Distressed companies often can achieve a successful restructuring of their financial affairs through a sale of all (or substantially all) of their assets under Section 363 of the Bankruptcy Code. In fact, “sale cases” have become more prevalent in recent years because a more traditional Chapter 11 process—one in which confirmation of a plan of reorganization is pursued—often is laden with significant costs, delays and risks.
A Chapter 11 debtor that seeks to sell its assets must demonstrate to the bankruptcy court that it obtained maximum value for the subject assets. To accomplish that goal, the debtor will ask the bankruptcy court to approve a competitive auction process and related bidding procedures. The first step in that process typically entails the debtor’s execution of a binding “stalking horse” agreement with an initial purchaser against which higher and better offers can be solicited, and which spells out that the stalking horse will be deemed the “highest and best” bid if no competing proposals are received. By contrast, if competing bids are received, the stalking horse bidder may not prevail even if it is prepared to provide additional consideration to the estate at the auction.
There are both advantages and disadvantages to serving as a stalking horse bidder in a 363 sale.
Advantages of Stalking Horse Bids
A stalking horse bidder will have leverage over other bidders in several noteworthy respects. First, the bidder gains the opportunity to negotiate the financial and legal terms of an asset purchase agreement with the debtor that will serve as the “floor” bid, rather than merely stepping into an agreement that someone else negotiated and may not be perfectly acceptable. For example, the stalking horse will choose precisely which assets it wants to acquire and which liabilities it wants to or does not want to assume. It also will be in position to negotiate representations and warranties, material adverse change (MAC) clauses, termination provisions and other important M&A aspects of the deal.
Another significant attribute of serving as a stalking horse bidder is that the bidder will have had the opportunity to complete due diligence (including access to management and critical employees), pursue requisite financing and apply for any regulatory approvals (such as, for example, under the Hart-Scott-Rodino Antitrust Improvements Act) well ahead of other bidders. (Indeed, sometimes these can be accomplished before the bankruptcy filing even becomes public.) These opportunities are vital in situations where a debtor must proceed on an expedited basis with its sale process—usually due to liquidity constraints and pressure from the secured lender—and might enable the stalking horse bidder to squeeze out a competitor who is unable to complete due diligence and gain comfort with the transaction in the short time frame approved by the bankruptcy court. Additionally, stalking horse bidders may bargain for the opportunity to engage in early discussions with key customers, vendors and landlords to get those constituents comfortable with the bidder and its business model.
A stalking horse bidder also is in position to negotiate favorable bidding procedures aimed at discouraging other bidders from participating. The bidding procedures ultimately are subject to bankruptcy court approval, but the stalking horse bidder may be in position to control crucial aspects of the procedures. These include the criteria for determining whether a bid is qualified to participate in the auction, the bid deadline, the terms under which the secured creditor may be allowed to credit bid, whether bidding will be open or silent, and whether competing bids are shared with the stalking horse.
Another benefit to a stalking horse bidder is that it typically is induced with bidding protections in the form of an expense reimbursement and a break-up fee. Although the purchaser usually must dedicate substantial resources on the transaction, the fees and expenses incurred for legal and financial advisors, due diligence and other out-of-pocket expenses related to the deal generally are reimbursable by the seller and its bankruptcy estate (subject to a cap and appropriate documentary support). The bankruptcy court must approve the expense reimbursement, usually at the bidding procedures hearing, but the stalking horse bidder should insist that the order approve the expense reimbursement as an “administrative expense” of the bankruptcy estate.
A stalking horse bidder also may be able to bargain for a break-up fee as an additional financial inducement to serve as the “floor” bidder for the debtor’s assets. A break-up fee should be reasonable—generally no more than 3 percent of the purchase price—to avoid challenges from the United States Trustee, a creditors’ committee or other parties in interest that could argue that it will “chill” bidding. This fee also is subject to bankruptcy court approval. The stalking horse should be mindful of the jurisdiction in which the debtor’s case will be filed or is already pending. Not every bankruptcy judge approves break-up fees, even when they are in the range of reasonableness.
If an expense reimbursement and break-up fee are approved by the bankruptcy court, all competing bids will have to top the stalking horse purchase price with the amount of those bidding protections. Even if approved, generally neither the expense reimbursement nor the break-up fee is payable unless there is a closing on, and not mere acceptance of, a higher or better transaction.
Finally, a stalking horse bidder may be able to extract an exclusivity provision in its asset purchase agreement, especially if the debtor underwent a robust pre-petition marketing process of the assets. Essentially, this is a “no-shop” provision in which the debtor agrees not to solicit, initiate or encourage other offers from potential bidders. If an exclusivity arrangement is obtained, it will further limit the amount of time prospective bidders have to negotiate with the debtor and to conduct due diligence. An exclusivity arrangement, however, undoubtedly will expire as soon as the proposed bidding procedures are approved and the competitive auction process unleashed.
Serving as a stalking horse bidder has some risk. First, if the stalking horse is negotiated prefiling, aspects of it may be challenged by the creditors’ committee, the U.S. Trustee and other parties in interest (but they would not likely include the secured lender, who would have actively participated in the negotiations). There also is risk that the bankruptcy court may not approve the agreement as presented, especially if the challenges have merit.
Second, by setting the floor price for the assets, a stalking horse bidder takes on risk that the assets prove to be less valuable than the purchase price, or that the business deteriorates during the auction process (but perhaps not to the level of a MAC out). For example, if no one shows up at the auction, the stalking horse may wonder if it overbid for the assets. Once the bankruptcy court approves the stalking horse agreement, it becomes binding on all parties and difficult, if not impossible, to renegotiate.
Third, the stalking horse may be outbid at the auction. In this situation, all the stalking horse gets is the expense reimbursement and break-up fee, if approved by the court. This outcome can be highly disappointing, especially if the stalking horse had its heart and mind set on the transaction.
The Bottom Line
Given the complexities of asset acquisitions in a bankruptcy case, parties considering serving as a stalking horse should pay careful attention to the advantages and drawbacks outlined above and consult experienced professionals.
Ilana Volkov, a Hackensack, N.J.-based partner at Cole Schotz, maintains a national practice concentrated in the area of bankruptcy and corporate restructuring. She has significant experience representing debtors, unsecured creditors' committees, secured and unsecured creditors, purchasers of assets, commercial landlords, shareholders and other parties in interest in business reorganization cases and related litigation.
Reprinted with permission from the February 23, 2015 edition of Corporate Counsel © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 - firstname.lastname@example.org or visit www.almreprints.com.
Originally printed in Corporate Counsel.
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