With classic reorganizations a relic of the past, and retail bankruptcies and distress sales way up, the question of what assets may be sold in a retailer’s 363 auction of its primary business assets early in the case is of paramount importance.  One of Delaware’s newest Bankruptcy Judges, Kevin P. Gross, addressed this issue last week in the Whitehall Jewelers’ bankruptcy case, one day before the bid deadline and ten days before the scheduled August 8th auction.  In re Whitehall Jewelers Holdings, Inc., 2008 WL 2951974 (Bankr. D. Del. 7/28/08) (pdf).  The Deal’s Jamie Mason provided this background to the auction:

A Delaware judge has approved the bidding procedures for bankrupt jewelry retailer Whitehall Jewelers Holdings Inc.’s going-out-of-business sales at all of its stores but not the stalking-horse bidder’s breakup fee. Since the breakup fee was denied, the group has reserved the right not to participate in the auction, so it’s unclear if there will be a stalking-horse bidder for the sale. The stalking-horse bidders had agreed to pay Whitehall, which sells diamonds, gold, precious and semiprecious jewelry and watches, 55.5% of the value of the inventory if it’s between $169 million and $177 million. However, if the inventory is worth between $138 million and $145 million, Whitehall will receive 53.5% of the value. This means that Whitehall could receive between $73.8 million and $98.2 million, depending on what its inventory is worth.

With much riding on the value of the inventory, Judge Gross was asked to determine whether it is permissible under Code section 363(f)(4) to sell approximately $63 million of consigned goods in inventory from Whitehall’s 373 retail stores in a 363 sale?  The consigned goods weren’t segregated at the stores, and the vendors themselves split into two general groups: 

  • Those who failed to file financing statements and those who filed improperly or who failed to comply with UCC Article 9, including those who did not refile when Debtors changed their name (too conveniently so, charged these consignment vendors) from "Whitehall Jewellers" to "Whitehall Jewelers"; and
  • Those whose consignments are governed by UCC Article 2 and therefore are subject to the claims of Debtors’ creditors.

Section 363(f)(4) was implicated because the Debtors argued that the consignment vendors’ interests in the consigned goods is in bona fide dispute within the meaning of Section 363(f)(4), which permits assets sales free and clear of any third party interest in the property only if such interest "is in bona fide dispute." 

After reviewing various cases within and outside the district, Judge Gross concluded that no sale of the consigned inventory was permitted under Code section 363(f)(4) "without first demonstrating to this Court that the consigned goods are property of the estate." Judge Gross, however, would only resolve that issue by way of a full-blown adversary proceeding and not through a contested sale motion under Section 363. While recognizing the burden on Whitehall from having to initiate over 120 adversary proceedings (i.e, complaints) in the short time available before the sale, Judge Gross concluded that he had no choice in the matter, stating:

While Bankruptcy courts must be flexible in their approach in order to address the circumstances, the Debtors’ effort to utilize Section 363(f)(4) is simply too far beyond the Court’s range of permissible movement.   There are a number of issues which remain to be decided. In addition to the perfection issues for the Consignor Vendors’ interests, there are such pivotal issues as:


• Was the name change from Whitehall Jewellers to Whitehall Jewelers an effort to deceive the Consignor Vendors?

• Are the Debtors generally known/substantially engaged in the sale of Consignment Goods?

• Did some Consignment Vendors properly terminate their Vendor Trade Agreements** pre-petition?

The Debtors may, of course, continue with the sale of the Asset Goods. They may not, absent adequate protection to or consent from the Consignment Vendors, proceed with the sale of Consigned Goods.

**  Note:  Vendor Trade Agreements were described by Judge Gross as follows:

The relationship between the Debtors and each Consignment Vendor is in nearly all instances governed by a Vendor Trading Agreement (the "VTA"), which in its generic form provides, in part:  

The Parties intend that the transfer and delivery of goods by Consignor to Consignee pursuant to these Terms of Consignment shall be characterized as a "Consignment" by a "Consignor" to a "Consignee" within the respective meanings of each such term under the Uniform Commercial Code as adopted in each applicable jurisdiction (the "U.C.C.") and the provisions of the U.C.C. relating to consignment, including without limitation Section 9-103, 9-317, 9- 319 and 9-324 thereof, shall apply hereto.  VTA, ¶ 1(c).

The VTA further provides:

Consignor is and shall remain the owner of Consigned Merchandise, retaining full title to each item of Consigned Merchandise….  Consignee shall acquire no right, title or interest in the Consigned Merchandise other than the right to possess the Consigned Merchandise as a consignee and sell the Consigned Merchandise as provided under the Terms of Consignment.  VTA, ¶ 2.

Finally, the VTA provides that Consigned Goods were "sold to Whitehall by Vendor on a ‘sale or return’ basis ."  VTA, ¶ 9.

© Steve Jakubowski 2008