NATCHEZ — Community Health Systems won’t be allowed to count the so-called “break-apart fee” in its stalking horse agreement with Adams County as part of its cash bid if the auction of Natchez Regional Medical Center turns into a bidding war and CHS wins, Judge Neil Olack ruled Wednesday.

The federal bankruptcy court reviewed the bidding process for NRMC’s proposed sale Wednesday, and Olack made a number of changes to it in response to arguments from creditors and questions he raised himself.

One of the key changes CHS argued against was the judge’s disallowance of using the $500,000 break-apart fee as a credit should the company have to bid against a competitor.

In a stalking horse agreement, a pre-auction bidder commits to buying the hospital with a negotiated sale price that acts as a base bid. If someone else wins the auction, however, the stalking horse is given a break-apart fee for the initial risk they assumed.

CHS’ attorney Patrick Darby argued the company should be allowed to consider the break-apart fee as a credit in bidding because it is money that the other bidders would pay to CHS and Adams County would never realize the benefit of its inclusion if the other bidder wins.

“When you cut out the breakup fee, the net effect to the debtor (NRMC) is the same,” Darby said.

Healthcare Management Partners Chief Executive Officer Scott Phillips — who helped negotiate the agreement with CHS on behalf of the county — argued the fee should be considered as currency.

“As soon as there is a topping bid, they have earned their break-apart fee,” Phillips said. “If (CHS) has to bid again, the (hospital) is still better off than it was.”

Phillips said he did not believe CHS would submit a second bid, however, because CHS already owns Natchez Community Hospital and a second bid would mean the market was competitive.

If the market is considered competitive, CHS might run afoul of Federal Trade Commission anti-trust guidelines, Phillips said.

Olack said he would ultimately allow the fee should CHS be outbid, but if the company entered a second or subsequent bid and won the auction, it would have to pay the full cash price of the bid.

The judge said he could not find any legal authority to allow for such a credit arrangement, and some previous cases did not allow for a stalking horse to receive a break-apart fee if the horse entered even a second bid.

“You want to include that fee as if it is part of your purchase price, and I am not going to allow it,” he said.

Before addressing the issue of how the break-apart fee could be used, the judge first asked the parties involved to justify its use at all.

Phillips said that by entering a stalking horse bid, CHS had created value for the sale, a sentiment Darby also presented to the court.

“If anyone shows up, I think it will be because my client created that market,” Darby said. “That is the purpose of the break-apart fee, to foster that (competitive) environment.”

During the testimony justifying the break-apart fee, CHS’ Vice President of Acquisitions Terry Hendon said the company has had approximately 75 people working on the due diligence of the sale, with between 40 and 50 on site in Natchez.

The process has cost approximately $400,000 to date in out-of-pocket expenses, and the company has spent approximately $200,000 on internal costs, he said.

When Olack said he would allow the break-apart fee to be part of the bidding process, he said the fee would stand a $500,000 without consideration for CHS’ internal costs.

The hospital’s creditors also objected to a provision in the bidding process that would have required any bidder to sign an asset purchase agreement that was identical to the one CHS has negotiated, and Olack said the language of the bid procedure would have to be altered to require that bids be “substantially similar” rather than a perfect mirror.

“Simplicity has its own beauty, but a purchaser may not want one of the purchased contracts,” Olack said. “It is hard for me to see why that would make them a disqualified bidder.”

Darby said the court should consider that the seller of the hospital, Adams County, operates on a slightly different objective than a regular business bankruptcy.

“The debtor is entitled and probably required to consider the net effect a sale will have on the facility and what it will do in the community,” he said.

“(In this instance) I think the debtor says, ‘I am not liquidating this facility, I am trying to keep it open.’ They can say, ‘CHS is the higher and better bidder because I have confidence in what they will do.’”

Some of Wednesday’s hearing focused on technical aspects of the bidding process.

In one instance, the creditors asked for the removal of language from the document describing the bidding process that described how the proceeds of the sale would be disbursed.

The hospital’s attorneys said the language was included for informational purposes only, and Olack said he would rather have it removed so it could not be construed as an order that the funds would have to be disbursed exactly as described.

The judge also ordered a language change in the bid procedure that would have allowed the hospital “sole and absolute discretion” in determining which bidders were qualified bidders, and instead, required that bidders would be considered qualified subject to compliance with the court’s orders.

Olack ordered the attorneys to draft an order in line with the court proceedings, which he will later sign.

The judge said the court will schedule a confirmation hearing for a plan of adjustment — how the hospital’s creditors will be paid — once a date has been set for the hospital auction.

Under the terms discussed Wednesday, bidders at the auction — which is mandated by state statute — will have to outbid CHS’s initial price of $18 million by at least $1 million. Each subsequent bid will have to exceed the previous one by $100,000.

Phillips said an auction may take place in early September.

The hospital sought bankruptcy protection amidst an ongoing sale attempt earlier this year when its trustees said NRMC’s financial liabilities had exceeded its assets by $3 million.

The sale process was initiated last July after hospital representatives told the county supervisors — whose duty includes closing the sale on the county-owned hospital — that the hospital’s long-term survival as an independent entity was unlikely.