Archive for the ‘Assets Sales and Acquisitions’ Category

One’s Crisis is Another’s Opportunity: Section 363 Sales

Wednesday, March 31st, 2010

With the increasing numbers of companies which were once thought to be giants of industry filing for bankruptcy, more opportunities to purchase major assets are becoming available to savvy buyers looking to expand their business or asset base. The Bankruptcy Code provides debtors with the ability to liquidate all or a part of their assets through court-supervised sales and buyers with the ability to obtain those assets at more favorable prices than they would pay if the sale were consummated outside of a bankruptcy.

One of the most advantageous provisions of the Bankruptcy Code is that a deal can be approved and consummated relatively quickly, providing for approval on as little as 40 days notice (or less in exigent circumstances).  For example, in the Chrysler case, the sale of substantially all of Chrysler's assets to New CarCo (and Fiat) was approved and closed within approximately 40 days after the bankruptcy filing, while in the Lehman case, the time frame was even more expedited – with entry of an order approving the sale to Barclays only 3 days after the filing of the sale motion.

Basic Procedures for Purchasing Assets From a Debtor

The purchase and sale of assets in a bankruptcy case often begins with a "stalking horse" bidder who has agreed to buy the target assets pursuant to a negotiated asset purchase agreement. The stalking horse bidder is often the bidder who, after some general solicitation of bids outside of bankruptcy, makes the highest bid for the most assets and is the most able to complete the purchase and/or requires the least amount of time, if any, to undertake a due diligence review.

Once an agreement has been reached and finalized with the stalking horse bidder, the debtor will begin the process of seeking bankruptcy court approval of the asset sale. Section 363 of the Bankruptcy Code provides debtors with two options for asset sales: private sales or public auctions. In both private sales and public auctions, a debtor seeking to sell property will be required to provide public notice of the sale and time for parties to object.

In a private sale, the debtor will make a motion to the bankruptcy court for approval of the sale transaction, setting forth the basis for the sale, the terms of the sale, a proposed hearing date for approval of the sale and a deadline by which any objections to the sale must be filed. Although no auction process is contemplated in a private sale, interested parties may submit competing bids for the target assets by "objecting" or otherwise responding to the sale by the objection deadline creating, in essence, in a de facto auction for the assets. Typically, however, debtors and bankruptcy courts prefer public auctions to private sales because, among other things, public auctions provide better protection against subsequent claims that the debtor failed to maximize value for the benefit of its creditors.

The sale of Lehman's assets to Barclay's provides a good example of how private sales are utilized in certain circumstances, but are not necessarily favored by the courts. In that case, although the sale was not actually called a private sale, the sale of Lehman's assets to Barclays was undertaken without an auction process being proposed by the debtors or implemented by the court. In approving the sale on an extremely expedited time frame without any competitive bidding procedure, the bankruptcy court noted that the sale had been approved under a unique set of extraordinary circumstances, in an emergency situation, and because it was clear that Barclays was the only interested buyer. Accordingly, the court made clear that the process implemented in that case would not have precedential value.

In a public auction, a debtor will make a motion or motions to the bankruptcy court describing the basis for the sale, the terms of the sale, the procedures for accepting "higher and better" offers and a proposed time and place for the auction of the assets, requiring two separate orders from the bankruptcy court. The first order will be a "procedures order" approving the form of the purchase agreement and the procedures for competing offers and the auction, including break-up fees, bid increments, competitive bid qualification requirements, the auction date and the sale approval hearing date. The second order will be the "sale approval order", which will be entered after the auction has been conducted, and will authorize the sale of the assets to the bidder making the "highest and best offer" for the assets. Each order will be subject to separate objection deadlines and hearing dates.

