The COVID-19 pandemic has resulted in an unexpected and unprecedented disruption for many companies. As a result of the economic slowdown, some affected companies are facing a sudden liquidity crunch that could threaten the viability of their businesses going forward. As material payment obligations approach, illiquid companies may be required to consider formal reorganization proceedings such as Chapter 11 bankruptcy filings in order to preserve going concern values of their business and assets. As part of that strategy it may be wise to consider a strategic sale of assets to generate much-needed cash flow. While the current environment may cause a depression of asset value or make values uncertain, bankruptcy sales can be advantageous if a quick resolution to debt distress is needed.
For buyers, distressed acquisitions present a special opportunity to purchase assets at a discount while avoiding the risks of taking on unwanted liabilities. The unique nature of the Chapter 11 bankruptcy process enables purchasers of distressed assets to receive value-enhancing protections that would otherwise be unavailable to them in a more standard purchase of assets or merger.
General Considerations Surrounding Distressed Asset Sales
Selling assets—whether through a bankruptcy process or otherwise—can help distressed companies eliminate unprofitable business divisions and sell other properties that no longer fit into the company’s goals, transforming those assets into cash at a time when other sources of liquidity may be unavailable. From a buyer’s perspective, a distressed sale may present a strategic opportunity to enter a new business space, expand into an untapped market, or optimize current operations with additional synergies.
In determining whether to conduct a private sale or sell assets in a bankruptcy proceeding, a company may evaluate a number or relevant factors, including the marketability of and demand for the assets being offered, the size of the contemplated sale, timing pressures, fiduciary duties owed by the board to the company’s stakeholders, liabilities associated with the assets, and sensitivity to adverse publicity. Certain of these factors may be particularly important to buyers, and sellers who design their sale process with the concerns of prospective buyers in mind may generate more interest and ultimately realize a greater return for their assets.
This article outlines the most common processes by which distressed assets may be sold, summarizing the primary advantages and drawbacks associated with each option.
Selling Assets Outside of Bankruptcy
Advantages
A distressed company may elect to liquidate assets through a normal marketing and sale process. For a private company that is a seller, the advantages of selling outside of bankruptcy are manifold. A private sale can be done discreetly and in a manner that avoids the negative publicity and harm to brand reputation associated with a bankruptcy filing. It also allows the company’s management to focus on the sale and on ongoing business operations, without the distraction of simultaneously overseeing bankruptcy proceedings.
Private sales also have the advantage of allowing the seller and buyer to retain a large degree of control over the transaction structure, without judicial or creditor interference. Deal protections, such as exclusivity provisions, lockups and breakup fees, encourage prospective purchasers to expend resources diligencing the marketed assets, and are more likely to be enforceable at contractually agreed upon levels in a private sale than in a bankruptcy case.
For sellers, direct costs associated with a private sale tend to be significantly lower than those incurred in bankruptcy. That said, if a distressed company is headed for an inevitable bankruptcy filing, the total costs associated with selling its assets may actually be lower if the sale is conducted as part of the bankruptcy process, as bankruptcy courts tend to closely scrutinize fees (namely, those of professional advisors and those related to deal protections) and may intervene to disallow fees deemed to be inequitable.
Risks
Distressed asset sales outside of bankruptcy involve significant risks, many of which are borne by prospective purchasers.
One of the foremost risks is that the underlying transaction may be subject to judicial review and avoidance by the presiding bankruptcy court if the seller eventually files for bankruptcy. The buyer and seller run the risk that a bankruptcy court reviewing the equities of the extrajudicial transaction will review whether the debtor-seller received less than “reasonably equivalent value” for its assets and, as a result, order an ex post facto unwinding of the transaction as a fraudulent transfer. In fact, individual creditors or creditors’ committees may insist that the transaction be investigated, and a fraudulent suit be instituted as a method to reach a “deep pocket” for recovery. Accordingly, even if the transaction is ultimately found not to have been a fraudulent transfer the buyer may be subjected to significant litigation and settlement costs. A transaction approved by a bankruptcy court would avoid this risk entirely.
A buyer of distressed assets also runs the risk that the seller, if it files for bankruptcy, will reject the asset purchase agreement (to the extent that ongoing obligations exist) and/or any related agreements, such as a shared services contract or transition services agreement. When a debtor rejects a contract in bankruptcy, the counterparty is left with nothing more than an unsecured claim equal to the amount of damages resulting from the rejection. A purchaser relying on a seller’s continued adherence to the terms of a contract executed prior to a bankruptcy filing should consider whether its seller-counterparty is likely to file for bankruptcy in the future, and whether in the event that it does, the rejection of the contract would significantly affect the overall value the purchaser stands to receive in the transaction.
