Just about a month ago, Residential Capital and certain of its affiliates commenced their Chapter 11 cases with two proposals for the sale of substantially all of their assets—one being a sale to non-debtor affiliate Ally, tied to a plan proposal enjoying the support of certain ResCap secured noteholders and a group holding residential mortgage-backed securities, the issuance of which ResCap was integrally involved. Last week, during the hearing to approve bidding procedures, ResCap faced challenges to both proposed sales as to price and the terms of the stalking horse sale agreements. Concurrently, one of the competing bidders, Berkshire Hathaway, also successfully sought the appointment of an examiner to investigate ResCap’s pre-bankruptcy actions, especially regarding transactions with its affiliates.

The events of last week’s hearing serve to remind investors that while the bankruptcy process is flexible and can, if necessary, adapt to major developments early in a Chapter 11 case, debtors will be held to their proof in justifying the need for speed, demonstrating a diligent and continuing discharge of their responsibility to maximize values, and the lack of any higher or better feasible alternatives. In conformity with those principles, ResCap encountered not only procedural objections, but through the participation of a clearly qualified bidder at the sale procedure stage, “live” evidence of a viable, more valuable alternative that arguably confirmed the inadequacy of the pre-bankruptcy process, including the rejection by the bankruptcy court of a “no shop” or “no solicitation” provision in one of the proposed stalking horse agreements.

The Company1

The Chapter 11 case includes 51 separate entities (collectively, ResCap or the Debtors), led by Residential Capital along with the business’ other core entities, Residential Funding Co. and GMAC Mortgage. Together, the Debtors make up the mortgage arm of the non-debtor parent company Ally Financial, which through its banking affiliate Ally Bank, serves, among other things, as a major lender supporting the wholesale and retail sales efforts of Chrysler and General Motors. Concurrently with the auto bail out and shortly thereafter, Ally received about $17.4 billion in bailout money, and the U.S. government took a 74 percent stake in the company.

Meanwhile, ResCap and its residential mortgage affiliates—which business includes the origination of residential mortgages and their packaging to promote and issue residential mortgage backed securities—are defendants in multiple litigations alleging breaches of warranties and representations brought by or on behalf of holders or guarantors of RMBS originated by the Debtors. Ally is also a defendant in some of the RMBS related litigations. Addressing the RMBS litigations is a major focus of the ResCap Chapter 11 cases, complicating the proposed sales “free and clear” of all claims, liens, and interests and the ability of ResCap to formulate and propose a plan using the sale proceeds.

The business of the Debtors themselves embodies two distinct lines: (i) originating and servicing residential mortgage loans, and (ii) the “legacy loan” business, consisting mainly of mortgage loan and other residual financial assets. The servicing unit—the most valuable piece of ResCap’s business—is the fifth largest in the United States, servicing over 2.4 million loans with an aggregate unpaid principal balance of $374 billion. Approximately 68 percent of these loans are owned, insured or guaranteed by government sponsored Fannie Mae, Freddie Mac and Ginnie Mae. The support of interested governmental entities (referred to in the papers as GSEs) is critical to the ongoing value of the servicing business. When the Debtors filed for bankruptcy on May 14, 2012, their stated purpose in doing so was to facilitate an orderly sale of the servicing and origination line with the cooperation of the GSEs, and an orderly wind-down and sale of the legacy loan business.

Prepetition Sale Process

By August 2011, ResCap was increasingly concerned over, among other things, liquidity covenants under its credit agreements, impending debt maturities, and the extent of liability for reps and warranties made in connection with prior mortgage loan sales. These concerns led ResCap to begin considering Chapter 11, and between the months of October and January, ResCap and its advisors began preparing for a potential auction of the business.

In January 2012, ResCap initiated a narrowly focused marketing process, and by the next month had received several initial indications of interest. One of the potential bidders was Nationstar Mortgage Holdings, a company with an established mortgage servicing business majority-owned by Fortress Investment Group. After an evaluation of the bids against a valuation of the assets, ResCap ultimately concluded that Nationstar’s bid was the highest bid for ResCap’s origination and servicing business, the largest portion of ResCap’s assets, and therefore, the best. In the weeks leading up to the bankruptcy filing, ResCap negotiated the terms of a bankruptcy sale to Nationstar, coordinating along the way with the GSEs to garner support. Concurrently, ResCap and Ally began discussing a settlement of all claims between the affiliates under a Chapter 11 plan providing for debtor and third-party releases to Ally. Ally intended to serve as stalking horse bidder for ResCap’s legacy loan business and to temper that bid in connection with its support for the plan.

Thus, upon filing for Chapter 11, the Debtors’ had plans in place for two separate asset sales; one to Nationstar and one to Ally. Nationstar’s stalking horse bid included a $2.4 billion purchase price and provided for a $72 million break-up fee in the event that Nationstar was overbid at auction, as well as expense reimbursement for Nationstar up to $10 million. The bid procedures also provided for a minimum bid increment of $25 million above the Nationstar bid in order to qualify. The purchase agreement contained a “no shop/no solicitation” provision through the entry of an order approving the solicitation procedures but did not have a fiduciary out.