In the context of a public auction, it is generally advantageous to be the stalking horse bidder, as opposed to a subsequent competing bidder. The stalking horse bidder will have some control over the terms of the auction and will negotiate the form of the purchase agreement upon which any future bidders will be required to base their bids. However, competing bidders who are able to work within the terms of the stalking horse's agreement can end up as the successful buyer of the assets at the auction, thereby reaping the rewards of a stalking horse bidder's labors. To offset the risk to the stalking horse bidder that another bidder may win the assets at the auction, and to induce a stalking horse bidder to negotiate and create a competitive market for the debtor's assets despite the potential "loss" of the assets in an auction, the stalking horse bidder's purchase agreement often includes "break-up" fee and/or expense reimbursement provisions, which are intended to cover the stalking horse bidder's costs and, in order to be approved, must be reasonable. In most cases, courts have agreed to approve break-up fees equal to anywhere from 2% to 4% of the overall purchase price, or which are based on the actual, reasonable expenses incurred by the stalking horse bidder.

In some cases, bidding at an auction can be very lively, often taking hours and, in rare cases, days, and increasing the price ultimately paid for the assets by millions of dollars over the original price proposed by the stalking horse bidder. For example, in the case of Riverstone Networks, two bidders emerged – Lucent Technologies and Ericsson. At the auction, held over two days and through numerous rounds of bidding, the purchase price for the assets was increased by $47 million, with Lucent, the stalking horse bidder, ultimately winning the assets with a final bid of $217 million in cash and cash equivalents. In others, there may be no bidding at all, with the auction, if not canceled, lasting no more than 10 minutes so as to create a complete record stating that no competing bidders came forward, and that the stalking horse bidder is the winning bidder. Accordingly, each auction is different depending on the type of assets and the market for the assets – no two are exactly the same.

The Purchase Agreements in the Bankruptcy Context

In addition to providing for a break-up fee and/or expense reimbursement, a purchase agreement in a bankruptcy case differs in certain material respects from a purchase agreement outside of the bankruptcy context. First, a bankruptcy purchase agreement will provide that its effectiveness is conditioned upon the entry of the sale approval order. In addition, the sale of a debtor's assets is usually made on an "as is, where is" basis, with the representations and warranties that a debtor is willing or able to provide being fairly limited and surviving only until closing of the sale. Indemnification by a debtor is rare. The principal reasons for these differences are that:  (1) the debtor is generally not an economically viable entity and its representations and warranties are of limited value; (2) the debtor will ultimately be discharged from most of its liabilities as part of the bankruptcy case, including claims under the purchase agreement; and (3) the creditors of the debtor desire finality and do not wish to have ongoing exposure that may diminish the assets of the debtor available for distribution.

A potential buyer of assets should not, however, let these differences and limitations deter it. The fact is that a properly drafted sale order will provide a buyer of distressed assets with essentially the same or better protection as a buyer outside of bankruptcy, by providing that the assets are being sold free and clear of any liens, claims, encumbrances or other interests therein (resulting in what is referred to as a "cleansing" of the assets) and that the buyer is a "good faith" purchaser. This language alone generally protects a buyer from, and is generally enforceable against, any claims of a third party or the debtor in or to the assets and releases any liens or other encumbrances on the assets, with such liens, claims, interests or other encumbrances attaching to the proceeds from the sale of that asset.

Closing Thoughts

Each sale of assets by a debtor in bankruptcy is unique. The fundamental principle in all sales is that the sale be conducted in a manner that is reasonably calculated to maximize value for the debtor's creditors and estate, and that each sale be negotiated and conducted on an arms' length basis in "good faith" by the debtor and purchaser. These general rules apply equally to all bidders providing all potential buyers with the same protections, but also submitting all buyers to the jurisdiction of the bankruptcy court.

In addition, the scope of the assets that can be sold through these section 363 sales is extremely broad – the assets can be in the U.S. or outside the U.S., and they can be tangible assets like inventory, equipment, real property, fixtures etc. and they can also include intangibles such as stock, leases, mortgages, loan portfolios and intellectual property. Consequently, they can be an effective tool to expanding a company's business and, in many cases, represent tremendous opportunities to a savvy purchaser.

