The dearth of credit available for companies in financial distress means an asset sale may be the only way to save the business and jobs. It also presents unusually attractive investment opportunities for public and private companies, private equity and hedge funds, and other investors with capital and an ability to move expeditiously.
The recent asset sales of Chrysler and General Motors were each approved in fewer than 35 days and resulted in a complete restructuring of each corporation’s assets and liabilities outside a plan of reorganization through a sale under section 363(b) of the Bankruptcy Code (the “Code”). The ability to quickly restructure and acquire a complex, multi-national operating business in a section 363 sale in bankruptcy highlights the advantages of buying and selling assets in bankruptcy when a company is in financial difficulty. These advantages are even more pronounced when dealing with smaller financially distressed companies where there are fewer complexities.
Advantages of Asset Sales Within Bankruptcy
An asset sale may be conducted either outside of a plan of reorganization pursuant to section 363(b) of the Code or as part of a plan. The plan can be a reorganization plan or a plan of liquidation. A section 363 asset sale can be implemented and consummated more quickly and at far less cost than a sale done as part of a plan of reorganization, because the latter requires compliance with all of the detailed confirmation requirements of section 1129 of the Code, including approval of a disclosure statement and successful solicitation and voting on the plan.
There are other reasons why a sale of assets in bankruptcy is advantageous. First, a bankruptcy sale has the advantage of transferring title to the assets free and clear of any “interest” in the property to be sold. Consequently, assets can be sold “free and clear” of liens, claims and encumbrances, leaving the purchaser with clear title.
Second, a bankruptcy sale of assets may avoid the risk of successor liability for tort claims. However, there is uncertainty as to whether or not this risk, particularly as to future claims, may be entirely eliminated by conducting the sale of assets within the context of the administration of the bankruptcy estate. In Chrysler, prepetition claims for successor liability were cut off, but on appeal the Second Circuit did not address the ability of the bankruptcy court to eliminate future claims. In General Motors, the asset purchaser agreed to be responsible for future claims.
Third, leases and executory contracts are easier to transfer in bankruptcy, because restrictions on transfer such as anti-assignment clauses, which are generally enforceable outside of bankruptcy, are unenforceable in bankruptcy. Also, because unprofitable contracts and leases can be rejected by a debtor under section 365 of the Code, the buyer is able to pick and choose which contracts it wants to keep.
Lastly, sales outside of bankruptcy can be challenged under state law as fraudulent conveyances when creditors think the sale price is inadequate. The risks of fraudulent conveyance attack are eliminated when the asset sale is conducted under bankruptcy court supervision, since section 548 of the Code, which grants the trustee the power to avoid fraudulent transfers, applies only to pre-petition transfers. Moreover, the bankruptcy court approves the sale agreement and other terms, thereby giving the purchaser additional protection.
The Sale Process
- Due Diligence A company facing financial difficulty that wishes to sell its business to preserve its going concern value usually retains an investment banker to assist in the marketing and sale of the business. A “data room” or “e-room” with financial and operating information about the company will be made available to those prospective purchasers that sign a confidentiality agreement. A company that is insolvent has a fiduciary duty to its creditors and other stakeholders to maximize the value of its assets. Nonetheless, a buyer has the ability to take advantage of the distressed seller’s marketing efforts by conducting significant due diligence early in the marketing process. This should enable a buyer to obtain a clear understanding of the strengths and weaknesses of the business, which assets are desirable and should be acquired, which contracts should be assumed and which employees need to be retained. A buyer’s ability to conduct due diligence early in the process also will enable the buyer to structure the transaction and negotiate the asset purchase agreement in a manner that is most advantageous to the buyer, including various bidding protections that may make it more difficult for other interested purchasers to bid successfully for the assets.
- Sale Structures The structure of a sale for which bankruptcy court approval will be obtained can take many forms. It can be a straight acquisition of specific assets for cash or a combination of cash, notes and/or equity of the buyer. The consideration also can be structured as part cash plus the assumption of liabilities or just the assumption of liabilities. In certain circumstances, the buyer may want to structure the acquisition as a “loan to own” transaction, where the buyer either acquires the senior secured debt and/or makes a debtor-in-possession loan to the seller to finance the company’s operations until the sale is closed. Under this structure, the buyer obtains the right to credit its secured debt as either all or part of the consideration for the purchase price. This structure can give the buyer control over the auction and sale process, because the debtor-in-possession financing agreement can contain various milestones as to the timing of bids, the sale hearing, bid procedures and the duration of the debtor-in-possession financing.
