Units) to Angus America, Inc. (Angus) for $625,000, subject to higher and better offers at an auction.

The approved disclosure statement and proposed plan of liquidation contained bidding procedures (Conditions of Sale) governing the auction. The Conditions of Sale required each qualified bidder to pay a $50,000 deposit (Deposit), which would be forfeited to the Debtor by the winning bidder if the sale failed to close for any reason.

On March 7, 2012, the Court conducted a competitive auction, which the Goldstein Development Corporation (Goldstein) won with a bid of $940,000. Goldstein increased its deposit to $94,000, an amount reflecting 10% of the purchase price. Angus became the back-up bidder with a bid of $930,000.

However, Hunts Point objected to the sale, and among other things, required from the purchaser:

While Goldstein's bid remained open, the Debtor negotiated with Angus and agreed to accept $780,000 if Angus satisfied Hunts Point's requirements. Goldstein subsequently withdrew its bid and the Debtor finalized its deal with Angus for $780,000, secured by a $78,000 deposit. However, Angus also eventually backed out of the deal, and the Debtor retained its $78,000 deposit. The Debtor ultimately sold the property to Westside Foods, Inc. (Westside Foods), for $625,000.

Goldstein contested the forfeiture of its entire $94,000 deposit. The Bankruptcy Court held that because Goldstein repudiated its bid, it forfeited the Deposit. However, the Court held that the forfeiture was limited to $50,000, because the Conditions of Sale defined the Deposit as $50,000, and ordered the Debtor to return the $44,000 balance. Goldstein appealed to the District Court, which affirmed the Bankruptcy Court's order.

On March 29, 2013, the Debtor commenced an adversary proceeding, seeking, among other things, to recover as contract damages under the Conditions of Sale:

The Debtor moved for summary judgment on the question of whether the Conditions of Sale allowed the Debtor to recover its ordinary contract damages in excess of the Deposit. Goldstein cross-moved for summary judgment to recover its attorneys' fees and expenses.

The Court granted the Debtor's motion for summary judgment and held that it could recover ordinary contract damages in excess of Goldstein's and Angus's retained deposits, subject to an evidentiary hearing to determine the amount of additional damages. The Court denied Goldstein's motion for summary judgment in all respects.

First, the Court noted that the parties did not enter into an asset purchase agreement and the Conditions of Sale did not require the successful bidder to do so. Therefore, the contract consisted of Goldstein's bid and the Debtor's acceptance as confirmed in the sale order, with the Conditions of Sale governing the parties' rights. The Conditions of Sale were silent on the issue presented. They did not describe the forfeited Deposit as "liquidated damages" or as the Debtor's exclusive remedy, or state whether the Debtor can recover additional damages. The Court held that because neither party offered extrinsic evidence to resolve the ambiguity, summary judgment was appropriate.

Next, the Court noted that under New York law, a prospective purchaser who defaults on a real estate contract without a lawful excuse forfeits his deposit, even where the contract does not contain a forfeiture clause. This rule also applies to sales of property held in a cooperative ownership, even if they are not technically sales of real estate. However, unless a seller has elected to accept the deposit as liquidated damages and as its exclusive remedy, the seller may recover the difference between the contract price and the market value of the property at the time of the breach, less any deposits paid by the purchaser. Further, liquidated damages must be expressly agreed to and will not be implied. Because the Conditions of Sale did not expressly limit the Debtor's remedy to the retention of the Deposit, the Court would not imply a limitation, and the Debtor was entitled to recover contract damages less the deposits it retained from Goldstein and Angus.

Finally, the Court ordered that an inquest be conducted to determine the correct amount of damages, which it held is additional rent plus the difference between the Goldstein bid and the market value at the time of the breach (rather than the difference between the Goldstein bid and the ultimate sale price, as the sale occurred several months after the breach), reduced by the deposits forfeited by Goldstein and Angus.

This case demonstrates that an entity that wishes to obtain the assets of a debtor through a bankruptcy auction must protect itself as it would with any other asset acquisition.

First, the parties must address all potentially ambiguous terms in the documents that govern the sale. If a court deems the language of the document governing the sale to be ambiguous, it will interpret the contract and give meaning to the ambiguities. In certain cases, when no extrinsic evidence exists or is offered to aid in the resolution of ambiguities, a court may give an ambiguous term meaning without holding an evidentiary hearing.

Second, even if the sale is governed by court issued documents, the parties should draft a separate asset purchase agreement to set out the basic terms of the agreement, such as conditions precedent and liquidated damages. Otherwise, the parties could end up bound to an agreement that they never contemplated. For instance, if the asset purchase agreement included a condition precedent requiring the assignment of the sublease by a certain date, Goldstein would have been able to repudiate its bid without paying any damages if that condition was not met.

Third, purchasers should ensure that the asset purchase agreement expressly limits the forfeited deposit as the seller's exclusive remedy should the purchaser breach the agreement and fail to close the sale.

For more information on the sale of assets under a Chapter 11 plan, see Practice Note, Buying Assets Under a Chapter 11 Plan.