Authored By:

Malani J. Cademartori
(212) 634-3085
mcademartori@sheppardmullin.com 

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The Precedential Value of an Unprecedented Sale - Lessons from Chrysler

Tuesday, July 14th, 2009

On June 10, 2009, the sale of substantially all of Chrysler's assets closed, just 42 days after the country's third largest automaker filed for bankruptcy protection. The closing followed a contentious sale hearing before the Bankruptcy Court, an expedited appeal to the Second Circuit Court of Appeals and a brief stay imposed by the United States Supreme Court. The source of the contention: three Indiana state pension funds, arguing that the sale of Chrysler's assets constituted a sub rosa plan of reorganization that upended the priority scheme of the Bankruptcy Code. Rejecting the Indiana pension funds' arguments and approving the sale, a decision upheld on appeal, the Bankruptcy Court avoided mention of the effect of unprecedented the governmental intervention in its analysis, relying on its interpretation of applicable bankruptcy law. As the sale process in the bankruptcy of General Motors nears completion, much has been learned from Chrysler.

The Chrysler Sale Transaction and Indiana Pensioners' Objections

Chrysler LLC and 24 of its domestic direct and indirect affiliates filed for Chapter 11 protection on April 30, 2009 in the United States Bankruptcy Court for the Southern District of New York. Shortly thereafter, Chrysler filed a motion seeking approval of the sale of substantially all of its operating assets to "New Chrysler" in exchange for $2 billion in cash and the assumption of certain liabilities. As part of the transaction, New Chrysler entered into two agreements with the UAW: a new collective bargaining agreement in which the UAW made unprecedented concessions and a settlement agreement relating to a 2008 class action that established a voluntary employees' beneficiary association, or VEBA, to fund legacy retiree health care obligations. Pursuant to the settlement agreement, the VEBA would be funded with a 55% membership interest in New Chrysler and a new $4.587 billion note. The remaining membership interests in New Chrysler would be issued to U.S. and Canadian governmental entities and a subsidiary of Fiat S.p.A. Ultimately, New Chrysler would be funded entirely by the U.S. and Canadian governments, contributing $6 billion in senior secured financing to support New Chrysler's operations after the sale.

The Indiana pension funds which challenged the sale held approximately $42 million (less than 1%) of Chrysler's $6.9 billion first-priority secured debt pursuant to an Amended and Restated First Lien Credit Agreement secured by substantially all of Chrysler's assets. The Indiana pension funds raised multiple objections to the proposed sale, including that it violated the Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief Program. However, its primary complaint was that the sale transaction constituted a sub rosa plan of reorganization that violated the priority scheme of the Bankruptcy Code because it sold all of the first lien lenders' collateral and essentially distributed the proceeds of the sale to unsecured trade creditors and the UAW.

Lesson One: A Quick Sale is Nothing More Than a Quick Sale

Section 363 of the Bankruptcy Code authorizes a debtor-in-possession, after notice and a hearing, to use, sell or lease property of the estate outside of the ordinary course of its business. However, a sale of assets under section 363 that, in essence, would direct or effectuate the terms of a reorganization plan is considered an impermissible sub rosa plan of reorganization. The rationale for barring such attempts is that they deprive creditors of the comprehensive protections normally afforded to them in the plan confirmation process, including formal disclosure, an opportunity to vote on acceptance and a fully noticed confirmation process. While a section 363 sale requires court approval and gives creditors the right to object, the more stringent and time-consuming plan confirmation requirements are not present. Thus, where a section 363(b) sale would preempt or dictate the terms of a plan, the sale should not be authorized. The Indiana pension funds argued that the Chrysler sale transaction was a sub rosa plan of reorganization in that it would sell their collateral to New Chrysler, which would use it to satisfy over $20 billion in unsecured creditor claims, leaving the first lien lenders with only 29% of the value of its collateral.

In rejecting this argument, the Court noted that the standard in the Second Circuit for determining whether to authorize a section 363 sale prior to and outside of the plan confirmation process is, simply, whether there was a "good business reason" for such a sale. The Court held there was an articulated business justification for the sale and for the necessity of completing it quickly. Moreover, the Court held that the sale was not a sub rosa plan of reorganization because the Debtors were receiving fair value for the assets being sold and all of the proceeds from the sale would be paid to the first lien lenders. 

