Rising interest rates, inflation, and a global economic slowdown create the perfect storm, pushing some companies into financial distress. These conditions can also create opportunities for investors to make strategic acquisitions of distressed assets.
A sale of distressed assets can benefit creditors, by generating cash to pay down debt, as well as buyers, by providing a means for savvy investors to enhance their own portfolio and expand into new markets through the targeted acquisition of assets for a relative bargain. A distressed asset sale may even be the centerpiece of a debtor’s financial restructuring, enabling it to shed burdensome or unproductive assets and alleviate its debt load.
The best procedural vehicle for meeting the goals of the transaction will depend on the circumstances. Let’s look at some of the most common types of distressed asset sales.
Sales Under Section 363 of the Bankruptcy Code
Section 363 of the Bankruptcy Code – which governs the use, sale, and lease of property of the estate – allows a debtor or bankruptcy trustee to sell assets outside the ordinary course of business. A debtor may use section 363 to sell assets ranging from a single piece of equipment to its entire business. A section 363 sales offer multiple advantages for both buyers and sellers that are not available in other types of distressed asset sales. The most significant advantage is that buyers in a section 363 sale take the assets free and clear of all liens, claims, and encumbrances if certain conditions are satisfied. This allows the debtor to sell its assets “as is” with limited representations and warranties, while enabling the buyer to acquire clean title and protection against successor liability claims and other liabilities arising from the debtor’s operation of the assets. The finality and certainty of a bankruptcy sale order can increase demand for the assets and generate a higher sales price, which in turn helps maximize value for the debtor’s bankruptcy estate and for the creditors.
Section 363 sales offer several additional advantages. Prospective buyers can choose which of the debtor’s executory contracts and leases they want to acquire. As long as the debtor or buyer satisfies outstanding amounts owing under the relevant agreements, and the buyer provides adequate assurance of future performance under the contract, then the debtor may assume the contract and assign it to the buyer as part of the section 363 sale. Typically, anti-assignment provisions in a debtor’s contracts will not be enforced in bankruptcy. This ability to choose valuable contracts to acquire in a sale, while leaving burdensome contracts with the debtor’s bankruptcy estate, makes a section 363 sale particularly attractive to buyers acquiring a debtor’s business.
Section 363 sales also provide good faith purchasers protections to prevent the unwinding of a sale by a later modification or reversal of the sale on appeal, so long as the sale order includes a finding that the buyer has acted in good faith. Moreover, section 363 sales insulate buyers from fraudulent transfer liability, since the auction process ensures that the debtor receives the highest and best price for the assets, and sale orders typically bar future fraudulent transfer claims.
The Bankruptcy Code provides a detailed framework for section 363 sales. Sales under section 363 are frequently conducted by auction in furtherance of the Bankruptcy Code’s value maximization policy objectives. A typical section 363 sales process begins with the debtor marketing the assets and identifying prospective buyers, and then selecting one of the buyers to serve as what is referred to as the stalking horse bidder. The purpose of a stalking horse is to set the baseline purchase price at a public auction to be conducted later pursuant to court-approved procedures, and to entice other prospective bidders into the auction process.
After selecting the stalking horse, the debtor and the stalking horse will execute an asset purchase agreement governing the terms of the sale. Because the stalking horse incurs substantial transaction costs in negotiating a deal with the debtor that has no guarantee of closing, the asset purchase agreement will typically provide for certain bidding protections for the stalking horse. These protections usually include a break-up fee, overbid protections, and expense reimbursement in the event that the stalking horse is not the winning bidder, or the debtor otherwise terminates the transaction.
The sales process is similar regardless of whether the 363 sales pleadings are filed with the bankruptcy petition or later in the case: (1) the debtor will file a motion to approve bidding procedures, which sets forth the terms of the auction process (including required qualifications for bidders and bids, bidding deadlines and deadlines for sale objections, and rules governing opening bids and the auction process); (2) the court will hold a hearing on the bidding procedures; (3) the court will approve the bidding procedures (or a modified version thereof); (4) the debtor will continue to market the assets and solicit additional bids; (5) if the debtor receives additional qualifying bids, it will proceed to an auction; (6) at the conclusion of the auction, the debtor will select the bid that it deems to be the highest and best offer for the assets in accordance with its sound business judgment. The debtor’s selection of the winning bidder is subject to bankruptcy court approval, and a hearing to approve the sale is typically held shortly after the conclusion of the auction. If the court approves the sale, it is statutorily stayed for 14 days unless the court waives the 14-day stay period (which routinely occurs), thus permitting the sale to close soon after court approval.
