CHAPTER 6 Conducting a § 363 Sale

• Jurisdiction: United States

CHAPTER 6: Conducting a § 363 Sale

CONTRIBUTING AUTHORS:

Melissa A. Hager (Morrison & Foerster LLP)

Samantha L. Martin (Morrison & Foerster LLP)

Brett H. Miller (Morrison & Foerster LLP)

Jordan A. Wishnew (Morrison & Foerster LLP)

Edward T. Gavin (Gavin/Solmonese LLC)

A. OUTSIDE OF THE ORDINARY COURSE OF BUSINESS

Section 363 of the Bankruptcy Code generally authorizes the trustee or debtor in possession (the "debtor") to use, sell or lease property of the estate, both in the ordinary course of business and outside of the ordinary course of business.²⁰² In recent years, § 363 sales have gained popularity as an efficient and meaningful step toward a restructuring.

1. ADVANTAGES AND DISADVANTAGES FOR THE DEBTOR AND BUYER

There are many advantages for the debtor associated with the strategic disposition of assets through § 363 sales, including:

• speed;
• shedding undesired contracts and assets;
• obtaining the "highest and best" possible price for the assets through an auction process; and
• the potential ability to obtain better terms for debtor-in-possession (DIP) financing due to the increased liquidity available to the debtor post-sale.

There are significant advantages for the prospective buyers as well, namely:

• speed;
• the ability to acquire the assets free and clear of any creditor claim or interest;
• protection from certain successor liability claims;
• a determination that the assets have been purchased for fair value, thereby protecting the buyer's officers and directors from future undervaluation claims; and
• the ability to obtain desirable contracts through the assumption and assignment process, including those with anti-assignment provisions.

While § 363 sales pose few disadvantages to the debtor, there are several drawbacks for potential buyers, including:

• the uncertainty associated with the auction process whereby bids are subject to "higher and better" offers;
• the transparency of the auction process in which the identity of the bidder and amount of the bids is public information;
• competition from secured lenders that have the right to credit-bid, which means that they may bid the amount of their claim in lieu of making a cash bid;
• the need for court approval (including overcoming objections to the sale); and
• the expense involved, including costs related to due diligence and participating in the bid process, which may be subject to reimbursement (although any reimbursement is subject to court approval).

It should be noted that sales pursuant to a plan of reorganization, an alternative to § 363, involve even more potential obstacles and longer periods of time, as they are subject to the confirmation of a plan of reorganization, which can be a lengthy and uncertain process.

2. GOALS AND MOTIVATIONS OF VARIOUS PARTIES

The debtor and its various constituents may have divergent goals during the § 363 sale process.

The Debtor/CRO. The debtor's primary goal, which permeates its bankruptcy case, is to maximize the value of its estate for the benefit of creditors. As a result, the debtor is mainly interested in minimizing the time and expense associated with the sale and maximizing the bids at the auction.²⁰³ To achieve these goals, the debtor is best served by identifying a bidder to serve as a "stalking horse" bidder prior to announcing the sale process. The stalking-horse bidder should be one that the debtor determines is qualified to bid and is willing and able to close the transaction absent higher and better offers. The debtor's negotiations with the stalking-horse bidder are critical because the parties are setting a "floor" for the terms of the transaction. The debtor also may need to coordinate the sale process in accordance with any milestones set by the secured lenders.²⁰⁴

The Creditors' Committee. The creditors' committee's primary goal in the § 363 sale process is to ensure that the debtor has set an open and fair bidding and auction process to maximize value for its estate. The creditors' committee will seek to minimize barriers to bidder participation and promote spirited bidding at the auction. To do so, the creditors' committee may seek to keep the overbid amounts low, limit breakup fees and expense reimbursements to the stalkinghorse bidder, and gain consultation rights in connection with key decisions to be made during and after the auction. These consultation rights may include decisions about altering bid increments, waiving compliance with the specific provisions of the bid procedures and choosing the successful bidder.

Interested Bidders. Most interested bidders will behave strategically to gain the debtor's valuable assets at the lowest possible price. However, some bidders may enter the auction for less obvious reasons, such as to drive up the price for competitors that are interested in the assets, or to gain entry into the diligence process and obtain information about a competitor or business that is not otherwise generally available.

