As is the case with a transaction outside of bankruptcy, a buyer looking at a distressed company can identify any liabilities that it might want to assume and those assets that it would acquire, including real property, personal property, contracts and leases, as well as those items it would like to exclude. Bankruptcy courts, meanwhile, regularly approve mechanisms to limit disruptions to the debtor company's business as a result of either the bankruptcy or the transaction. These mechanisms include transition service agreements and consulting agreements.
Section 363 sales have a number of advantages over transactions conducted outside bankruptcy. For example, if the buyer is also one of the company's creditors with a lien on the assets, Section 363(k) of the Bankruptcy Code allows the creditor to "credit bid" the entire amount of the debt. A third-party buyer (that is not a creditor) also can take advantage of this, reaching a deal to buy a lender's claim-often at a steep discount-and get a substantial leg up on the competition via the credit bid.
"Credit bid" is a term of art. It's the ability of lenders to essentially repay themselves without having to lay out the money. The following example should help illustrate one of the benefits of a strategy like this. Say a company called Deadbeat Inc. borrows $10 million from a lender (MegaBank), which gets a first priority lien on all of Deadbeat Inc.'s assets. Deadbeat Inc. can't repay the loan, and its assets are no longer worth $10 million. Deadbeat Inc. identifies a potential buyer (Bargain Hunter). Bargain Hunter is willing to pay $5 million to buy all of Deadbeat Inc.'s assets.
MegaBank wants out, does not want to wait until the sale closes and is willing to accept $5 million and take a loss for the rest.
Bargain Hunter approaches MegaBank and buys the bank's loan. Bargain Hunter then enters into a stalking horse agreement to buy all of Deadbeat Inc.'s assets for $5 million. Since MegaBank had a first priority lien on all of Deadbeat Inc.'s assets, MegaBank is entitled to all of the sale proceeds, but since Bargain Hunter bought MegaBank's loan, Bargain Hunter gets the money. Instead of actually paying that money to itself, Bargain Hunter can "credit bid" under the Bankruptcy Code and thus reduce the amount of the loan by the amount of the purchase price.
Let's take this example a step further. Another buyer (OverPayer) comes in and wants to bid against Bargain Hunter. OverPayer offers $7 million and says that since Bargain Hunter only paid $5 million, Bargain Hunter is only entitled to be paid (and thus, credit bid) $5 million. The Bankruptcy Code protects Bargain Hunter and allows it to credit bid the entire amount of the loan (i.e., $10 million)-even though it paid less. Thus, OverPayer will need to pay more than $10 million to win the auction.
This is where the real benefit of acting early and buying out the bank comes in. Bargain Hunter gets the benefit of the entire discount it got in buying the loan-and can use it to outbid other bidders.
Furthermore, the order approving the Section 363 sale should give the buyer the following significant safeguards and protections:
Section 363(f) of the Bankruptcy Code says the debtor's assets can be transferred to the buyer free and clear of a wide variety of claims, liens, encumbrances and interests, and the sale order will include many determinations necessary to allow such a transfer. One makes sure that the buyer is not a successor and has no liability for the debts. There is also a waiver of bulk sales laws.
Once the sale is approved, the likelihood of an appeal is very slim. The appeal of a sale order will be deemed moot as long as the buyer acted in good faith. Thus, the finding of good faith in a sale order will give the buyer significant comfort, after it has invested time and effort, that the sale will not be reversed.
Since the sale goes on in a federal court-approved process, the risk of future litigation prompted by the transaction is greatly minimized. A transaction with a distressed company outside of bankruptcy, for instance, could be subject to fraudulent transfer claims by a creditor who asserts that the buyer did not provide fair consideration. Such litigation should be dismissed almost immediately in a bankruptcy case after the entry of a sale order (assuming that all parties acted appropriately).
Breakup fees, expense reimbursements and other bid protections designed to protect the buyer are also approved in nearly all cases. The bankruptcy court will often require that the assets be marketed for sale and that the debtor conduct a sales process, which includes implementing bid procedures. The usual structure of a process with bidding procedures includes the debtor identifying a "stalking horse" purchaser of the assets with whom it has negotiated and executed a definitive agreement for the sale of substantial assets. The stalking horse agreement would be subject to a competitive bidding process, but the stalking horse would be entitled to a breakup fee (usually around 3% of consideration) and possibly an expense reimbursement in the event that its offer is outbid. The debtor would seek approval of the breakup fee, expense reimbursement and any other bid procedures. The bid procedures usually set forth the requirements of any competing bids, including the required structure of the offer (for example, if it were all cash and came without financing contingencies); the deadline for the submission of competing offers; the minimum amount of consideration that must be given in the competing offer (which, generally, is the consideration under the stalking horse agreement plus the breakup fee and the expense reimbursement plus a minimum overbid); the rules for any auction of the assets, including the amount of bidding increments; and the approval of backup bids in the event the winning bidder does not close the transaction.
After the bankruptcy court approves the breakup fee and bid procedures, the debtor will run the sales process and hold an auction. Then the court will conduct a hearing to consider approval of the sale and determine whether the sale is an exercise of the debtor's business judgment (a fairly low threshold to meet). Assuming that no other government approvals are necessary, the sale can close soon after the court's approval. Depending on the facts, a sales process often closes days after court approval and the entire process is often completed within 60 days from start to finish.
The sale is often approved on terms very favorable to the buyer. The potential discounted value, the structure of the transaction and the timing of the sale can make the option highly attractive next to other investment opportunities.