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Section 363 Sales In The US « Back
Pauline Renaud, October 2009
The current financial crisis has dramatically increased the number of US companies filing for Chapter 11 bankruptcy protection in recent months. For investors, such situations provide them with an opportunity to acquire the assets of distressed companies at a discount, via the Section 363 bankruptcy sale process. The process can also be an appealing option for creditors and debtors, and it is increasingly the case that bankruptcy has become a vehicle for sales as much as for reorganisations. But while they offer great advantages for debtors, creditors and potential investors alike, Section 363 sales also require advance planning and a full understanding of the process. This is particularly important, as there are a number of potential pitfalls along the way.

An increase in 363 sales

A Section 363 sale allows the debtor to sell assets ‘free and clear’ of the company’s liabilities, and the 363 sale process usually starts with the debtor selecting a so-called ‘stalking horse’ bidder and negotiating an asset purchase agreement (APA).

“This APA serves as a floor against which all other bids for the assets will be made at auction,” explains Robert Harris, a partner at Waller Lansden Dortch & Davis LLP, and chair of the firm's Finance and Restructuring practice. “In exchange for coming forward and negotiating the initial APA with the seller/debtor, the bankruptcy court often grants the stalking horse certain bidding protections, such as expense reimbursement, and break-up fees in the event its bid is exceeded.” Following that, a bankruptcy court approves the procedures governing the sale, and an open auction process ensues, thereby ensuring that the assets are sold at a fair price. “The notice and auction procedures usually contemplate some sort of market testing procedure, either by way of a stalking horse proposal, which is tested against overbids from third parties, or without a stalking horse by way of an open or closed auction, or other bid process such as sealed bids,” confirms Neil B. Glassman, a partner at Bayard, P.A. “Although such market testing procedures are not always required, the idea of a 363 sale is that the notice provisions for the sale and the ‘auction’ procedures are supposed to maximise value for the estate and its constituents.”

Following that auction process, courts generally require only a ‘sound business justification’ to approve a sale, and are usually quite deferential to the debtor, particularly in cases where the future of the company is at stake. Typically, the bankruptcy court will approve the highest bid received at the auction or, if there are no other bidders, the stalking horse bid itself. The basic standard for a sale is usually that it has to be in the best interest of the estate and creditors. Finally, the court enters a sale order, approving the sale and clearing title to the assets. Most Section 363 sales usually follow that process but there have been several recent Section 363 sales that have been somewhat atypical, notes Nancy L. Sanborn, a partner at Davis Polk & Wardwell LLP. “This includes the sale of Lehman Brothers’ investment banking business to Barclays, where the sale was approved only five days after the Chapter 11 filing, and the Chrysler and GM sales, where the sales included the provision by the purchasers of substantial amounts of cash and equity to junior claimants in connection with assumption of contracts or entry into new contracts with the junior claimants, notwithstanding that other unsecured and/or secured debt claims would not be paid in full.” However, sales of this nature are unusual and likely to becoming rarer, particularly now that the market is seeing the early signs of recovery.

Amid the current crisis, there has been a substantial increase in the number of Section 363 sale cases, particularly in the retail and automotive sectors. Some experts believe that this is mainly the result of a growing availability of assets being offered for sale, rather than an increased availability of funds to purchase those assets. However, others explain that “in the current economic climate, distressed investors are becoming increasingly active in Section 363 sales. I have seen estimates that distressed takeovers, where creditors convert their prior debt positions into equity in a restructured or reorganised entity, are occurring at nearly double the pace of 2008. Additionally, it appears that the deals are significantly larger in size than in recent years,” observes John Rapisardi, a partner and co-chair of Financial Restructuring at Cadwalader, Wickerman & Taft LLP. But others believe that with an increase in available capital, funds specialised in distressed investing will contribute to a jump in the amount of assets purchased, particularly in the real estate sector.

In addition, strategies, such as ‘credit bidding’ and ‘loan to own’ strategies, have also come into play, and are being used by investors to acquire distressed debt – either to force other bidders to pay a higher price or to obtain control of their collateral, notes Ms Sanborn. “There have been several interesting cases recently, where agent banks have submitted credit bids on behalf of lending syndicates. Although objecting lenders have argued that their consent should be obtained to authorise a credit bid, courts have held that credit bidding is simply an exercise of remedies. Accordingly, an agent bank may submit a credit bid on behalf of, and thereby bind, the lending syndicate if directed by the number of lenders who have the right to direct the agent bank to exercise its other remedies with respect to the collateral,” she explains. There has also been an increase in the use of DIP financing strategies by potential buyers. Such loans typically include terms that are more favourable to the lender than traditional out-of-court loan agreements. And although DIP loans must be approved by a bankruptcy court, their approval does not require a formal bidding process. Furthermore, DIP financings can also lead to a shorter sale process, and increase the likelihood of closing the sale transaction. This is because they often put pressure on the company to proceed with a sale to comply with requirements and deadlines contained in the DIP financing agreement, triggering event of default and, potentially, causing the loan to become due immediately if these requirements are not satisfied.
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