Additionally, in a private sale, prospective purchasers generally have less ability to “cherry pick” desirable assets out of a seller’s business unit and, as a result, may be forced to take on value-draining property and liabilities along with the targeted assets the purchaser seeks to acquire. A purchaser may also be deemed to take on liabilities that it did not expressly assume, in the event that a creditor is successful in pursuing a successor liability claim. In bankruptcy sales, on the other hand, it is common practice for courts to reduce or eliminate a purchaser’s exposure to liability for existing claims related to the acquired assets.
Selling Assets in Bankruptcy
Unlike private asset sales conducted outside of a court’s jurisdiction, a sale of assets via bankruptcy proceedings necessarily implies a high degree of court oversight and adherence to the statutory provisions of the Bankruptcy Code. The framework provided by the federal bankruptcy process creates greater certainty and finality for the parties to the transaction. This can generate increased demand for the marketed assets and often provides unique opportunities for transacting parties to explore value-additive deals not available elsewhere. However, the formalities of the bankruptcy process can also create impediments to the buyer and seller’s desired transaction structure.
Bankruptcy offers three primary sale vehicles: a 363 sale; a pre-packaged plan sale; or a plan sale negotiated after a bankruptcy filing.
Conducting a 363 Sale
A 363 sale, which gets its moniker from section 363 of the Bankruptcy Code (governing the use, sale or lease of properties), allows a debtor to sell assets as part of its bankruptcy proceedings, even if such assets constitute substantially all of its assets or business. 363 sales almost always require that the assets be sold pursuant to a public auction. The 363-sale process often involves selection of a “stalking horse” bid—a starting point that serves as a baseline for all subsequent bids. The stalking horse bidder usually has more time than other bidders to conduct diligence, and is typically entitled to certain protections, including a break-up fee and expense reimbursement in the event that the seller selects a higher bid at auction or otherwise terminates the deal.
Often, the stalking horse bid is chosen prior to the actual bankruptcy filing and an asset purchase agreement is executed simultaneously with the bankruptcy filing. In such cases, the motion to approve bidding procedures (discussed below) is filed immediately after the bankruptcy petition. This is especially important if the going concern business is a “melting ice cube” and the sale must occur quickly. However, 363 sales can also occur during the course of any Chapter 11 already in progress. One of the main benefits of the 363 sale is that it can close without the need to await the cumbersome negotiation process among the debtor and its various creditors over a plan of reorganization.
Regardless of whether the 363 sale timeline begins before or after the bankruptcy filing, the process typically starts with the debtor-seller marketing its assets to gauge interest and attract potential purchasers. After receiving offers from prospective buyers, the debtor-seller will conduct an unofficial mini-auction to select the stalking horse. If this preliminary process is successful, the debtor will execute an asset purchase agreement (APA) with the selected stalking horse bidder; otherwise, the debtor can proceed without a stalking horse. The duration of this pre-auction negotiation period can vary significantly depending on the parties’ level of urgency and the complexity of the transaction; generally, it takes anywhere between one to four weeks for the parties to agree upon terms and execute a stalking horse APA.
Once the stalking horse APA is finalized, whether simultaneously with the bankruptcy filing or at a later time, the debtor-seller will file a motion seeking approval of the APA and bidding procedures (including deal protections). A hearing to approve the bidding procedures is typically held on 21 days’ notice, though this timeline can be shortened “for cause.” At the conclusion of the bidding procedures hearing, the court will usually enter an order approving the bidding procedures and APA, subject to any modifications it may deem to be appropriate. The debtor-seller will then remarket the assets, now supported by a baseline stalking horse bid. This bidding period typically lasts between four and six weeks. In some instances, there is no competition for a debtor-seller’s assets and an auction proves to be unnecessary—in such cases, the lone bidder can acquire the debtor-seller’s assets swiftly after obtaining court approval and the parties can close the sale on an expedited timeline. Where competitive interest does exist and multiple qualified bids are submitted, the debtor-seller will move forward with a public auction a few days after the conclusion of the bidding period. At the auction (which can last anywhere from a few hours to a few days), the debtor-seller will ultimately select the bid that, in its business judgment, it deems to be the highest and best. The debtor-seller’s selection is sometimes made in consultation with other interested parties such as major creditors and creditors’ committees, and is always subject to bankruptcy court approval.
A few days after the conclusion of a successful auction, the debtor will conduct a sale hearing to seek the court’s approval of the winning bid. Shortly after the sale hearing, subject to any objections, the court will typically enter an order approving the sale. By default, the closing of the sale is stayed for 14 days after entry of the order, during which the sale may be appealed; however, the court has the discretion to, and often will waive the 14-day stay to allow the sale to close immediately.
