In times of economic turmoil, when sales of assets are difficult to negotiate and close, it is not unusual for sales of distressed assets to be halted by unresolved or disputed claims asserted by creditors or equity owners of the entities owning the assets.
The sale of a parcel of real estate may be thwarted by disputed mechanics or materialmen’s lien claims of record; the sale of a business by a deadlock among its owners. At such times, crowded dockets in the civil courts are ill equipped to afford a timely resolution to the matters in dispute, resulting in a paralysis of the ability to provide desperately needed liquidity by selling troubled assets.
However, where these obstacles block the ordinary sale process, salvation may lie in the federal bankruptcy court. Section 363 of the Bankruptcy Code provides the authority to sell individual or business property relatively quickly and free and clear of any and all liens, claims or other encumbrances. A title that passes to a purchaser at a Section 363 sale is clean, as attested by a court order, and, in the case of real estate, is also readily insurable.
As for the liens and claims against the assets sold, they do not disappear; instead they are transferred to the proceeds of the sale. Any disputed liens or other claims are adjudicated in the bankruptcy court, but do not hold up or in any way delay or impair the sale and the transfer of clean title to the buyer.
“To get the benefit of Section 363, the owner must become a ‘debtor’ the subject of a voluntary or involuntary bankruptcy proceeding,” says Francis L. Carter, of Counsel to Katz Barron Squitero Faust. “But, where the asset owner’s financial condition is sufficiently dire, bankruptcy may be the best perhaps the only viable option where the paramount need is to sell assets.”
Smart Business spoke to Carter about sales of assets and how Section 363 can make a tough sell a little bit easier.
How do bankruptcy sales work?
To assure that sales are both fairly conducted and seen as being fairly conducted, bankruptcy sales of property outside the ordinary course of business are almost always competitive sales; i.e., sales at public auction. Depending on the type and value of the property, the debtor or bankruptcy trustee may employ brokers, investment bankers or auctioneers to prepare and offer the debtor’s property for sale. The process generally starts with the selection of a ‘stalking horse’ bidder, who contracts to purchase the property, subject to court approval. This approval can only be obtained if the court finds that the purchase and sale contract embodies the highest and best offer. This can only be done after affording other qualified potential buyers the opportunity to bid for the property.
Why would you enter into a contract to purchase an asset from a seller who is free to accept a higher offer from a competing bidder?
Not surprisingly, there are a number of advantages conferred on a stalking horse bidder. The stalking horse negotiates the initial contract, which determines the structure and contours of the sale, including what assets are included or excluded, as embodied in the substantive provisions of the purchase and sale agreement. Later bidders are usually required to substantially conform their bids to the terms of the stalking horse contract, which have already been negotiated and spelled out. Typical terms include the amount of the bid deposit required to qualify a prospective bidder to participate, the length of the due diligence period preceding the auction, the notice requirements for the auction sale, the minimum amount of the initial overbid, the minimum increment for further bids, the earnest money required to be deposited by the winning bidder immediately following the auction, and the time for the winning bidder to close.
Also, the stalking horse contract may specify which executory contracts or unexpired leases of the debtor/seller related to the asset to be sold are to be assumed and assigned to the buyer and which are to be rejected.
What happens if another purchaser outbids the stalking horse?
The stalking horse typically negotiates certain bidder protections, including entitlement to be reimbursed for professional fees and out of pocket expenses incurred in doing its due diligence and negotiating the stalking horse contract. In sales of assets of sufficient size and complexity, there’s an entitlement to receive a break up fee, which is a fixed amount of compensation to be paid to the stalking horse for having exerted the effort to become the stalking horse, but where it is outbid by another purchaser. To be effective, however, the bankruptcy court must approve these provisions for payment of a break up fee or expenses before the sale takes place.
Who benefits most from Section 363 sales?
Section 363 sales are not always primarily for the benefit of the debtor seller and its general unsecured creditors. Secured creditors can also use these sale procedures effectively. Many civil courts are clogged with foreclosures. It can take months for even an uncontested foreclosure to reach the point of a public sale following a final judgment. Section 363 sales can streamline and shorten this process, allowing a secured creditor to credit bid its lien at the auction sale.
Where there is no equity in the asset to be sold, and therefore no benefit to the debtor’s estate to be realized from the sale, bankruptcy law prohibits the sale and generally requires that the fully liened asset simply be abandoned as burdensome, leaving the lien creditor to pursue foreclosure or other civil remedies outside the bankruptcy court. This prohibition, however, is usually overcome by the secured creditor agreeing to make a guaranteed payment to the debtor’s estate in an amount negotiated with the debtor, trustee or creditors committee.
For many reasons, Section 363 sales benefit both buyers and sellers, providing an effective means to make a timely sale of assets that might otherwise prove impossible.
Francis L. Carter is of Counsel to Katz Barron Squitero Faust. Reach him at FLC@katzbarron.com.