- The Asset Purchase Agreement Once the buyer reaches an agreement in principle with the debtor for the purchase of the assets, the parties will negotiate and enter into an asset purchase agreement. Typically, the asset purchase agreement will contain provisions that the assets being sold are “as is” “where is” with “all faults” and that the sale is subject to higher and better offers and the approval of the bankruptcy court. A debtor/seller will try to limit the representations and warranties in the agreement. But if the buyer has negotiating leverage, the asset purchase agreement may contain certain representations and warranties that are usually found in a purchase agreement done outside of bankruptcy.
- Bidding Protections Because the asset sale is subject to higher and better offers at an open auction and also subject to court approval, prospective buyers should be reluctant to act as a “stalking horse” without some form of protection or compensation for their efforts. Because the seller wants a stalking horse bid that establishes a floor for the value of the assets as well as the terms and conditions of the asset purchase agreement that can be shopped to other interested bidders, the prospective buyer will have leverage prior to execution of a definitive purchase agreement to negotiate bidding protections and other bidding procedures that govern the auction, such as: (i) the timing of the date for other bids; (ii) the date of the auction sale; (iii) the amount of the break-up fee and/or expense reimbursement; (iv) the overbid amounts pursuant to which subsequent bids must exceed prior bids; (v) the amount of any deposit that must be submitted by a competing bidder; and (vi) the qualifications competing bidders must provide to demonstrate their ability to close the sale within the specified deadline.
The most common bid protection devices are break-up fees, reimbursement of due diligence expenses and minimum bidding increments. These bidder protection devices are not enforceable without court approval. A break-up fee is a payment of a sum of money to the stalking horse bidder if the sale to such bidder is not consummated because it was topped by another bidder’s higher offer or the seller terminates or breaches the agreement and the purchaser is not in default at the time of termination or breach by the seller. Break-up fees ranging from one to four percent of the purchase price are usually approved by bankruptcy courts. The purpose of the break-up fee is to compensate the initial or stalking horse bidder for the time and expense in entering into the transaction, as well as its lost opportunity costs. An expense reimbursement provision can be used in conjunction with a break-up fee to reimburse the initial bidder’s expenses in conducting its investigation of the seller’s assets, preparing its bid and negotiating a purchase agreement. Such expenses can include legal, accounting, investment banking and other professional fees and expenses incurred by the bidder, which typically are capped at a negotiated sum. Of all the bidding incentives, an expense reimbursement is the least controversial and the easiest for which to obtain court approval.
Minimum overbid amounts are the amounts by which competing bids must exceed the earlier bid. The amount by which the first opening bid must exceed the original offer equals the sum of any break-up fee and/or reimbursement expense plus the minimum overbid amount. Lastly, a buyer may be able to negotiate a windowshop provision, which prohibits the debtor from soliciting higher and better offers from other sources for a specified period of time, but allows the debtor to consider unsolicited offers, provide information and, under certain circumstances, accept a competing offer.
- The Auction and Sale Hearing Once the debtor and the initial bidder have entered into an asset purchase agreement, the debtor will file a motion to (i) approve the bidding procedures, including the date when other bids must be submitted, the amount of the deposit that must accompany a bid, the amount of the break-up fee and expense reimbursement, the overbid amounts and other rules that will govern the auction; (ii) set a hearing date and objection deadline with respect to the proposed bidding procedures; (iii) set the time, date and place of the auction sale; (iv) approve the proposed sale to the initial bidder or such other bidder making a higher and better offer; (v) set the time and date of the hearing to approve the sale and the assumption and assignment of executory contracts and leases; and (v) set the deadline for objections to the sale and the assumption and assignment of executory contracts and leases.
