Distressed entities seeking to sell assets often encounter commercial and legal challenges related to existing claims or resistant constituents. One possible solution to those challenges is to sell assets in bankruptcy through a “363” sale process. Section 363 of the US Bankruptcy Code allows a debtor, following notice and a hearing, to “use, sell, or lease” its property outside of the ordinary course of business. The section 363 sale process is fairly flexible, and allows debtors to sell assets (including their entire business through a sale of all or substantially all their assets) efficiently at any time during a bankruptcy case.
Benefits & Advantages
Open Process/Competitive Bidding: Section 363 sales are typically conducted through an open, competitive marketing and auction process that aims to attract as many potential purchasers as possible, generate competition and maximize the value of the assets to be sold. Section 363 sales often include an initial “stalking horse” bid that creates a “floor” price for the assets. Higher and better offers are then solicited from other parties. This helps to maximize value and to increase potential recoveries for creditors and stakeholders.
Benefit of the “Automatic Stay”: Outside of bankruptcy, both the seller and prospective buyers may have to worry about adverse creditor action (such as acceleration of debt, or even foreclosure) interrupting the process. By contrast, the breathing spell afforded to a debtor by the automatic stay, which arises upon the filing of a bankruptcy proceeding, typically provides comfort to both parties that there will be sufficient time to market and solicit bids and to get to closing, assuming there is sufficient liquidity to fund the case.
Free & Clear Protections: In a 363 sale, assets can be sold “free and clear” of liens, claims, and other encumbrances. Section 363(f) of the Bankruptcy Code states that assets sold through a 363 Sale are transferred free and clear of such interests, as long as one of the following conditions is met: (1) applicable nonbankruptcy law permits sale of such property free and clear of such an interest; (2) the entity holding the interest consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. This ability to “cleanse” the assets through a 363 sale is often a primary consideration for potential purchasers when assets might otherwise be clouded by existing debt and legal claims (existing and contingent).
Advantageous Provisions for Contracts: A debtor also may be able to assign executory contracts and leases in a 363 sale that it would not be able to assign outside of bankruptcy; in particular, under section 365(f) of the Bankruptcy Code, anti-assignment clauses (clauses that prevent the transfer of the contract to another party without consent) or termination provisions for change of control can be overridden in certain circumstances, allowing such contracts to be assigned without consent. In order to do this, the debtor must cure any defaults under the contract and provide adequate assurance of future performance by the assignee (e.g., the purchase buying the assets in a 363 sale). This allows a purchaser to take assignment of agreements that it would not be able to obtain outside of bankruptcy. Conversely, executory contracts and unexpired leases that are not advantageous may be excluded, and the debtor may “reject” those contracts and disaffirm continuing obligations, typically leaving the counterparty with only an unsecured damage claim.
Efficiency, Finality & Certainty: A 363 sale often can be completed within a short time frame. Indeed, it may be possible to initiate and complete the sale process in a period of 30 to 90 days. The bankruptcy court’s oversight and approval of the 363 sale process also provides finality and certainty for purchasers. The court’s entry of a sale order validates the sale process, confirms the transfer of title, and protects the buyer from any subsequent claims or challenges by the debtor or its creditors (including typically for successor liability or for inadequate consideration). Additionally, a finding in the sale order that the purchaser acted in good faith protects a buyer from an appealed sale order, ensuring the sale order remains effective.
Risks & Challenges
Court Approval: As noted above, court approval is one aspect of a 363 sale that provides certain benefits to potential purchasers. However, the need to obtain court approval adds an additional layer of complication to a 363 sale, and introduces a level of risk (e.g., in the event the court does not approve) as well as potential delays and added costs (in the event objections to the sale require it to be adjudicated).
Limited Due Diligence: The winning bidder will almost always be required to purchase assets on an “as-is” basis and will be required to submit bids with limited diligence and no financing contingency. Case timelines will also often require a buyer to perform its due diligence on the assets and agreements within a finite time frame.
Potential Downsides to Competitive/Open Process: The competitive, public process may also be a downside for some prospective purchasers. Debtors have a fiduciary duty to maximize value, meaning they typically market assets to as many prospective buyers as possible, and the public nature of a bankruptcy case can increase visibility of the sale and attract more interested parties. This can give debtors leverage with respect to the purchase price of the assets and eliminate many “buyer-friendly” provisions in a purchase agreement. And while a break-up fee and expense reimbursement may provide some financial compensation, a buyer who also might be able to obtain exclusivity outside of bankruptcy also runs the risk of substantial non-recoverable opportunity costs if outbid.
Funding: Financing difficulties may arise due to the distressed state of the assets, the short timeline, and potential unknown liabilities. Lenders may impose stricter terms and conditions for financing a 363 Sale transaction, and traditional lenders may not be able to act quickly enough.
Overpayment Risk for “Stalking Horses”: Stalking horse bidders take inherent risk by setting the floor price and committing to a bid at the outset of a competitive bidding process. If no other parties submit a qualified bid, the stalking horse bidder may be left second-guessing whether they could have purchased the assets at a lower price.