Senior Secured Creditors. Most secured creditors are primarily concerned with obtaining full repayment of the secured debt through the sale of their collateral. In fact, secured creditors may choose to credit-bid at the auction in order to drive up the price that the successful bidder will need to pay for the assets. Increasingly, however, hedge funds, private-equity groups or other strategic investors are employing a "loan-to-own" strategy to effectively acquire ownership of a company's assets by purchasing the distressed debtor's senior secured debt—often at a discount. In this scenario, the new secured lender is then in a position to quickly pressure the debtor into a § 363 sale and, via credit-bidding, effectively convert its position from creditor to owner.²⁰⁵

Junior Secured Creditors. Junior secured creditors also are concerned with obtaining full repayment of their secured debt. However, these creditors are in a much more precarious position because, depending on the jurisdiction, they may not have the ability to object to the extinguishment of their liens when the assets are sold for a price that is insufficient to provide them with a full return. Junior secured creditors may also be subject to additional limitations pursuant to intercreditor agreements with the senior secured lenders.

Some courts have held that a debtor may sell assets free and clear of the property rights of junior lienholders whose nonbankruptcy liens are not supported by the collateral's value (e.g., there may be a sale free and clear of "out-of-the-money" liens).²⁰⁶ Other courts, however, have held that a debtor may not sell its assets under § 363 free and clear of a lienholder's interest if the price of the asset is equal to or less than the aggregate amount of all claims held by creditors who hold a lien or security interest in the asset being sold.²⁰⁷

To the extent a senior secured creditor intends to acquire ownership of its collateral in a jurisdiction that does not allow a debtor to sell assets free and clear of an out-of-the-money junior secured party, the senior secured party may instead choose to acquire the collateral through a plan of reorganization or seek stay relief and foreclose on the collateral.

B. BASIC OVERVIEW OF THE STATUTORY FRAMEWORK

1. SECTION 363(b)

If the proposed use, sale or lease of property is other than in the ordinary course of a debtor's business, the debtor may use, sell or lease such property only after notice and a hearing.²⁰⁸ Where a debtor is uncertain regarding whether a transaction is in the ordinary course of business or needs court approval, it is advisable to comply with the notice and hearing requirements of § 363(b).²⁰⁹ Section 363 is frequently applied because most transactions involve the use, sale or lease of property of the estate.

2. SECTION 363(c)

The debtor may use, sell or lease property of the estate in the ordinary course of business without prior court approval as long as the continued operation of the business is authorized and the court does not require otherwise.²¹⁰ This section is particularly important in chapter 11 cases involving a business where the ongoing operations are essential to the going-concern value of the business. For example, the sale of inventory by an operating retail debtor would be considered an ordinary-course sale that can accomplished without court approval. However, if that retail debtor were to hold a "going out of business" sale, such sale would not be in the ordinary course of business and would require notice and a hearing.²¹¹

3. SECTION 363(f)

The debtor may sell property under § 363(b) or (c) free and clear of any interest in such property only if:

• applicable nonbankruptcy law permits the sale of the property free and clear of such interest;
• the interested party consents;
• the interest is a lien and the price at which the property is to be sold is greater than the aggregate value of all liens on the property;
• the interest is in bona fide dispute; or
• the interested party could be compelled, in a legal or equitable proceeding, to accept monetary satisfaction of its interest.²¹²

4. SECTION 363(k)

In a non-ordinary course sale of property that is subject to a lien, the lienholder may bid at the sale auction and offset its claim against the purchase price (this is referred to as a "credit bid").²¹³

5. SECTION 363(m)

If the bankruptcy court determines that the sale was conducted in good faith, the purchaser may receive the benefit of § 363(m), which provides that the reversal or modification of the sale order on appeal will not affect the validity of the sale, whether or not the purchaser knew of the pendency of the appeal, unless the sale is stayed by the bankruptcy court while the appeal is pending.²¹⁴

6. SECTION 363(n)

If the sale price was controlled by an agreement among the potential bidders at the sale, then the debtor may:

• avoid the sale;
• recover from one of the conspiring parties the amount by which the value of the property exceeds the sale

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