363 Preparedness: Practical Sell-Side Tips
The economic impact of the COVID-19 coronavirus remains uncertain, but many are preparing for an up-tick in bankruptcies and, in particular, 363 transactions – sales of assets pursuant to Section 363 of the US Bankruptcy Code. Here are some practical steps that can help you prepare for your own 363 process and finding your stalking horse.
1. Consider Leveraging Review Activities to Collect Necessary Documents. Many companies are exploring avenues of relief from contractual obligations in the current environment, and many alerts are already out there examining MAE, force majeure, termination and other provisions that may offer such relief. While you are reviewing important contracts from an operations/continuity perspective, consider that you do not want to have to collect documents twice – when your personnel are already working off-site (or could be soon) and dealing with other time-sensitive matters as they arise. Designate a team member to become the repository and organizer of contracts and other information that you would expect a buyer to request in order to more easily populate a data room. This will also help with the fourth item, as DIP lenders have an obligation to perform customary due diligence regarding the terms of their intended loan, including the extent and value of the assets securing the loan.
2. Arm Your Board with Fiduciary Duty Considerations. Do not wait until the eleventh hour to arm your board with the information your directors need to ensure they are complying with their fiduciary duties. The general rule is that directors (and officers) owe their fiduciary duties only to the company and its shareholders – and not to its creditors. However, for an insolvent business in Delaware (or, depending on the jurisdiction of incorporation, a business in the zone of insolvency), the duties are owed to all stakeholders and interests of creditors would be considered. Generally, creditors of an insolvent company may not bring direct claims for breach of fiduciary duties, but may assert derivative claims for breach of fiduciary duties. Be sure to understand the rights of creditors in your jurisdiction.
3. Evaluate How Your Other Stakeholders View a Section 363 Sale Process. How will your current lenders view a Section 363 sale process? Will they be likely buyers using the outstanding debt to “credit bid” for the assets? Will the sale process likely produce a bid that clears their debt or will they have a significant voice in how the sale is conducted? Are they the types of lenders who would typically seek to restructure and own similar assets or more traditional commercial lending institutions who are interested in getting their money back? Will they instead seek to forego a sale process entirely based on current valuations and try to negotiate a debt-for-equity conversion as part of a reorganization plan that vests ownership of the business in their hands? Are they the logical source of DIP financing (more on this in item 4 below)? How will your employees, suppliers and customers react to a Chapter 11 filing and an immediate sale process? How will those reactions affect short term operations and valuations?
4. Source Potential DIP Financers. Obtaining debtor-in-possession (DIP) financing may be crucial to having the runway necessary to complete a successful transaction. Make sure you understand your cash burn and take a hard look at projections. For larger DIP loans, negotiations may take several weeks. As mentioned above, consider whether your existing lenders may be the logical source of DIP financing, or whether there is sufficient equity in the collateral of your secured lenders (or sufficient unencumbered assets) such that a third-party financing process can be run. Maximizing your existing relationships may shorten the process, including by skipping a commitment letter. Note, however, that any DIP loan requires “notice and hearing” under the Bankruptcy Code, and courts only approve DIP financing retroactively under certain defined circumstances.
5. Consider Engaging Both a Financial Advisor and an Investment Banker. Other than the Chapter 11 overlay, a Section 363 sale process is similar to most other sale processes and usually is run by in-house corporate development leads and/or a sell-side investment banker. However, because of the Chapter 11 overlay, it is important that any business lead, in addition to industry experience, also has extensive experience in the distressed M&A space. Regardless, engaging an outside financial advisor conversant with the Chapter 11 process, including with the enhanced financial reporting that both the Bankruptcy Code and stakeholders will require, is standard practice in preparing for a Chapter 11 filing and a Section 363 sale process.
6. Identify Possible Stalking Horse(s). Has someone wooed you recently? Are there any companies that always seemed like a natural exit scenario for the business? How are those potential partners holding up in the current environment? Keep in mind that your initial bidder will need to invest more time and other resources than other bidders who show up in court, as they will be performing due diligence, negotiating the purchase agreement, etc. Accordingly, they may request exclusivity. Be sure that whoever you may go exclusive with understands your necessary timeline and is prepared to move at that pace.
7. Develop a Plan (with a Small p). This not only relates to how the sale process will be run, but also to the likely end game after the sale. On the process itself, it is not unusual to try to run as much of the sale process outside of bankruptcy, including identifying the best prospective purchaser and trying to negotiate and finalize an acceptable stalking horse bid. Getting as much time as the circumstances will permit to negotiate and document outside of bankruptcy will shorten the time the business has to function in bankruptcy. On the end game, are there other assets and businesses around which to attempt to reorganize? Will there be a liquidation plan? Or will the Chapter 11 case be converted to one under Chapter 7, or sought to be dismissed? It is essential to coordinate with your attorneys, investment banker and financial advisor to work through these issues and develop a reasonable, workable plan.