The Bankruptcy Rules require that not less than 20 days’ notice be given to all creditors and other parties in interest. The court may shorten the notice period for cause. When a sale involves substantially all of the debtor’s assets, it is not unusual for the process to take approximately 60 days or more, so that adequate notice can be given of the hearing on approval of bidding procedures, with sufficient time to allow the debtor to market the property and solicit higher and better offers prior to the auction. However, in an emergency, such as a limited time period imposed by a lender, the inability to finance continued operations, or threat of liquidation, the court has broad discretion to shorten the notice and hearing dates to ensure that the value of the debtor’s assets do not decline.
Standard for Obtaining Approval of a Sale of Assets Outside a Plan
Because the Code contemplates that the reorganization of the debtor will be undertaken in accordance with a plan for which detailed procedures on claims, classification, treatment, voting and disclosure must be followed, sale transactions of substantially all the assets of a company that constitute a sub rosa (clandestine) plan of reorganization or an attempt to circumvent the requirements for plan confirmation are prohibited. Accordingly, to obtain approval of a sale of substantially all of a debtor’s assets outside a plan, the debtor must prove that there is a good business reason for approval of the sale. In the case where the sale transaction has a sound business justification that can lead towards confirmation of a plan and is not designed to evade the plan confirmation process, the transaction is deemed proper. Courts will approve such sales when there are exceptional circumstances, such as the need to preserve and maximize the debtor’s going concern value and prevent liquidation, particularly where the company’s revenues are inadequate to support continued operations and there is no other financing available.
Both the Chrysler and General Motors cases are good examples of such exceptional circumstances. For instance, in both cases, newly government sponsored entities were formed to acquire substantially all of the assets of each debtor, so that the new company could operate free of burdensome entanglements with the old entities that remained in chapter 11 in order to liquidate the bad assets and resolve claims. In Chrysler, in exchange for the transfer of the assets to New Chrysler, New Chrysler agreed to assume certain liabilities of the old entity and pay old Chrysler $2 billion in cash. In addition, in consideration of a 20 percent equity interest with the right to acquire up to an additional 31 percent of New Chrysler’s equity, Fiat agreed to provide access to certain technology, distribution capabilities in other markets and other cost-saving opportunities. In General Motors, the old entity received approximately $45 billion of consideration plus the value of 10 percent of the post-closing outstanding shares of New General Motors for the sale of its assets to New General Motors. Given the fact that there were no alternative sources of debtor-in-possession financing, which financing would terminate absent prompt approval of the sale, no other competing bids and the alternative to an immediate sale was the liquidation of each company, the sales of Chrysler and General Motors were approved by the bankruptcy court very quickly — within 35 days of the commencement of each chapter 11 case.
The courts in Chrysler and General Motors concluded that each sale did not constitute a sub rosa plan, because in each case the applicable debtor would have remaining assets to distribute under a plan. Indeed, each sale brought in value that would be shared by creditors pursuant to a plan subject to confirmation by the court. The courts were not troubled by the fact that each purchaser was assuming certain liabilities and excluding others (such as bond debt), since the transaction structures were not deemed an attempt by the debtors to get around the Code’s distribution scheme. Nor were the courts concerned by the provision of equity ownership interests to certain pre-petition creditors (the United States Treasury, the Canadian government and the UAW union), since the courts reasoned that such allocation was “neither a diversion of value from the Debtors’ assets nor an allocation from the proceeds of the sale of the Debtors’ assets.” Notably, the Second Circuit, in affirming the approval of the Chrysler sale, noted the need for flexibility and speed to preserve going concern value and recognized that in certain circumstances a 363(b) sale may, in effect, be a reorganization.
The speed within which Chrysler and General Motors were restructured through a section 363 sale process demonstrates the efficacy of buying and selling assets in bankruptcy. In the current economy, where many companies face severe liquidity constraints and do not have sufficient financing, buyers should be able to acquire financially distressed businesses and restructure them through use of a 363 sale with the guidance of sophisticated professionals. In particular, with a plethora of distressed companies, a dearth of debt capital, an abundance of equity capital and general investor caution in the marketplace, aggressive companies and funds have an unusual opportunity to buy troubled firms, pare expenses and realize healthy investment returns.