Brief Overview of Sales of Going Concern Businesses and Distressed Real Estate
For various microeconomic or macroeconomic reasons, it is common to see a once successful company or previously valuable real property, at some point in time, become “distressed”. In those circumstances, it can be difficult for the owner of the business or real property to dispose of the assets due to layers of obligations, such as mortgages, liens, tax liens, judgment liens, and potentially burdensome tenant leases.
Under state law, selling such property with these competing interests can be slow, expensive, and uncertain. Further, the disposition of real property, for instance, through a foreclosure proceeding, often leads to a sale price that is much less than what may be achieved through an organized sale process.
In these circumstances, an owner of a going concern business or an owner of a real property asset may choose to file a chapter 11 bankruptcy case and utilize the automatic stay imposed by a bankruptcy filing (see section 362(a)) of the Bankruptcy Code) to stay any prepetition litigation and use the provisions of section 363 of the Bankruptcy Code to effect an orderly sale of assets. Unlike state law, in which all mortgages and liens must be paid in full with the consent of the holder of such mortgage or lien, under the Bankruptcy Code, the Chapter 11 debtor may be permitted to sell its business or property “free and clear” of such existing mortgages and liens and any other encumbrances, with such obligations to attach to the proceeds from the sale in the order of priority under the Bankruptcy Code and applicable law.
Sale orders also traditionally include provisions for the benefit of a purchaser that make clear to creditors with unpaid claims that the purchaser is not a “successor” to the selling debtor entity and that the price paid for the assets/real property was “reasonably equivalent” to the value of such assets/real property, thereby avoiding fraudulent transfer litigation that may otherwise ensue. Further, parties involved in a sale of real estate in a Chapter 11 case may utilize section 1146(a) of the Bankruptcy Code, which exempts sales from transfer taxes, which depending on the size of the real property, could result in millions of dollars in savings. Finally, aside from the foregoing, the Bankruptcy Code provides a mechanism for rejection of burdensome leases or, on the other hand, assumption and assignment of valuable leases to the buyer.
As a result of the foregoing, a buyer can get clear title when purchasing distressed assets from a bankruptcy estate and avoid the complexity of multiple liens and encumbrances on the chapter 11 debtor’s business and real property, which liens and encumbrances are removed from the public record, with the holders’ recourse limited to the available sale proceeds.
Case Study: Potential Sales of Other Types of Assets of the Estate, such as Litigation Claims
Earlier this month, in a recent Chapter 11 bankruptcy case of American Signature, Inc. (“Debtor”) [D. Del. Case No. 25-12105], a residential furniture retailer operating more than 120 stores across 17 states under the Value City Furniture and American Signature Furniture brands, the Debtor successfully sold its going concern business and real property assets through a court-supervised sale process to a newly formed entity called ASI Purchaser LLC (the “Purchaser”), an entity affiliated with the Schottenstein family, which had longstanding ownership ties to the business. Since the Purchaser was affiliated with the Debtor, through common ultimate ownership, the Purchaser is an “insider” under the Bankruptcy Code, thereby requiring heightened court scrutiny to ensure the sale transaction was fair and conducted in good faith. To address these concerns, the company established an independent conflicts committee and conducted a formal marketing process to solicit competing bids. No higher offers were received, and the court ultimately approved the Purchaser as the successful bidder after determining the transaction represented the best available outcome for creditors.
What makes this sale more unique than the usual section 363 bankruptcy sale was the inclusion of the Debtor’s estate’s litigation claims against the Schottenstein family in the list of purchased assets. Usually, litigation claims will be excluded from a sale of going concern assets and real estate to insiders. However, in this case, in the context of approval of the sale of the going concern assets and real estate, and after significant negotiations with the creditors committee appointed in the bankruptcy case, the sale included litigation claims, in which the Schottenstein-controlled Purchaser increased the purchase price by almost $11 million and provided other valuable consideration to the estate. The terms of the “settlement” between the Purchaser, the Debtor and the creditors committee were included in the Court’s sale order. The increased proceeds provided an immediate additional benefit to the Debtor’s estate without the need for potentially risky litigation against the Schottenstein family that would have been very expensive and which may not have been successful.
It is important to note that sales of litigation claims are rare but under appropriate circumstances, as demonstrated by the American Signature Inc. bankruptcy case. potential targets (oftentimes, a company’s shareholders or affiliates) can utilize the provisions of the Bankruptcy Code to “buy peace” from any future litigation claims by purchasing such litigation claims through section 363 of the Bankruptcy Code.
Conclusion
Bankruptcy sales can present attractive and often lucrative opportunities for parties seeking to purchase distressed businesses and real properties, free and clear of existing mortgages, liens and encumbrances, through a court-authorized process, overcoming hurdles that may otherwise face investors outside of bankruptcy.
Further, as noted by the American Signature Inc. case, bankruptcy sales also provide an avenue for insiders to purchase its’ companies assets or real property from the bankruptcy estate with full transparency and court approval, and in the rare case, purchase litigation claims against themselves.
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