As the economic fallout from the coronavirus pandemic continues, it is likely that significant opportunities will arise for funds and other investors looking to deploy capital by purchasing existing businesses and assets.  Many struggling companies are contemplating bankruptcy and, in connection with the bankruptcy, an asset sale to be conducted under Section 363 of the U.S. Bankruptcy Code (“363 Sales”).  363 Sales allow distressed companies to sell their assets via a quasi-private auction under the protection of the bankruptcy proceedings.  While the bankruptcy process can seem unfamiliar and full of obstacles, 363 Sales offer prospective purchasers a unique and, potentially valuable, opportunity.

The Benefits of Investing via the 363 Sale Process

363 Sales offer purchasers the flexibility to negotiate terms similar to private sales while enjoying additional protections and benefits associated with purchasing assets through bankruptcy auctions.  These benefits include:

  • the ability to reject assets and liabilities, obtaining the assets free and clear of encumbrances;
  • the ability to avoid or expedite third party and certain governmental consents to the transaction;
  • an expedited sale process; and
  • increased legal and court protection of the transaction and transaction documents.

In addition, as further described below, certain bidders can obtain “stalking horse” status in the bidding process by participating early, which protects that bidder from downside risk of being outbid in the auction process. Furthermore, bidders who are secured creditors of the debtor can incorporate the cancellation of some or all debt owed to them in their bid – a practice known as “credit bidding” – allowing them to make better offers without tying up additional resources.

In contrast to private deals, 363 Sales must be approved by a bankruptcy court, which requires the deal terms and certain negotiations to be public, subjects the process to stricter procedural requirements and gives creditors (including contract parties) the opportunity to object to any potential sale.

Understanding the 363 Sale Process

Under a 363 Sale, after filing for bankruptcy, the debtor submits a plan for the sale process for approval by the bankruptcy court. This plan includes provide an asset purchase agreement and a deposit with their bid – and selecting a winning bid.  At the end of the bidding period, the debtor is generally required to hold a public auction at which eligible bidders may increase and modify their bids.  At the auction, the debtor chooses the best offer and announces the winning bid subject to the approval of the bankruptcy court.  Following the auction, the bankruptcy court holds a sales hearing and, subject to objection by interested parties or the court, approves the sale, including all of the terms of the transaction.

The debtor may, even prior to filing for bankruptcy, solicit initial bids for its assets and select a bidder’s offer as the “Stalking Horse” subject to court approval.  The Stalking Horse and debtor negotiate the terms of an asset purchase agreement, which is submitted to the bankruptcy court for approval to serve as the bidding floor for the eventual auction of the debtor’s assets.  

While the Stalking Horse has the advantage of making the first offer, the debtor ultimately has a duty to obtain the best value for its assets, which can result in later bidders taking advantage of the Stalking Horse’s initial efforts and expenses to make a better offer.  To offset these risks, bankruptcy courts generally approve certain incentives for the Stalking Horse, which can include expense reimbursements, break-up fees, limited exclusivity periods, and favorable bidding procedures.  Negotiating the proper incentives can prove essential in strengthening the Stalking Horse’s bid and reducing or eliminating the costs of losing the auction.

Understanding the procedure and intricacies of the 363 Sale process can allow purchasers to obtain valuable assets on favorable terms at bargain prices. 

For more information about the benefits and process of participation in a 363 Sale, please contact the authors.

The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP.  Specific legal advice depends on the facts of each situation and may vary from situation to situation.  Information contained in this article may be incomplete and is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.