Introduction

Acquiring assets from a bankrupt company presents unique opportunities for investors, business owners, and legal professionals. Understanding the intricacies of a Section 363 sale process, the role of a stalking horse bidder, and the dynamics of bankruptcy sales is crucial for navigating these complex transactions successfully.

What Makes Bankruptcy Asset Sales Unique?

Section 363 of the US Bankruptcy Code allows a debtor (the company or person in bankruptcy) to sell assets outside the ordinary course of business, typically through a court-approved auction process. This mechanism enables the sale of assets “free and clear” of existing liens, claims, and encumbrances, providing buyers with a clean title.

The section 363 sale process is a public auction. The debtor must market the assets and sell them through a court-approved auction process.

This process benefits buyers by offering:

• Expedited Transactions: Bankruptcy courts often prioritize swift asset sales to maximize value and reduce administrative expenses.
• Transparency: The auction process’s public nature ensures that all interested parties have access to information, promoting fair competition.
• Legal Protections: Court approval of the sale minimizes the risk of future disputes over asset ownership.

However, potential buyers must conduct thorough due diligence to understand the specific terms and any possible exceptions that might affect the sale.

Benefits of Buying Assets in Bankruptcy

Purchasing assets through a bankruptcy sale can offer several advantages:

• Discounted Asset Prices: Assets are often sold at reduced prices due to the distressed nature of the sale.
• Acquisition Free of Liens: Buyers can acquire assets free and clear of most prior claims. James Sullivan, partner at Seyfarth Shaw, notes that assets bought out of bankruptcy are often priced lower than when purchased through a typical M&A transaction and are acquired free and clear of virtually all liens, claims, and interests burdening the assets.
• Court-Supervised Process: The involvement of the bankruptcy court provides a structured environment, reducing the risk of undisclosed liabilities.
• Opportunity for Strategic Expansion: Buyers can acquire valuable assets, intellectual property, or business units that align with their strategic goals.

The Role of the Stalking Horse Bidder

A stalking horse bidder is an initial bidder chosen by the debtor to set the baseline bid for the assets. This arrangement establishes a minimum price, encouraging other potential buyers to participate in the auction. The stalking horse bidder often negotiates certain protections, such as break-up fees, to compensate for the risks associated with being the initial bidder.

Often in section 363 sales, there will be an initial ‘stalking horse’ bidder that will perform the initial due diligence on the assets to be sold and enter into an asset purchase agreement with the debtor for the sale of the property, subject to the possibility of higher and better offers being accepted at the auction.

Break-up fees are payments made to the stalking horse bidder if another bidder wins the auction. These fees compensate the initial bidder for the time and resources invested in setting the floor price. The debtor and the stalking horse bidder negotiate these bid procedures and may seek and receive input from others, including secured creditors. Richard Corbi of Corbi Law notes that a bidder might not win the assets despite all their upfront effort if the auction gets competitive.

The Auction Process & Competitive Bidding

The auction process in a bankruptcy sale is designed to maximize the value of the debtor’s assets. Key steps include:

1. Bid Procedures Approval: The debtor proposes bidding procedures, which must be approved by the bankruptcy court. These procedures outline the requirements for potential bidders and the rules governing the auction.
2. Marketing the Assets: The debtor markets the assets to attract potential buyers, providing necessary information to facilitate due diligence.
3. Submission of Qualified Bids: Interested parties submit bids that comply with the approved procedures by a specified deadline.
4. Auction Conducted: If multiple qualified bids are received, an auction is held where bidders can increase their offers competitively.
5. Selection of Winning Bid: The debtor, in consultation with creditors and subject to court approval, selects the highest and best offer, considering factors beyond just the purchase price.
6. Court Approval: A sale hearing is conducted where the court reviews the process and approves the sale to the winning bidder.
7. Closing the Sale: Following court approval, the transaction is finalized, and the assets are transferred to the buyer.

It’s important to note that the ‘highest and best’ offer isn’t solely determined by the monetary value. Cliff Katz explains that other considerations include the ability to close promptly, contingencies, and the impact on stakeholders.

Risks and Challenges of Bankruptcy Sales

While bankruptcy asset purchases offer attractive opportunities, they come with inherent risks:

• Due Diligence Constraints: The expedited nature of bankruptcy sales can limit the time available for thorough due diligence.
• Potential for Overbidding: Competitive auctions may drive prices higher than anticipated, potentially reducing the expected value proposition.
• Regulatory Approvals: Certain transactions may require approvals from regulatory bodies, which can introduce delays or complications.
• Successor Liability Concerns: Although assets are sold free and clear, certain liabilities, such as environmental obligations or union contracts, may transfer to the buyer under specific circumstances.
• Financing Challenges: Securing financing for distressed assets can be more complex, requiring lenders to be familiar with bankruptcy processes.

Jonathan Friedland explains that potential buyers of distressed companies often have the ability to influence whether the target company files bankruptcy at all, “Bankruptcy is just one tool among many that are available to a financially distressed company, and many transactions happen in the context of an Article 9 sale, a receivership sale, or an assignment for the benefit of creditors.” Friedland notes that “these other venues each have their relative pros and cons as compared to purchase through bankruptcy.” Editors’ Note: for more information on business bankruptcy alternatives, read Buying Operating Assets from a Distressed Seller and Dealing with Corporate Distress 18: Buying & Selling Distressed Businesses.

Private Sales in Bankruptcy

Not all bankruptcy asset sales involve public auctions. In some cases, a debtor may pursue a private sale, negotiating directly with a buyer without a competitive bidding process. This approach can be advantageous when:

• Time Is of the Essence: Private sales can be faster, avoiding the time-consuming auction process.
• Limited Market Interest: If the pool of potential buyers is small, a private sale may be more practical.
• Confidentiality Concerns: Private negotiations can keep sensitive information out of the public domain.

However, private sales still require court approval, and the debtor must demonstrate that the sale serves the best interests of the estate and its creditors.

Special Considerations for Foreign Buyers

Foreign investors interested in acquiring US assets through bankruptcy should be aware of additional considerations:

• Regulatory Compliance: Transactions may be subject to review by the Committee on Foreign Investment in the United States (CFIUS), especially if they involve sensitive industries.
• Currency Exchange Risks: Fluctuations in exchange rates can impact the overall cost of the investment.
• Legal Representation: Engaging US-based legal counsel is essential to navigate the complexities of the US bankruptcy system.
• Tax Implications: Understanding the tax consequences in both the US and the investor’s home country is crucial for effective planning.

Conclusion: Is a Bankruptcy Purchase Right for You?

Acquiring assets through bankruptcy can be a strategic move, offering access to valuable assets at potentially discounted prices. However, it’s essential to approach such opportunities with a clear understanding of the process, associated risks, and legal implications. Engaging experienced legal and financial advisors is crucial to navigating the complexities of bankruptcy.

To learn more about this topic, view Advanced Bankruptcy Transactions / Purchasing Assets in Bankruptcy. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested in reading other articles about purchasing distressed assets.

This article was originally published here.

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