Buying Assets from a Bankrupt Company

My friend and very good client, Andy, owns a boat making company.  Not the best business to own in a bad economy.  He is faring better than his competitors because he is always looking for opportunities.  He learned a competitor was having a tough time and was contemplating bankruptcy.  For Andy, this was an opportunity to acquire assets for a bargain and diversify his product.  Andy was able to strike a deal with the competitor and the competitor's lender to purchase the assets through a bankruptcy for less than 25% of the assets' market value.  Not only would he get a steal, but the diversification would help his business weather the bad economy.

The current economic environment provides great opportunities to purchase assets of distressed companies through the bankruptcy process.  A sale under Section 363 of the United States Bankruptcy Code ("Section 363 Sale") can present buyers with many benefits that cannot be obtained in sales outside of bankruptcy.

This article provides a brief overview of the typical Section 363 Sale process, recognizing that each Bankruptcy Court has its own preferences.

Sale Process

The Section 363 Sale process in bankruptcy is straightforward.  The debtor first markets its assets to possible purchasers.  Assuming one or more potential purchasers makes an offer to purchase the debtor's assets, the debtor then selects what it considers the highest or best bidder to act as the "stalking horse" bidder.  The debtor and the stalking horse bidder then negotiate an asset purchase agreement.  After a tentative agreement is executed with the stalking horse bidder, the debtor files a motion with the Bankruptcy Court seeking approval for the debtor to sell its assets at a bankruptcy auction and approval of the bid procedures that will govern the conduct of the ensuing auction process.

Bid procedures generally are negotiable.  The procedures will provide for the scheduling and notice of the auction and a deadline for prospective buyers to submit bids.  The procedures are intended to encourage competitive bidding in order to maximize the value of the assets.  The procedures also will include provisions to address the risk to the stalking horse bidder that it will be outbid at the auction, such as allowing for the stalking horse bidder to receive a break-up fee and expense reimbursement, and requiring minimum bid increments (e.g., how much higher a subsequent bid must be in order to defeat the stalking horse bidder's offer).  The debtor and the stalking horse bidder negotiate these bid procedures and may seek and receive input from secured creditors and others.

The debtor may file a motion asking the Bankruptcy Court for an expedited hearing to consider the bid procedures.  If the Court grants the motion, the Court may approve the procedures within several days.  The debtor then will notify its creditors and potential bidders of the auction.  Normally, the time period for submitting bids is 20 to 30 days after the Bankruptcy Court approves the bid procedures.  (The process may be shorter or longer depending on circumstances present in the case.)  However, the process must provide adequate time for the debtor to provide bidders with due diligence information.  The auction then is held, and the debtor will select the highest and best bid at the auction.  If there are no other bidders, the auction is cancelled and the stalking horse bidder is the successful bidder.

The next step is for the debtor to seek the Bankruptcy Court's approval to sell its assets to the successful bidder.  The debtor must establish that there is a sound business purpose for selling its assets.  Creditors and other parties in interest are entitled to object to the sale.  The Bankruptcy Court is required to consider the interests of all parties (including whether the asset is increasing or decreasing in value) in determining whether or not to approve the sale of the debtor's assets pursuant to the auction.

Benefits and Risks

A properly conducted Section 363 Sale benefits all major parties in a bankruptcy case.  Debtors fulfill their fiduciary duty to maximize the value of their assets for their creditors.  Secured creditors know that if the sale has been conducted according to procedures approved by the Bankruptcy Court, the best price has been obtained.  Also, each creditor has the option to "credit bid" – that is, offer cancellation of the debt owed by the debtor to the creditor as the creditor's bid.  Unsecured creditors sometimes can obtain a carveout from proceeds of a secured creditor's collateral.  Buyers acquire the assets free and clear of liens or other claims and obtain other protections, such as rubber-stamp approval that the sale was in good faith.  Individual creditors also have the opportunity for the buyer to assume certain contracts, thereby curing any defaults under those contracts. 

Of course, there are risks.  For one, the terms of the deal are made public.  Further, affected parties are included in, and may complicate, the negotiations of the stalking horse bid and the bid procedures.  In addition, buyers need to understand that their offers typically will be subject to higher and better bids, meaning that the buyers run the possible risk of being outbid.

Andy didn't follow this process closely enough and the Bankruptcy Court denied the proposed sale.  Andy got greedy.  He tried to limit the competitive bidding allowed under the sale procedures.  The Bankruptcy Court felt those procedures would chill the bidding and prevent the other creditors from getting full value for the sale of the assets.  What's more, because Andy chose not to implement the stalking horse concept, he was not able to recoup the time and money he spent in trying to put the deal together.

Conclusion

The current economic climate offers opportunities to buyers who understand the sale process in bankruptcy to purchase assets of a distressed company at a bargain price.  However, the flexibility and efficiency afforded by Section 363 Sales are not without limits or risks.  While Section 363 Sales are used frequently due to the benefits the process provides to the bankruptcy, the process requires an appropriate evidentiary showing and careful planning.

For further information regarding the issues described above, please contact Paul A. Fanning.

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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.