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On June 30, Callaway Golf Co. announced that it had agreed to purchase the majority of the assets of Top-Flite Golf Co. The announcement coincided with Top-Flite’s filing for bankruptcy protection in the U.S. Bankruptcy Court for the District of Delaware (Case No. 03-12002). Indeed, the purchase agreement required Top-Flite to make the bankruptcy filing and seek court approval of the sale. This deal, known as a “363 sale,” is an example of the increasing use of � 363 of the U.S. Bankruptcy Code to acquire assets from financially distressed entities and illustrates some of the benefits and rationales of purchasing assets through such a sale. There are three principal means of acquiring assets through bankruptcy: purchasing assets pursuant to � 363; implementing a plan of reorganization pursuant to � 1123 and related sections; and purchasing claims, secured or unsecured, from creditors of the debtor in an effort to control or influence certain assets or the plan process itself. A bankruptcy acquisition has several advantages for potential purchasers, including the possibility of acquiring a distressed entity’s assets free and clear of some or all of their prebankruptcy liens and free and clear of liabilities of the entity. Of these methods, the 363 sale is generally the fastest and most direct. Although formerly reluctant to permit sales of substantially all of a debtor’s assets without the procedural and substantive protections of a confirmed plan of reorganization, including the solicitation of creditors through a court-approved disclosure statement, it has recently become fairly commonplace for bankruptcy judges to authorize such sales pursuant to � 363 of the code. Recent examples include the acquisition of the businesses of Vlasic Foods by a private investment group, the acquisition of TWA by American Airlines, the acquisition of Republic Technologies’ steel bar business by a private investment group and the acquisition of substantially all of the assets of Exodus Communication by Cable & Wireless. The debtor initiates a motion to approve a 363 sale, but the purchase agreement is often negotiated prior to the bankruptcy proceeding. This type of prebankruptcy negotiation, followed by the filing of a bankruptcy petition and a motion to approve the sale, is exemplified by the Top-Flite case. Top-Flite filed the sale motion just four days after commencing bankruptcy. Typically, to implement a 363 sale, a prospective purchaser and debtor (or, if done prepetition, as in the Top-Flite case, the entity that becomes the debtor) will execute an asset purchase agreement, and the debtor will file a motion, or separate motions, seeking approval of bidding procedures and the 363 sale itself, appending the purchase agreement to the motion papers. The Federal Rules of Bankruptcy Procedure require that the debtor provide all parties in interest with at least 20 days’ notice of the proposed sale. The notice period is designed to elicit higher and better offers and provide creditors an opportunity to object to the terms of the sale. Often the notice period will be longer than 20 days, particularly if significant assets are being sold. The proposed sale becomes public knowledge and any other interested bidders may seek to enter into negotiations with the debtor, subject to the bidding procedures. In order to mitigate the risks of liabilities or liens following the assets under successor liability or other legal doctrines, it is critical from the purchaser’s point of view that notice of the sale be provided to all known or potential creditors and claimants, including taxing authorities and potential lien holders. Sale must be bona fide With few exceptions, bankruptcy courts require that all material-asset sales be subject to market testing to assure that the debtor’s estate is receiving the highest and best offer for the assets. The term “highest and best” is intended to allow for issues besides aggregate value, such as certainty of closing and form of consideration, to be taken into account in determining which offer to accept. The requirement of market testing means that the first prospective purchaser may play the role of a stalking horse. To ensure that the initial bidder is not discouraged from negotiations by the prospect of becoming a stalking horse, and then finding its efforts go to waste if another bidder appears, the asset purchase agreement will typically require that the debtor seek, in its motion for approval of bidding procedures, court authorization to pay a “topping fee” or other termination payment, and reimburse expenses, in the event that another bidder ends up purchasing the assets or the agreement is terminated for other reasons, such as a breach by the debtor. The amount of the payment-usually extensively negotiated-is intended to be sufficient to reimburse the initial bidder for expenses such as those related to due diligence, necessary regulatory approvals and financing commitments, and, if appropriate, to compensate it for creating a structure that could induce other bids. For example, the purchase agreement between Top-Flite and Callaway contains several such provisions. Though the purchase agreement was negotiated prior to Top-Flite’s bankruptcy, these purchaser protections were contingent on approval by the bankruptcy court. (At press time, the bankruptcy court had approved Callaway’s initial bid, but refused to approve the topping fee and expense reimbursement provisions. Competing bids are due no later than Aug. 27.) In fact, this is common, and the purchase agreements for 363 sales (whether negotiated inside or outside bankruptcy) will usually give the purchaser the right to terminate the agreement if the bargained-for bidding protections are not approved soon after the motion for the sale itself is filed. Callaway’s purchase price bid was