Even though a sale under section 363 occurs within the boundaries of a well-established statutory structure, and, as such, offers some degree of predictability, a 363 sale comes with inherent uncertainties associated with any type of court proceedings. Creditors and contract counterparties must receive notice of the proposed sale and have the right to object, competing bidders may complicate the process, and the court could deny the proposed bidding procedures (or override previously approved procedures if it deems it to be in the best interest of the estate to do so) or decline to approve the sale entirely. Thus, both the debtor and the proposed purchaser must be prepared to respond to unexpected disruptions as soon as the section 363 pleadings are filed.
The 363 sales process can involve negotiations with numerous stakeholders, and the final deal (and the final sale order) will often reflect concessions made to satisfy objections filed by interested parties. Notwithstanding the complications that may arise during the 363 sales process, once the court enters a final order approving a 363 sale (and relevant appeals periods expire), the parties to the transaction can enjoy a higher degree of certainty, finality, and protection than that afforded by other kinds of distressed asset sales.
UCC Article 9 Sales
Creditors with claims secured by personal property, such as equipment or inventory, often must take advantage of a sale under Article 9 of the Uniform Commercial Code to realize the value of their collateral. Such sales are often at discount prices and can have other advantages attractive to distressed asset purchasers.
Article 9 governs the relationship between debtors and their secured creditors with respect to personal property. In general, a secured creditor may enforce its rights in collateral after default by the borrower by repossessing and disposing of the property securing the loan. The secured creditor’s remedies include the right to sell the collateral to a third party. To properly effectuate a sale under Article 9 after default by the debtor, a secured creditor must follow the statutory requirements for repossession, notice, and commercial reasonableness of the sale.
First, the secured creditor must repossess the collateral in accordance with the procedures set forth in Article 9 (which vary depending on the type of collateral). Once the secured creditor has repossessed the collateral, it must provide proper notice before it can sell the collateral to a third party. Article 9 sets forth detailed requirements with respect to which parties must receive notice of the sale, the content of the notice, and the timeliness of the notice.
Compliance with these notice provisions ensures only that the notice of the sale is reasonable. In order to insulate the sale from future legal challenges, a creditor foreclosing on collateral is also required to conduct a sale that is commercially reasonable in method, manner, time, and place. For non-judicial sales, disposition, collection, and enforcement of collateral is considered commercially reasonable if it is 1) made in the usual manner on any recognized market; 2) at the current price in any recognized market at the time of disposition; and 3) in conformity with reasonable commercial practices among dealers in the type of property being sold. Despite these general guidelines, the question of whether a sale was commercially reasonable may be a question of fact that turns on the underlying circumstances. Accordingly, the Alabama UCC recognizes that a transaction may still be commercially reasonable even if the secured party may obtain a greater amount for the assets using a different method.
A commercially reasonable sale can take many forms: it can be a public or private sale, it can take place at any time or place and on any terms, it can be made by one or more contracts, and the collateral may be sold as a unit or in parcels. Courts consider the sales price, manner of sale, timing of sale, and conduct of sale in evaluating commercial reasonableness. With respect to the manner of sale, courts generally find public sales to be commercially reasonable if the secured creditor provides sufficient notice to the public.
Private sales are more likely to be deemed commercially reasonable if the creditor can show that it retained a broker to assist with the sales process, or at least solicited multiple offers before making a sale. The timing of the sale must also be commercially reasonable, and the secured creditor cannot delay a sale if doing so will cause the value of the collateral to decline.
An Article 9 sale may be an attractive option for buyers, debtors, and secured creditors. It is generally faster and less expensive than a sale in bankruptcy, so it may be beneficial in cases where the value of the assets is deteriorating rapidly. A debtor can benefit from an Article 9 sale by negotiating the secured creditor’s release of deficiency claims, personal guarantees, or other collateral in exchange for the debtor’s cooperation with the Article 9 sale.
Article 9 sales provide benefits for buyers as well, including the opportunity to purchase collateral at a discount while avoiding the expense and delay of a bankruptcy auction process. Upon completion of the Article 9 sale, the buyer takes whatever rights the debtor had in the collateral, free and clear of the foreclosing creditor’s security interest and any subordinate security interests. And while an Article 9 sale cannot insulate the buyer from fraudulent transfer or successor liability in the way that a 363 sale can, the buyer may conclude that the risk of such claims is relatively low.
One obvious disadvantage of an Article 9 sale is that it is limited to personal property and cannot be used to sell real property. While an Article 9 sale may be sufficient to sell discrete items of personal property, it may not be practical to sell an entire business through this process. Moreover, an Article 9 sale may be disrupted by a bankruptcy filing at any time.
