Interested in Purchasing Assets from a Distressed Debtor? – Some Considerations

‍Companies run into financial trouble.  Did they take on too much debt with the last acquisition?  Were their forecasts too rosy?  Did they fail to have the appropriate personnel to take advantage of their assets?  Did they mismanage their business?  Was it fraud?

For any of the above reasons, one company’s failure becomes another company’s opportunity.  While investing in distressed companies may not be the best investment, purchasing their assets out of a bankruptcy case may be. 

This article highlights some considerations when evaluating whether to submit a bid for distressed assets. [1]

‍ Why Is It Called a “363 Sale”? 

A “363 Sale” refers to the bankruptcy code section that allows the sale of assets outside the ordinary course of business.  A 363 Sale is a court-approved process, requiring the debtor to put parties-in-interest on notice of the sale, identify contracts and leases that could potentially be assigned to a purchaser, and prove in a court hearing that the debtor has obtained the best offer for the assets and that the sale has been proposed in good faith.

If court approved, the debtor obtains a finding that the buyer is a good-faith purchaser and the buyer gets the debtor’s assets free and clear of interests (as explained below).

What About Those Bid Procedures?

‍The bid procedures set out the requirements to be a qualified bidder, including, but not limited to, disclosures and financial capability of the potential bidder to close the transaction, what information must be submitted as part of the bid, deposit requirements, deadlines to submit the bid, and form of the asset purchase agreement for mark-up by the potential bidder. 

In many cases, a potential bidder may be a newly formed entity.  The owners of the new entity will be required to demonstrate that such owners have sufficiently capitalized the new entity or will honor such entity’s commitments.  This will require documents and other disclosures that will be submitted to the debtor and its professionals and other consulting parties.[2]

What is Credit Bidding?

Credit bidding[3] allows holders of interests that are not subject to a bona fide dispute to bid at a sale of the subject property.  This likely will be the debtor’s lenders.  This also could include a leaseholder.  For example, if a real property lease is part of the sale of assets, such lessor also could credit bid, using the “cure amounts” owed to it under the lease.[4]  In either situation, a party who may want to credit bid must make sure that the bid procedures allow for such credit bidding. 

Are There Any Benefits to Being the Stalking Horse Bidder?

In many cases, a debtor may have been negotiating with potential bidders, before or during the bankruptcy case.  Identifying a “stalking horse bidder” and getting court approval for such bidder helps the debtor by setting a floor price for the assets – it shows the court and creditors that the assets are worth at least the stalking horse price.  In exchange, the “stalking horse bidder” receives bid protections, which may include: (i) minimum bid requirements and overbid procedures; (ii) break-up fees, which is a fee paid to the stalking horse if the stalking horse is outbid and not declared the winning bidder; and (iii) reimbursement of expenses (such as professional fees expended) for its due diligence.[5]

Most stalking horse bidders likely have had much more time for their due diligence of the debtor’s assets.  Also, the form of asset purchase agreement used for the bid procedures is the form already heavily negotiated by the stalking horse bidder and the debtor.  If there are any other qualified bidders, they will make their proposed changes against the stalking horse bidder’s negotiated form. 

What Does “Free and Clear” Really Mean?

The Bankruptcy Code allows a debtor to sell its property free and clear of “interests”[6] when proper notice is provided to such holders   

What are “interests?”  The Bankruptcy Code does not define an “interest”.  Since the Congress used the word “interests” rather than liens and encumbrances, an “interest” is something else in addition to liens and encumbrances.  The key to determine whether “something” is an interest is whether the interest can be converted to a monetary claim (i.e, “washed off” the property). If yes, then the interest may be extinguished through a 363 Sale. 

Failure to provide notice all interest holders would prevent a buyer from taking such property “free and clear” of such interests.

Examples of interests could be, not only liens and encumbrances, but also easements and possessory interests under a lease. 

Does Highest Cash Price Always Win?