It is important to keep in mind that the bidding procedures, the auction process, and the sale itself can be challenged by various stakeholders. This bears noting because of the frequency with which disagreements between creditor constituencies occur, thereby delaying the sale timeline and sapping value from the transaction.
Perhaps the most significant advantage of a 363 sale is that it allows the purchaser to acquire the assets free and clear of all liens, claims, encumbrances, or other interests of other parties, so long as certain conditions set forth in section 363(f) of the Bankruptcy Code are satisfied. Also, importantly, prospective buyers are usually given the latitude to submit bids for strategic assets, rather than a comprehensive bid for all assets marketed by the seller. The seller can then evaluate the bids it receives holistically, comparing discrete bid packages and determining which package or combination of packages represents the best overall return for the assets being sold. Relative to a sale pursuant to a Chapter 11 plan, a 363 sale can move much more quickly, as the transaction can be closed shortly after entry of a court order approving the sale without waiting for court approval of a plan of reorganization providing for how the proceeds will be distributed amongst various creditor classes. A related advantage is that the sale cannot be undone by a later reversal or modification of the sale order, as long as the court order approving the sale includes a finding that the purchaser has acted in good faith. Transactions conducted in the bankruptcy context also avoid fraudulent transfer and preference inquiries that can threaten to derail or unwind out-of-court asset sales conducted pre-bankruptcy and avoid the rejection of transition services or similar post-close agreements described above.
Selling Assets Pursuant to a Pre-Packaged Plan
Another sale method that has become increasingly popular in recent years is the pre-packaged plan. Generally speaking, a sale pursuant to a plan provides more flexibility than a 363 sale by allowing the parties more options in structuring the transaction and dictating the use of proceeds.
In any successful Chapter 11 case, the plan of reorganization (or liquidation) is confirmed by the court at the end of the bankruptcy process. The plan sets forth the mechanics of creditor recoveries and the allocation of the debtor’s assets upon emergence from bankruptcy, and in some cases, it may provide for the sale of property of the debtor’s estate. A Chapter 11 plan—whether pre-packaged or otherwise—must comply with several important requirements imposed by the Bankruptcy Code, including acceptance by certain classes of creditors, greater recoveries for creditors than would be obtained in a Chapter 7 liquidation, and payment of priority claims in full. In general, a buyer of a debtor’s assets pursuant to a plan becomes more intimately involved in the bankruptcy process than does a buyer in a 363 sale, so a plan sale may be more appropriate where the prospective buyer is willing and able to play an active role in the proceedings.
A pre-packaged plan, which requires a debtor-seller to construct a plan of reorganization and secure requisite votes for acceptance of the plan prior to filing for bankruptcy, materially reduces the time that the debtor-seller spends in bankruptcy. Thus, a pre-packaged plan represents a particularly attractive alternative to other bankruptcy sales by minimizing court interference in negotiations, and thereby reducing transaction costs and disruption to business continuity.
By harnessing the authority of the Bankruptcy Code to extinguish debts and transfer assets free and clear of liens and liabilities while minimizing the bureaucratic procedures and oversight involved in the bankruptcy process, a pre-packaged plan, in some sense, allows sellers and buyers alike to have their cake and eat it, too.
However, although a pre-packaged plan is, for the reasons described above, often viewed as the premier commercial sale option in the bankruptcy context, such a plan often isn’t considered a realistic option due to the heightened level of pre-bankruptcy cooperation between stakeholders with competing interests that is required to effectuate it. In the context of a pre-packaged plan, the success of the sale transaction remains inextricably linked to the achievement of plan consensus, which must be reached without the usual shepherding presence of the court. The buyer and seller should be mindful that the lengthy negotiation period generally required to reach consensus on a pre-packaged plan can be very disruptive to the debtor-seller’s relationship with its trade creditors. Such disruptions can threaten to damage the viability of the assets being sold or otherwise create operational headaches for the seller.
Selling Assets Pursuant to a Plan Negotiated After Bankruptcy Filing
Finally, a debtor-seller may elect to sell distressed assets via a Chapter 11 plan of reorganization or plan of liquidation that is negotiated with stakeholders after a bankruptcy filing.
A plan negotiated post-petition generally represents the lengthiest of all the sale options available to sellers of distressed assets. The traditional plan timeline requires extensive notice periods, which are often extended as the various stakeholders try to reach agreement on a plan that satisfies statutory requirements. This process typically results in many months passing between the filing of the Chapter 11 petition and the plan becoming effective (at which point any sale pursuant to the plan may finally close). That said, for a debtor that doesn’t have the luxury of time to engage in extensive pre-bankruptcy negotiations, negotiating a plan and any associated asset sales after filing for bankruptcy may be the best available option.
A company exploring options for selling assets in light of disruptions caused by COVID-19 should consult with restructuring counsel to evaluate available tools and establish a value-maximizing strategy.
