Energy industry bankruptcies of all types are expected to increase, offering an opportunity for companies to acquire assets for their operating portfolios while taking advantage of the bankruptcy process. We have received numerous inquiries about how the bankruptcy process can be used to acquire assets. This Insight provides answers to frequently asked questions about what is known as the 363 or "stalking horse" bankruptcy auction process.
WHAT IS THE OPPORTUNITY?
Rapid and unexpected fluctuations in regulation, fuel demand and pricing, power demand and conservation, import and export issues, and construction and labor costs can easily push a company teetering on the edge of financial solvency over the edge and into bankruptcy. The recent bankruptcy filings of Energy Future Holdings and affiliated entities shows that even large and highly-diversified energy companies can be pushed beyond their limits. Spotting companies that are on the edge and being prepared to act quickly can put someone seeking to acquire assets in a favorable position to take advantage of the bankruptcy auction process.
THE BANKRUPTCY AUCTION
Instead of proposing a plan of reorganization, bankruptcy debtors are increasingly electing to sell their assets through what is known in bankruptcy as a "363 sale." Selling assets, rather than reorganizing, occurs frequently in cases involving complex markets (such as energy) and can present opportunities to acquire assets at below market prices, to leave the seller's liens and liabilities behind, and to cherry-pick the seller's most lucrative contracts – even in situations where others are looking to purchase these same assets.
THE BANKRUPTCY CODE OFFERS ADVANTAGES AND PROTECTIONS FOR "STALKING HORSE" BIDDERS
Section 363 of the Bankruptcy Code establishes a court-managed process through which a debtor often sells everything it owns. These auctions provide an opportunity for companies interested in a debtor's assets and who are prepared to act quickly. Under the Code, an initial bidder in a "363 sale" called a "stalking horse" can negotiate a comprehensive agreement to purchase assets from the debtor. The resulting agreement is then used as the benchmark against which other parties' bids are measured. Essentially, other bidders must exceed the stalking horse agreement to remain in the auction.
Being a stalking horse bidder offers a buyer notable advantages over other bidders, the most significant of which usually include more time to assess important financial information, an opportunity to conduct other due diligence prior to negotiating the purchase agreement, and setting terms in the purchase agreement to control how the asset purchase transaction will be structured. Procedural protections built into the bankruptcy 363 sale process offer additional advantages that a stalking horse can often incorporate into the auction process during the purchase agreement negotiations. These protections include:
- A break-up fee between 2% and 5% of the sale price
- Expense reimbursements
- The imposition of minimum increments for competing bids and qualification requirements for any competing bidders
- Strict deadlines for competing bids
- Favorable timelines for the auction, final court approval, and closing of the transaction
BUYERS TAKE ASSETS FREE AND CLEAR
When a debtor seeks permission from a bankruptcy court to sell its assets, it virtually always asks to do so "free and clear" of existing liens and other liabilities to get a higher price for their assets. In the 363 sale context, the term "lien" includes everything from UCC security interests to judgments. In addition, past bankruptcy court rulings make it clear that, absent extreme circumstances, buyers in a 363 sale do not inherit responsibility for past environmental liabilities, regulatory issues, or tort claims that were, or could have been, asserted against the debtor. In the energy context, the opportunity to acquire assets without concerns of there being a skeleton in the closet is significant.
DEBTORS' CONTRACTS: ASSUME THEM OR REJECT THEM?
Debtors in bankruptcy have the option to assume or reject executory contracts, i.e., those contracts under which both parties are still under an obligation to perform. In a 363 sale context, this option is extended to the buyer subject to limitations relating to past due amounts. This option can be used by a buyer as leverage to renegotiate existing contracts that, if modified, a buyer may wish to retain. While FERC-approved energy contracts can be rejected, the standard for such action is typically based on the more stringent "public interest" review and not the typical "just and reasonable" review, and a bankruptcy court may consider FERC's view of the public interest considerations before allowing rejection.
HOW CAN YOUR COMPANY TAKE ADVANTAGE OF THIS POTENTIAL OPPORTUNITY?
Monitoring 363 sale opportunities nationwide can be challenging. It is critical, of course, to maintain a sense of industry trends and pay close attention to specific companies that may be under financial distress. In our experience, the most effective approach involves maintaining a network of well-connected industry players, and legal and financial professionals that are motivated to identify new opportunities as they arise. These contacts can help your company obtain important information about upcoming bankruptcy filings and potential asset sales before your competitors are able to do so. Sophisticated professionals may also be willing to work cooperatively with your company to develop an active plan for finding and taking advantage of 363 sales that present unique opportunities to grow your company quickly with limited risk.