Billions of dollars and countless hours are devoted to finding, bidding for and purchasing distressed companies or strategic assets from bankruptcy estates. These opportunities arise most often in Chapter 11 cases that were filed with the sale of business assets as a primary goal — or at least a strong possibility. Commonly, companies with one or more strong core businesses
are saddled with too much debt and are forced to seek Chapter 11 bankruptcy protection. Sales of entire businesses are attractive to potential buyers because § 363(f) of the Bankruptcy Code allows for the sale of property free and clear of any interest in the property sold if certain requirements are met. Section 363 sales are an integral part of the bankruptcy rubric, which may occur prior to proposal of a plan or as part of a plan. However, potential buyers must be willing to devote time and money to pursue a bankruptcy deal with uncertain results.
A debtor that is seeking to sell its operating assets must engage in a process that has the purpose of maximizing the value realized from that sale. This process usually requires some marketing of the assets for sale, followed by a competitive bidding and auction process.
The debtor may offer incentives to the first to bid on the assets to kick-start the competitive process. Generally, the first offer accepted by the debtor is called the “stalking-horse bid.” Incentives can include “no shop” provisions so that the stalking-horse bidder can conduct due diligence unfettered by other interested parties; reimbursement of due diligence and legal expenses; and/or a “break-up” fee.
To conduct an auction, a debtor must obtain approval of the bidding procedures (as well as any incentives offered to the stalking horse). The bidding procedures provide guidelines for potential bidders to follow to qualify to participate in the auction and the manner in which the auction is conducted. Appropriate bidding procedures will require potential bidders to prequalify by way of demonstrating the financial ability to close, submission of an executable asset-purchase agreement and submission of a “good faith” deposit. This “weeding out” process can be healthy and may lessen the “clutter” of parties that are not serious contenders to buy the assets or competitors who want nothing more than improper access to confidential business information. The bidding procedures will include a minimum starting bid, as well as bidding increments — i.e., the amount by which a bid must exceed the prior bid in order to continue.
With great frequency, bidding procedures are approved that give the debtor substantial discretion in the manner in which the auction is actually conducted and how the “winning bid” is chosen. The bidding procedures may state that the debtor will determine in its sole discretion, subject to approval of the bankruptcy court, which bid is “highest and best.” Also, a debtor often reserves the right to modify certain of the procedures and adjourn the auction from time to time — all nominally in the interests of maximizing the amount realized at the auction. At times, if a creditors’ committee is formed, such a committee may have the right to “consult” with the debtor, but will rarely be given veto power.
HURDLES FOR BIDDERS
Potential bidders have a number of obstacles to overcome. After identifying a potential acquisition target, bidders must deploy staff and professionals — and money — to conduct due diligence. If the bidder decides to prepare a bid that meets the qualifications set forth in the bidding procedures, the bidder must prepare the necessary asset-purchase agreement and other documentation in order to submit to the seller, and usually concurrently therewith, the good-faith deposit. Although there is no rule, a good-faith deposit ordinarily ranges from 3 percent to 10 percent. Further, the bidder may have to demonstrate a certain amount of liquid assets that would be available at the closing. Therefore, merely to be a bidder qualified to participate in the auction, a bidder must make a substantial commitment in time and money and be sure not to miss any deadlines.
Next, in order to start the auction itself, a nonstalking-horse bidder must bid at least the purchase price of the stalking-horse bid; the expense reimbursement; the “break-up” fee and the minimum bidding increment. At the auction itself, there may be certain noncash consideration that a party may bid that may not be easily measurable in strictly monetary terms. For example, I was involved in a case in which the debtor was auctioning certain real property that was occupied by several residents who did not pay rent. The only bidders were the stalking-horse bidder and a qualified third-party bidder. Both bids provided that the residents could remain on the premises, but had to ultimately leave after a certain period of time, which was approximately the same in both bids. At the auction, the two parties engaged in spirited bidding, and at one point, the cash consideration in the two bids were essentially the same. The stalking horse then changed its bid to provide that the residents could stay indefinitely, thereby saving the debtor’s estate and creditors the potentially substantial expense and concern of relocating the residents. At the auction, both the debtor and the creditor’s committee favored the stalking-horse bidder, despite the other bidder’s willingness to make a significantly higher monetary bid. Ultimately, the bankruptcy court approved the stalking-horse bid over the objection filed by the competing bidder.
This raises a question: What rights does a losing bidder have to challenge a debtor’s decision regarding which is the “highest and best bidder”? Most courts addressing this issue have held that a losing bidder has very limited standing to challenge.
The overriding principle for the limited standing granted to a disgruntled bidder is the need for finality, which is of central importance to bankruptcy estate auctions. Bidders should know that the auction is the only chance to obtain the assets desired. This emphasis on finality will help yield the highest and best offers from the participating bidders. In addition, bankruptcy courts seek to protect the interests of the estate in obtaining the highest value, rather than protecting a losing bidder who has no pecuniary stake in the outcome (other than its own self-interest).
On the other hand, courts have recognized that an exception exists when an unsuccessful bidder challenges the intrinsic structure of the sale because it is tainted by fraud, mistake or unfairness. Therefore, if the auction was conducted in an unfair manner (i.e., departing substantially from the court-approved procedures) or collusion or fraud tainted the bidding, then a bidder could petition the bankruptcy court to reopen the bidding. This is consistent with the principle that the highest and best bid should be obtained for the estate.
The oft-cited decision by the U.S. Court of Appeals for the Seventh Circuit in Corporate Assets Inc. v. Paloian, 368 F.3d 761 (7th Cir. 2004), is noteworthy. In Paloian, the bankruptcy court upheld the debtor’s decision to reopen an auction for a bidder who claimed that it was unaware of material changes made to a competing bid. After the auction was held, the disgruntled bidder made a bid approximately 9 percent higher than the final bid at the auction, and the auction was reopened. The second auction yielded the same winning bidder as the first, although the winning bid was substantially higher. At the hearing on the debtor’s motion to approve the highest bid from the second auction, the winning bidder argued that its original winning bid should be reinstated at the lower price. The bankruptcy court, in a decision upheld by the Seventh Circuit, rejected the argument. The Seventh Circuit noted the broad discretion that the debtor had to conduct the auction and to determine which bid would be brought to the bankruptcy court for approval sufficiently tempered the expectations of the bidders with respect to the finality of the bidding until court approval.
In short, bidders must be ready to commit significant resources to participate in an auction process that may turn out to be unpredictable — even those with court-approved bid procedures. The best defense is to engage experienced professionals to best navigate the bankruptcy-asset sale process.
Daniel H. Reiss is a partner at bankruptcy boutique Levene, Neale, Bender, Yoo & Brill in Los Angeles.