Also, the absence of a court order approving the sale and addressing any deficiency claims may increase the chances of later litigation over the transaction. Similarly, failure to comply with the strict statutory requirements and commercial reasonableness standards may result in challenges to the sale (and the fact that the commercial reasonableness standard is itself so fact-specific makes it more difficult for the parties to structure a completely attack-proof sale).
Federal or state court receiverships provide another vehicle for buying and selling distressed assets. In a receivership, a third party (the receiver) is appointed by a court to administer assets that are subject to a dispute or claim. The receiver’s mission is to safeguard and protect a defendant’s assets pending the court’s final disposition of the case at bar. Most often, the appointment of a receiver is sought by a creditor who believes that the debtor’s assets are being or may be mismanaged to the detriment of the creditor’s interests.
State and federal receivership statutes generally define a receiver’s powers in broad and vague language, leaving it to the supervising court to tailor the scope of the receiver’s authority to the specific needs of the case at bar. The order appointing the receiver should specifically describe the receiver’s powers. A receiver’s duties generally include the power to locate, seize, and take title to the entity’s assets; to manage the debtor’s business; and to sell or otherwise dispose of the receivership’s assets, subject to court oversight and approval.
The sale of assets by federal receivers is governed by 28 U.S.C. §§ 2001, 2002, and 2004. These provisions offer specific guidelines regarding certain procedural requirements, such as notice provisions, but are vague regarding other procedural matters. A federal receiver may sell receivership property – whether real or personal property – through either a public or private sale. The federal receivership statute imposes certain additional requirements for appraisals, notice, and pricing with respect to private sales. Both public and private receivership sales have to be made upon such terms and conditions as the court directs. Accordingly, before a receiver can sell receivership property, it should seek direction from the court regarding the terms and conditions upon which the sale may be made.
State receiverships statutes may include their own provisions regarding receivership sales. But in many states, including Alabama, general receivership statutes are sparse and lack specific statutory guidance for receivership sales. Accordingly, the court overseeing the receivership will impose the rules and procedures governing receivership sales in the case before it, either in the order appointing the receiver, an order authorizing the sale or governing sales procedures, or similar orders.
Selling assets in a receivership can have advantages over selling in bankruptcy. For example, a Chapter 11 bankruptcy case can be expensive. The costs of professionals and other administrative fees in bankruptcy can significantly reduce the recovery for creditors. Because receiverships are more flexible and have fewer statutory requirements than bankruptcy cases, a receivership generally is less expensive. And with fewer statutory requirements, receivership courts and the parties involved have more flexibility to tailor administration to the needs of the case.
There are disadvantages to selling assets in a receivership as well. The same lack of statutory structure that allows for flexibility can also create confusion and unpredictability. Receiverships are relatively uncommon, so judges frequently have little experience overseeing receivership cases (unlike bankruptcy judges, who are well-versed in the Bankruptcy Code and section 363 sales).
Also, while the Bankruptcy Code expressly provides for the sale of assets free and clear of liens, with the liens attaching to the sales proceeds, most receivership statutes lack similar provisions. Conflicting case law regarding whether a receivership court may order free and clear sales of receivership property, particularly where the property being sold is worth less than the value of all secured claims, can complicate the sale of encumbered assets. And as with Article 9 sales, a receivership may be superseded at any time by the filing of a bankruptcy case.
It is impossible to fully remove the “distress” from distressed asset sales, and there is no perfect procedure that will always guarantee top dollar return for creditors and sellers, a risk-free bargain for buyers, and an efficient, inexpensive, complication-free process. But each of the methods outlined offer certain advantages that parties can use strategically to acquire assets at a discount, generate much-needed cash for a business and its creditors, and potentially serve as the centerpiece of a more comprehensive debt restructuring.
Republished with permission. This article, "FROM THE ALABAMA LAWYER - Bankruptcy Sales (and Non-Bankruptcy Alternatives) for Buying and Selling Distressed Assets," was published by the Alabama State Bar on January 30, 2023.
 11 U.S.C. § 363.
 Id. at § 363(f).
 Id. at § 363(m).
 Ala. Code § 7-9A-611.
 Id. at § 7-9A-613(1).
 Id. at § 7-9A-612.
 Id. at § 7-9A-610.
 Id. at § 7-9A-627(b).
 Id. at § 7-9A-627(a).
 Id. at § 7-9A-610(b).
 28 U.S.C. § 2001(a).
 Alabama’s general receivership statute is found at Alabama Code §§ 6-6-620 to 6-6-228. Rule 66 of the Alabama Rules of Civil Procedure also govern state court receiverships. The Alabama Code includes specific receivership provisions governing matters such as insolvent bank receiverships, insolvent insurer receiverships, and corporate dissolution receiverships that are beyond the scope of this article.