After languishing for several years in the doldrums, the economy has finally caught some wind in its sails. Banks are back in the lending business, and owners and investors are shifting from asset protection to asset acquisition. While it might seem counterintuitive, an improving economy does not necessarily mean there will be fewer business bankruptcy filings. Further, a business bankruptcy filing very often presents a profit opportunity for parties who understand the dynamics of a bankruptcy sale and who are prepared to participate in a complicated, fast-moving sale process.
More filings in a stronger economy
There are two types of business bankruptcy filings—Chapter 7 and Chapter 11. While there can be acquisition opportunities in a Chapter 7 case, the process is fairly straightforward. Typically, the interested party negotiates one on one with the Chapter 7 trustee and, aside from bankruptcy court approval of the proposed sale, the process does not differ greatly from an asset acquisition outside of bankruptcy.
Chapter 11 cases are a different matter altogether. Upon the filing of a Chapter 11 bankruptcy, the company (known as the "debtor-in-possession" or, more commonly, the "debtor") continues operating with the same management team that was in place prior to the filing.
A business may use a Chapter 11 bankruptcy filing for a number of different purposes. The debtor might file Chapter 11 with the intention of reorganizing and eventually emerging from bankruptcy pursuant to a plan of reorganization. Alternatively, Chapter 11 filings are frequently used as a vehicle for selling assets, up to and including the sale of the entire company. Such sales can take place pursuant to a plan of reorganization, or may be conducted outside of the plan context. Sales outside of the plan context are referred to as "363 sales," in reference to the applicable section of the Bankruptcy Code.
The frequency (or infrequency) of Chapter 11 bankruptcy filings are not necessarily tied directly to the performance of the economy. The costs of a Chapter 11 bankruptcy is an important factor in the relationship between bankruptcy filings and the economic environment. A Chapter 11 bankruptcy case has the potential to be expensive. To deal with the expense, a debtor frequently must secure debtor-in-possession financing to "pay for" the bankruptcy case.
During the credit crunch of the past few years, DIP financing loans were few and far between. For this reason, companies that otherwise would have benefited from a Chapter 11 bankruptcy either did not file bankruptcy or had no choice but to file a Chapter 7 liquidation. However, now that banks are lending again, more Chapter 11 bankruptcy filings are likely to occur, as Chapter 11 once again becomes a viable alternative for companies needing to reorganize their debts, sell assets, or both.
Chapter 11 asset sales
In practice, Chapter 11 is used for a number of different purposes. One such purpose is a sale of assets via a 363 sale. The determining factor, once again, comes down to cost. The 363 sale process can be effectuated much more quickly than a plan of reorganization. This allows a company to enjoy many of the benefits of a bankruptcy filing while minimizing bankruptcy-related expenses.
The 363 sale process can move quickly. During the sale period, there will be a flurry of filings in the bankruptcy case, and the debtor will seek court approval of important deadlines and the requirements for participating in the 363 sale process. These filings are typically sent out to all of the debtor's creditors. In larger bankruptcy cases, the debtor may also employ an investment banker to contact parties who might be interested in submitting a bid, and otherwise market the assets for sale.
A debtor must obtain bankruptcy court authority to establish sale procedures and to approve the sale. The 363 sale process begins with a motion filed by the debtor seeking orders from the court granting such authority and approval. The sale process frequently is conducted via an auction. In that circumstance, the debtor will file a motion seeking the approval of bidding procedures governing the auction. Sometimes the auction will involve a "stalking horse" who has done due diligence on the assets, and has made an initial bid and entered into a proposed sale agreement. Interested bidders will be required to submit a bid in a particular amount over and above the stalking horse bid. In addition, bidding procedures typically require interested parties to pay a deposit and to demonstrate the financial wherewithal to close on the sale.
If a party is deemed a qualified bidder, the party will be permitted to participate in an auction for the sale of assets. The auction will be conducted pursuant to procedures also approved by the bankruptcy court. Bankruptcy auctions resemble mediations more than "open cry" auctions for assets. The parties usually gather at the office of the debtor's bankruptcy attorneys, and there may be a great deal of discussion between bids.
While the auction procedures purport to strictly govern the process, the debtor (and ultimately the bankruptcy court) is principally concerned with maximizing the value of a debtor's bankruptcy estate. It therefore is not at all uncommon for the debtor to diverge from the procedures on the basis that the divergence will provide greater benefit to the debtor's estate. For this reason, bankruptcy auctions can take on a "wild west" feel, where the parties appear to be making the rules up as they go along. Parties new to the process are well-advised to learn as much as possible about what procedures a particular bankruptcy judge has vigorously enforced in the past, and what procedures have been permitted to slip in the name of maximizing value.
Closing the deal
The auction will end when the debtor selects the "highest and best" offer. This is not necessarily the highest offer in dollar terms.
For example, if a debtor believes the party making the highest offer will have difficulty timely closing the deal, the debtor might select the next highest bid as "highest and best." The debtor then seeks approval of the sale at a hearing before the bankruptcy court. The assets are not actually sold until the bankruptcy court enters an order approving the proposed sale. However, once that order is entered and becomes final (i.e., is not appealed), a 363 sale order provides the purchasing party with one of the clearest manifestations of title under the law, as the assets are usually sold free and clear of any liens, claims or encumbrances.
No two bankruptcy asset sales are exactly alike. In addition, the process can be much more complicated than the general outline set forth above. The takeaway from this article is that parties interested in acquiring assets (whether personal property, real estate or an entire business) should consider including bankruptcy acquisitions in their searches. Moreover, parties wading into the bankruptcy sale process should be aware that it will be unusual and fast-moving, but potentially lucrative.
Jason Binford is a director in the Dallas-based law firm of Kane Russell Coleman & Logan PC where he practices in the firm’s Insolvency, Bankruptcy & Creditor Rights section. His experience includes representation of debtors and creditors in large to mid-size Chapter 11 and Chapter 7 cases. He has significant familiarity and expertise in issues unique to vendor creditors, as well as 363 sales, intellectual property, landlord/tenant and franchise issues.
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