Chapter VI Role of the Committee in 363 Sale Cases
| Jurisdiction | United States |
Chapter VI Role of the Committee in 363 Sale Cases
A. The Need for a Sale
Chapter 11 was conceived as a court-supervised forum for financially restructuring operating commercial enterprises. In recent years, however, most chapter 11 bankruptcies have evolved into a sale of substantially all of a distressed company's assets. The legal mechanism by which a sale process occurs is described in § 363 of the Bankruptcy Code136 — hence, the shorthand term "363 sale." The 363 sale can be part of a plan of reorganization, but more often it is a standalone process followed by a liquidating plan, a conversion to a chapter 7 case, or in certain instances, a dismissal.
Section 363 of the Bankruptcy Code provides that the debtor, "after notice and a hearing, may use, sell or lease, other than in the ordinary course of business, property of the estate"'137 As such, § 363 allows the sale of property outside of the ordinary course of the debtor's business, provided the applicable standards are established by the debtor. Typically, the lienholder must consent to the sale and usually does so when it is comfortable with the sale process being run by the debtor and its professionals. If the lien-holder does not consent, under certain circumstances the property may still be sold. In most cases, the assets are generally sold free and clear of the liens of the secured creditors, with the liens attaching to the sales proceeds.
The issues from the committee's perspective are two-fold. First, is the reorganization (going concern) value higher than the asset-sale value? Second, does the debtor have the resources — primarily financing — available to reorganize instead of selling its assets? Practically speaking, the issue of financing is usually under the control of the secured lender. A secured lender typically is not willing to lend the additional funds necessary to reorganize the debtor, nor is it typically willing to subordinate its secured position, so new financing has been and remains unavailable. The committee normally will attempt to gain some leverage with the secured lender to force it to "stay in the game" and support a process that maximizes value for its constituency and not simply for the secured creditor.
From a buyer's perspective, the purchase of assets free and clear of claims, liens and encumbrances frequently makes a bankruptcy sale a preferred means of purchasing a distressed company's assets. The end result of a proper and well-run sale process is the entry of a 363 sale order with numerous bells and whistles designed to cleanse the assets and leave the sins of the past with the bankruptcy estate. In addition, the purchaser usually qualifies for additional protection in that the sale to a good-faith purchaser will not be reversed on appeal.138 Pursuant to a sale order, the assets are delivered to the buyer and the sale proceeds remain in the estate subject to the further order of the court, if necessary, upon resolution of any dispute among parties claiming rights in the assets that were sold. While the assets are sold free and clear of all liens, there are other potential trailing liabilities of which a buyer needs to be aware. For instance, under different state and federal laws, it is possible to have successor liability for claims in areas such as environmental, employment and product liability. The law is muddled at best on these issues, and there still remains the risk of potential liability for a buyer from the debtor's previous operations even with the most comprehensive sale order.139
Debtors and committees strive to have a 363 sale effectuated on an "AS IS WHERE IS" basis, without the typical representations and warranties that buyers are accustomed to receiving in nonbankruptcy sales. Accordingly, the due diligence process is particularly critical for a buyer. Some buyers attempt to deal with the lack of customary warranties by making an offer that is not entirely cash; rather, they will issue a note for some portion of the purchase price or negotiate for a portion of the purchase price to be held in escrow for some period of time, so that the buyer may potentially offset claims that arise against the purchase price. Debtors and committees generally seek to obtain an-all cash deal from the ultimate buyer and eliminate any holdback.
The decision to sell assets versus reorganize rests with the debtor. To approve the use, sale or lease of property outside the ordinary course of business, a bankruptcy court need only determine that the debtor's decision is supported by some "articulated business justification."140 Once the debtor articulates a valid business justification, "[u]nder the business judgment rule, there is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company."141 When applying the "business judgment" rule, courts show great deference to the debtor's decision-making.142Notwithstanding this reality, courts will give weight to the committee's views with respect to the direction of a case, particularly if the proposed transaction is with an insider of the debtor or provides some tangible benefit to the debtor's insiders.
The formal 363 sale process commences when the debtor files a motion requesting the court's approval of a sale of its assets. That motion can be brought at any time during the chapter 11 case. Notice of the motion must be sent to all creditors and parties in interest, unless the court enters an order limiting notice. Generally, absent exigent circumstances, 21 days will be the shortest notice period for a hearing on the sale motion.143 Following the filing of the sale motion, the entire sale process will normally take 45 to 90 days. On rare occasions, an immediate sale is permitted if cause is demonstrated and there is minimal opposition. On the other end of the spectrum, a sale process could take four to six months or longer.
The sale motion may seek to approve a sale subject to higher and better offers, or a private sale without a competitive bidding process. Generally, the sale motion requests that the court approve sale procedures and a process so that an auction may occur at a later date. However, if the debtor and a specific buyer have finalized the sale terms, the motion may seek authority to sell assets at a certain price without an opportunity for competitive bidding. This private-sale approach is uncommon in practice and is typically used for discrete assets for which fair value is readily ascertainable. Generally, committees strongly oppose private sales because well-noticed public auctions provide better assurance that a fair price will be realized for the assets. The committee's viewpoint of the proposed sale process will generally be given considerable weight by the court.
The debtor has a fiduciary obligation to try to find the buyer who will pay the highest price for its assets. This is unlike a typical nonbank-ruptcy situation where a "no-shop" clause may be included in an asset purchase agreement or term sheet. This unusual dynamic often leads the first potential purchaser to seek special protections commonly referred to as "break-up" or "topping" fees to compensate the party for the sunk costs of due diligence if that party is not the ultimate purchaser of the assets. Granting these protections encourages a purchaser to come forward and establish a price...
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