The cash portion of a bid may not necessarily be the determining factor when a debtor (in conjunction with the consulting parties) decides on the winning bid and the back-up bid.  Other considerations include, but are not limited to: (a) when will closing occur; (b) is closing dependent on obtaining certain contract consents or governmental approvals; (c) what contracts and leases will be a part of the purchase; (d) what liabilities will be assumed by the purchaser; and (e) will the purchaser hire the debtor’s employees.  These other considerations may become the primary consideration in determining the winning bid. 

What About a Transition Services Agreement?

Often, a debtor and purchaser will enter into a transition services agreement.  The purpose is to maintain ongoing business operations while waiting for contract and lease consents, assumption and assignment decisions, transferring employees and systems, and obtaining government regulatory approvals. 

Is There a Deadline to Decide What Contracts and Leases to Take?

Generally, the debtor will file a notice with the court, identifying potential contracts and leases that could be assumed by the debtor and assigned to the buyer at closing and the cure amounts due to the non-debtor counterparties.  As part of its bid, each potential bidder would indicate which contracts and leases that it is interested in and the cure amounts it will pay. 

In some cases, the non-debtor counterparty to such contract or lease objects, whether to the cure amount or to the proposed buyer.  Time may not be a luxury for either the debtor or the potential bidders.  While most debtors will push the bidders to make a decision by closing, some bidders may request that the deadline to assume or reject certain contracts and leases be pushed until after closing – giving the winning bidder more time to negotiate amended or new deals with various contract counterparties.

For the non-debtor counterparty, this has various risks, including whether there will be monies available to continue to pay for post-closing goods and services and which party (the debtor or the winning bidder) ultimately will be liable for those services and goods. 

What Should the Back-Up Bidder Know? 

The debtor will inform parties that it has chosen a winning bidder and a back-up bidder.  The debtor will seek court approval for both bidders.  If the closing of the 363 Sale does not occur with the winning bidder, the back-up bidder (already approved by the court) will step in and move forward with closing the transaction. 

For the back-up bidder, it becomes a waiting game.  While most 363 Sales close quickly, there are times when closings are delayed.  It will be very difficult for the back-up bidder to terminate its bid or get its deposit back due to a delay in closing with the winning bidder.  A back-up bidder may point to its outside closing date, arguing that it also should be able to walk away due to the winning bidder’s delays.  Word of caution – check the bid procedures order, which may override any outside closing date in a back-up bidder’s asset purchase agreement. 

Conclusion

A 363 Sale provides an opportunity to obtain a debtor’s assets free and clear of interests.  This process, however, is not without its own risks, including, but not limited to, due diligence issues, non-debtor contract and lease counterparties’ demands, and pressure to outwit other potential bidders.  Having a knowledgeable bankruptcy attorney by your side to navigate the world of 363 Sales is key, as the facts and circumstances of each bankruptcy case are different.

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[1] While the considerations discussed in this article likely will occur in most bankruptcy cases, careful consideration of your options will be based on the specific debtor assets and your own interests. 

[2] Depending on the size of the case, the debtor may have to consult with other parties and their professionals in determining the winning bidder and back-up bids.  These “consulting parties” may include the debtor’s lenders, bondholders, and the committee of unsecured creditors.  Outside of these consulting parties, there may be other parties that could impact which bidder is chosen, such as government entities (depending on regulatory approvals) and major contract parties (if their contracts are key to the sale). 

[3] See11 U.S.C. § 363(k).

[4] Under the Bankruptcy Code, a debtor may assume and assign an executory contract or unexpired lease to the buyer.  One of the requirements for the assumption and assignment is that the amounts due under such contract or lease be cured or paid to the non-debtor counterparty.  These are the “cure and assure” requirements.

[5] Courts may cap break-up fees at 3-5% of the purchase price.  Read the bid procedures order to confirm whether the breakup fee and reimbursement of professional fees will be considered as separate categories or subject to the same percentage cap. 

[6] See11 U.S.C. §363(f).

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