Avoiding Violations of the Priority Scheme

Chapter 11 of the Bankruptcy Code requires, among other things, that a plan be fair and equitable and not discriminate unfairly among similarly situated creditors. The absolute priority rule, a fundamental principle of U.S. bankruptcy law, provides that a plan is fair and equitable if an unsecured creditor or other priority creditor receives full value for its claim or, if it does not receive full value, thatthe holder of any junior claim will not receive any property on account of such junior claim.  The words 'fair and equitable' are terms of art meaning senior interests and claims are entitled to full priority over junior ones.  The Indiana pension funds argued that allowing Chrysler "to ignore the priority scheme established by the Bankruptcy Code while selling substantially all of their assets, in permanent derogation of the Indiana Pensioners' property rights, would turn the law on its head." Specifically, they argue that the sale violates the priority scheme of the Bankruptcy Code because (i) the first lien lenders will be not be paid in full while U.S. and Canadian governmental entities, junior lienholders under Chrysler's TARP debt, will receive value; and (ii) the first lien lenders' $4.9 billion unsecured deficiency claim will ultimately be treated differently than the general unsecured claims of certain trade creditors and the UAW.

In rejecting these arguments, the Court emphasized three points. First, the membership interests in New Chrysler were not issued to the UAW and the U.S. and Canadian governments on account of their prepetition claims, but rather were issued as consideration for the contribution of new value. The U.S. and Canadian governments are providing New Chrysler with approximately $6 billion in funding, while the UAW is providing New Chrysler with a skilled workforce under a more competitive cost structure and a more restrictive collective bargaining agreement. Second, the membership interests in New Chrysler were issued pursuant to agreements between each party and New Chrysler, and not Chrysler as debtor. The consideration provided by New Chrysler was not value that would otherwise inure to the benefit of Chrysler's estate, so the agreements did not divert value from Chrysler's estate or allocate proceeds from the sale of its assets. Finally, parties to contracts that are assumed in a bankruptcy case are entitled to cure payments and adequate assurance of future performance -- the Bankruptcy Code recognizes that certain creditors may receive more favorable treatment than other creditors, either in their class or a higher priority class, as part of a sale, and that such disparate treatment does not violate the priority rules. 

Adequacy of Notice is in the Eye of the Beholder

Rule 2002 of the Bankruptcy Rules requires at least 20 days notice of a section 363 sale, unless otherwise ordered by the Court. While the Chrysler sale hearing began more than 20 days after Chrysler filed its sale motion, the Indiana pension funds, as well as many other parties, objected to the abbreviated and rushed sale process. As the Indiana pension funds stated in their objection, Chrysler "acted as if they were selling a Chrysler LeBaron and not a multinational corporation with billions of dollars in assets." They argued that the sale process effectively precluded anyone but New Chrysler from bidding on Chrysler's assets, was inherently unfair and failed to maximize the sale price. 

In holding that the notice provided was adequate, the Court focused on the need for expedited relief to prevent the erosion of the value of Chrysler's assets. The Court found that despite the complexity of the transaction, notice of the sale was adequate where information about Chrysler's troubles were known worldwide prior to the bankruptcy, there had already been an extensive marketing attempt, and the assets were "wasting" away. Adequacy of notice is to be judged on what is adequate under the circumstances of each case.

The Lessons

The Chrysler bankruptcy case demonstrate the flexibility of the Bankruptcy Code, which has permitted Bankruptcy Courts to adapt to and confront the challenges and turmoil of these unprecedented economic times. The Bankruptcy Court's decision to approve the Chrysler sale transaction relied upon the familiar values underlying U.S. bankruptcy law: equity, rehabilitation and the right to a fresh start. Although other Bankruptcy Courts, faced with less dire consequences, may act with more deliberation, the effect of the Chrysler bankruptcy case, and the precedent it has set, is undeniable.

Authored By:

Malani J. Cademartori
(212) 332-3847
mcademartori@sheppardmullin.com

and

Blanka Wolfe
(212) 332-3822
bwolfe@sheppardmullin.com

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