approximately $125 million. However, the agreement also required that a competing bid be at least 6% higher than Callaway’s. This increment included a $1.25 million expense reimbursement fee, a $4.375 million topping fee, each payable to Callaway if another bidder won the auction, and the inclusion in the bidding procedures of a requirement that competing bids be $2 million greater than the sum of the purchase price, the expense fee and the topping fee. Such fees serve many of the same purposes and have the same result as breakup fees play in purchase agreements outside of bankruptcy. Namely, they reduce the prospective buyer’s risk and encourage it to play the role of stalking horse, and they represent an incremental cost that must be taken into account by other prospective bidders. In the Top-Flite example, whether the minimum bid of $125 million plus the $7.625 million increment was viewed as a bargain or toward the top end of the spectrum of fair prices dictated whether alternative bidders participated in the auction. Even though competitive bids were made for Top-Flite, the contemplated procedures provided Callaway with the right to submit another topping bid after the auction was completed. Speedy results A principal advantage of 363 sales is speed. The plan confirmation process often entails contentious issues such as allocation of cash or other sale consideration to creditors, and may require lengthy notice and balloting periods that conflict with the business requirements of a prospective purchaser. The debtor may also have reason to favor a quick sale-for example, exchanging burdensome assets for cash may quickly enhance the debtor’s liquidity or a quick sale may be necessary to avoid precipitous declines in value. A 363 sale is usually structured for the assets to be transferred free and clear of liens and encumbrances (as well as free and clear of other claims-even those that might not be strictly considered a lien or encumbrance). This facilitates a debtor’s ability to sell what might otherwise be unattractive assets. Top-Flite, although selling for around $125 million, was encumbered with debts exceeding $430 million. Without severing the liability, a sale may not be possible. Moreover, outside of bankruptcy, potential purchasers of Top-Flite’s assets may be concerned that a transaction will later be challenged under fraudulent transfer laws in connection with a later bankruptcy proceeding. By structuring the acquisition as it has, Callaway was essentially requesting the blessing of a federal court as to the propriety of the transaction. As mentioned, court approval is required to complete a 363 sale. Bankruptcy courts typically have evaluated proposed 363 sales on the basis of whether: There are sound business reasons for the sale. The parties in interest received proper notice. The sale price is fair and reasonable under the circumstances. The purchaser is acting in good faith. Any secured lenders have either consented to the sale of their collateral or are otherwise protected under the code. The choice of deal structure (i.e., which debt, if any, is to be severed) depends in large measure on the purchaser’s goals. The appeal of acquiring assets free and clear is obvious. However, it should be noted that certain kinds of claims can be difficult to separate from the assets. For example, some courts have held that certain types of products liability, environmental and Equal Employment Opportunity Commission claims, may not be severed. On the other hand, if those parties had notice of the sale and failed to object, it could be argued that the “free and clear” provisions of the order approving the sale are res judicata. Regardless, � 363 generally allows parties to decide which liabilities to keep and which to discard. Under the Top-Flite agreement, Callaway agreed to assume Top-Flite’s liabilities for certain contracts, intellectual property and employees but not other liabilities, including existing debt. If a purchaser wishes to structure the acquisition so as to not require new financing, it may make sense to acquire the assets subject to certain additional existing liens. This would usually require negotiating agreements (including restructuring the underlying secured debt) with the secured creditors. These secured creditors may be a receptive audience if circumstances are such that their alternative is no sale and an ultimately low realization on the collateral. A final benefit offered by 363 sales is finality. Appellate courts are unlikely to overturn orders approving 363 sales, given the high standards for appellate review. Even if an appellate court overturns an order approving a sale, � 363(m) of the code provides that a reversal of an order approving a sale does not affect the validity of a sale to an entity that purchased the property in good faith. Often, evidence of good faith will be presented or proffered at the hearing to approve the sale, and the sale order itself will include such a finding. Therefore, unless an objector obtains an order staying the approval of the sale, assuming good faith, the sale will be final as of closing. In a situation where other methods of acquisition are less attractive because of the financial straits of the target company, the proposed Top-Flite sale under 363 and its ability to sever liability from assets permits Callaway to make the acquisition with the finality associated with a court order. Although the required auction process might ultimately have caused the deal to terminate, Callaway attempted to minimize its risk of loss with the topping and expense reimbursement clauses; unfortunately for Callaway, such procedures were not approved by the court. Steven M. Abramowitz is a partner, and Jonathan S. Krueger and E. Ramey Layne are associates, in the New York office of Houston-based Vinson & Elkins.

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