While the current outlook may be grim for the economy at large, the prospects of individual companies vary significantly, and some companies will continue to perform well despite the larger trends. For example, the designer retailer’s loss may become Walmart’s gain as consumers shop more closely for bargains. As the car manufacturers frequently say, “your mileage may vary.”
One such area where one company’s crisis may be another company’s opportunity is in the arena of corporate bankruptcy filings, which are expected to rise in 2009. For the company with a healthy balance sheet, and meaningful cash reserves or other access to capital, corporate bankruptcies can provide real opportunities.
Bankruptcy sales have become more and more common as companies have resorted to bankruptcy as a means to liquidate, rather than reorganize, a company’s assets. Commonly referred to as “Section 363 sales” (eponymously named for the Bankruptcy Code section from which they arise), they enable the debtor (or trustee) in a bankruptcy case to sell anything ranging from a single piece of equipment to the entire ongoing business enterprise. Under the terms of the Bankruptcy Code, proposed sales are subject to approval by the Bankruptcy Court, and generally (though not always) conducted through an auction process in which entities may bid for the assets offered for sale by a bankrupt debtor.
For those companies with available liquidity, Section 363 sales may provide an excellent opportunity to strengthen their existing operations through the strategic acquisition of individual assets or entire business units. Moreover, Section 363 sales provide the added benefit of having received the “blessing” of the bankruptcy court, without which a Section 363 sale cannot be concluded. Bankruptcy court approval can stave off the possibility of later challenges that the purchase was for less than fair value or somehow procedurally defective, and typically affords the purchaser the benefit of the safe harbor provisions of Section 363, which protect the integrity of the sale to a “good faith purchaser” in the event the order approving the sale is subsequently appealed. Of particular value to purchasers seeking to acquire entire business units, such sale orders may also contain provisions limiting or extinguishing any potential successor liability associated with the acquisition.
It is one of the great ironies of bankruptcy that it can be quite expensive for a company to declare itself bankrupt and file a petition for relief under the Bankruptcy Code. Combined with the ongoing cash flow needs of an ongoing business operation, many companies cannot successfully pass through a reorganization or liquidation in bankruptcy court without access to additional liquidity. The Bankruptcy Code addresses this need by permitting debtors to obtain “debtor in possession financing,” or “DIP financing,” to meet their ongoing liquidity needs.
In additional to the traditional methods of compensation (e.g., interest, fees), the Bankruptcy Code allows for a series of additional protections designed to compensate the lender who provides DIP financing to a debtor in bankruptcy. First, the typical DIP financing lender can – with court approval – obtain a first priority lien on any unencumbered assets and a second priority lien on encumbered assets. In a scenario where prepetition creditors have already imposed liens on all or substantially all the debtor’s assets, this may seem like cold comfort. However, the ability of a lender to obtain collateral to secure DIP financing is enhanced by the fact that the Bankruptcy Code nullifies the effect of “after acquired” property clauses by providing that property acquired by the debtor during the course of a bankruptcy case is not subject to liens granted prior to the bankruptcy case. Even in cases involving a debtor whose assets are fully encumbered at the start, a high turnover of inventory and receivables, for example, can nevertheless provide a steady stream of unencumbered collateral to secure DIP financing.
In addition, to the extent collateral is insufficient to fully secure a DIP financing loan, the Bankruptcy Code grants “superpriority” status to such loans to ensure that DIP financing loans are repaid before a single dollar is paid to other unsecured creditors, including other creditors entitled to priority treatment under the Bankruptcy Code. In less common circumstances, a DIP financing lender may even be granted a “priming” lien on already-encumbered collateral that takes precedence over all existing liens on such assets. In one of the other great ironies of commercial lending, corporate debtors in bankruptcy often make reasonably good credit risks because of these special protections offered to DIP financing lenders.
Although DIP financing is generally provided by banks and other traditional and nontraditional lending institutions, there is no requirement in the Bankruptcy Code that limits DIP financing to such institutions. Moreover, as some traditional DIP financing lenders have curtailed their own lending practices in response to the global credit crunch, the opportunity presents itself for other participants to step into the void and provide much needed liquidity to companies in bankruptcy.