As stalking horse for the auction of the legacy loan business, Ally offered $1.4 billion if the assets were sold outside of a Chapter 11 plan. The auction procedures required a $15 million minimum bid increment for any bids competing with Ally. At the same time, the purchase agreement with Ally required no break-up fee. The Debtors had also entered into three plan support agreements before the bankruptcy—the counterparties being Ally, a minority group of junior secured noteholders, and certain of the Debtors’ institutional RMBS investor/litigants. The plan support agreement with Ally provided that Ally would pay $750 million to the Debtors in exchange for a broad series of releases of all estate causes of action against Ally, as well as certain third-party claims. If the Debtors sold the assets pursuant to the contemplated Chapter 11 plan, Ally’s bid for the legacy loan business increased to $1.6 billion.

In addition to its involvement with the development of the Chapter 11 plan and its stalking horse bid for the legacy assets, Ally provided the Debtors with a $150 million debtor-in-possession loan, complete with a mandated timetable with respect to the sale process. Thus, at the time of filing, the Debtors came to bankruptcy court with what in their view was a complete roadmap for the progress of the case, including two willing buyers of substantially all of the Debtors’ assets, the framework for a largely supported Chapter 11 plan, and an ostensibly sufficient level of DIP financing. As the hearing would reveal, the process failed to identify another more valuable, feasible alternative.

The Process and Sale Hearing

The court received objections from almost a dozen parties. Among them were the U.S. Trustee, the Unsecured Creditors’ Committee, and Berkshire Hathaway. While there were typical objections from the U.S. Trustee to the reasonableness of the Nationstar break-up fee and expense reimbursement, the committee objected to what it characterized as a compressed timeline for the asset sales, seeking an additional 60 days that would give bidders a more realistic diligence opportunity, and permit the investigation into the propriety of the Debtors’ prepetition transactions with Ally to reach a conclusion.

Both the Committee and Berkshire asserted that the Ally “toggle” bid was improper because it linked the purchase price to the Chapter 11 plan containing releases in favor of Ally. Such a linkage could chill new bidding by infusing uncertainty into the process. It would be impossible for bidders to know whether the plan would be implemented, and moreover, the bid procedures were silent as to whether an initial bid could qualify at the $1.4 billion level, or would have to be at least $1.6 billion to qualify. Berkshire also proposed to supplant Nationstar and Ally as stalking horse bidder in both sales, offering a bid for the Nationstar assets at the same $2.4 billion price, but reducing the break-up fee to $24 million and requiring no expense reimbursement. With respect to the legacy loans, Berkshire overbid Ally by $50 million and omitted any linkage to estate claim releases (although, it did add a 3 percent break-up fee, eventually reduced to $10 million).

Interestingly, none of the objectors raised concerns over the provision in the Nationstar purchase agreement restricting ResCap from engaging, not only in substantive negotiations, but even in discussions of any kind over the assets with parties other than Nationstar. Where related “no-shop” or “no-solicitation” provisions would typically include certain “fiduciary out” language allowing the Debtors to consider better alternative offers, this provision omitted such language. While the provision was characterized at the hearing as a “no-solicitation” provision, Judge Martin Glenn later confessed that he “kicked [him]self” for not opening the agreement to check for himself.2

In response to the objections, the Debtors clarified that an opening bid of $1.4 billion (without plan linkage) would qualify at auction for the legacy loan assets. Nationstar agreed to match Berkshire’s proposed bid by reducing the break-up fee for the origination and servicing assets to $24 million and retracting the expense reimbursement requirement. Additional competition took place between Berkshire and Nationstar, both in anticipation of and during the hearing on the bid procedures and stalking horse motions. Ultimately, Berkshire’s bid ended up $100 million higher than the original Nationstar stalking horse bid, and included a reduction of the break-up fee to $12 million. Nationstar subsequently submitted a bid to the Debtors that was $125 million more than its original bid, but kept its break-up fee at $24 million. The minimum bid increment under the bid procedures was reduced to $5 million.

Following a full day hearing, the ResCap board met to consider the bids, and determined that Nationstar’s bid remained the highest and best for the origination and servicing assets, but decided that Berkshire’s bid for the legacy assets was higher and better than Ally’s offer.


Ultimately, upon the approval of the ResCap board and the recommendation of the Creditors’ Committee, the court approved Nationstar as the stalking horse for the origination and servicing assets, and approved Berkshire as the stalking horse for the legacy loan assets. It is important to remember that the “bidding activity” occurred in the context of a hearing to approve the bidding procedures and set the sale hearing for some time in September.

At this juncture, on a sale of substantially all of the Debtors’ assets early in a case, the burden on the Debtors is to demonstrate that the suggested procedures will develop the highest and best bids and that a diligent search by the Debtors led to the best available alternative. As of now, ResCap will move forward with two new stalking horse bids and agreements, based upon the credible evidence received at the hearing regarding the existence of a more valuable alternative and shortcomings in the sales agreements. While Glenn insisted that a fiduciary out be included before the agreement would be approved, he also observed that, as a practical matter, there had been no real detriment as a result of its omission. In fact, counsel for Nationstar had indicated on the record that there was no objection to the Debtors’ discussions with Berkshire. Yet, the judge’s strong initial reaction does serve as a reminder that such provisions are procedurally necessary, and that a court is not likely to tolerate the chilling effects of an aggressive “no-talk” provision in a stalking horse agreement.

Corinne Ball is a partner at Jones Day.


1. The factual material contained herein was taken from bankruptcy court pleadings of the Debtors and other parties in interest, as well as other publicly available documents.

2. Hr’g Tr., June 19, 2012, p. 15, ln. 21.