The continued uncertainty in the stock market coupled with the coming wave of loan maturities have left investors looking for alternatives asset classes and different places to park their money.
One area investors might want to take a look at is bankrupt and distressed companies.
Many well-known and sophisticated investors have made fortunes in distressed companies, and family offices have also turned their attention to the opportunities in this arena.
Investors interested in purchasing discounted assets and entities, investors willing to consider creative purchase options and structures, and those open to a transaction requiring court approval may find the bankruptcy process to be an attractive alternative to other types of securities.
In analyzing this opportunity, this article provides a brief overview of the bankruptcy process (focusing on Chapter 11 bankruptcy cases) and discusses the two principal ways of acquiring assets or equity through a bankruptcy case.
Brief Bankruptcy Primer
The bankruptcy process is governed by federal law and administered by federal bankruptcy courts throughout the United States and its territories. Bankruptcy judges are accustomed to overseeing large cases involving complicated issues of fact and law (think of General Motors, Lehman Brothers, Washington Mutual and WorldCom).
The "debtor" is the company that files for bankruptcy. Nearly any type of entity is permitted to commence a bankruptcy case with a voluntary petition. There is also a mechanism whereby a group of creditors (in most circumstances, three or more) can file an "involuntary petition" to force a debtor into bankruptcy. The filing of a bankruptcy petition creates a fictional "estate" that generally includes all of the debtor's present and future assets.
Upon filing, the debtor, through its officers and directors, often continues to manage its affairs as a "debtor in possession," or "DIP." In certain circumstances, usually involving fraud or gross mismanagement, a trustee will be appointed. The trustee takes over management of the debtor and displaces the officers, directors and shareholders.
Although it is called the "reorganization" chapter of the Bankruptcy Code, Chapter 11 offers a company the flexibility to accomplish various objectives, including a traditional restructuring, a debt-for-equity swap, a sale of equity or a sale of its assets as a going concern. Sometimes Chapter 11 is used for a straight liquidation or a "going out of business" sale.
Section 363 Sales
In recent years, the prearranged sale of assets has become the most prevalent type of bankruptcy filing.
Section 363 of the Bankruptcy Code allows companies to sell some or all of their assets outside the ordinary course of business, and it requires the approval of the bankruptcy court. If structured properly, so-called "Section 363 sales" are an efficient way to sell the debtor's assets. The debtor company has a great deal of flexibility in structuring these sales-so long as the process is transparent and its goal is to maximize value-even when creditor claims will be wiped out.