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    Posts Tagged ‘“break-up” fee’

    Buying Assets in Bankruptcy – To Be or Not to Be . . . a Stalking Horse?!

    Monday, March 1st, 2010

    With both the global and regional Southern California economies showing early signs of life – but still lacking the broad-based demand for goods and services required for robust growth – opportunities abound for strong industry players to make strategic acquisitions of troubled competitors or their distressed assets.

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    Ray Clark, CFA, ASA and Senior Managing Director of VALCOR Consulting, LLC, is no stranger to middle-market deals.  His advisory firm provides middle market restructuring, transactional and valuation services throughout the Southwestern United States from offices in Orange County, San Francisco, and Phoenix.

    As most readers are likely aware, distressed mergers and acquisitions can be handled through a variety of deal structures.  Last week, Ray dropped by South Bay Law Firm to offer his thoughts on a process commonly known in bankruptcy parlance as a “Section 363 sale.”

    In particular, Ray covers the “pros and cons” of this approach.

    The floor is yours, Ray.

    Today’s economic environment has created an opportunity to acquire assets of financially distressed entities at deeply discounted prices, and one of the most effective ways to make those acquisitions is through a purchase in the context of a bankruptcy under Section 363 of the Bankruptcy Code (the “Code”).  When purchasing the assets of a failed company under Section 363, there are distinct advantages to being first in line.  Depending on the circumstances, however, it may be best to wait and let the process unfold – and then, only after surveying the entire landscape, submit a bid.

    The 363 Sale Process

    A so-called “363 Sale” is a sale of assets of a bankrupt debtor, wherein certain discrete assets such as equipment or real estate – or substantially all the debtor’s business assets – are sold pursuant to Section 363 of the Bankruptcy Code (11 USC §363).  Upon bankruptcy court approval, the assets will be conveyed to the purchaser free and clear of any liens or encumbrances. Those liens or encumbrances will then attach to the net proceeds of the sale and be paid as ordered by the Bankruptcy Court.

    A Section 363 sale looks much like a traditional controlled auction.  Basic Section 363 sale mechanics include an initial bidder, often referred to as the “stalking horse,” who reaches an agreement to purchase assets – typically from the Chapter 11 debtor, or “debtor-in-possession” (DIP).  The buyer and the DIP negotiate an asset purchase agreement (APA), which rewards the stalking horse for investing the effort and expense to sign a transaction that will be exposed to “higher and better” or “over” bids.  The Bankruptcy Court will approve the bidding procedures, including the incentives, i.e., a “bust-up” fee, for the stalking horse bidder, and will pronounce clear rules for the remainder of the sale process.  Notice of the sale will be given, qualified bids will arrive and there will be an auction.  The sale to the highest bidder will commonly close within four to six weeks after the notice and the stalking horse will either acquire the assets or take home its bust-up fee and expense reimbursement as a consolation. 

    Advantages for the Stalking Horse Bidder

    Bidding Protections – During negotiations with the debtor for the purchase of assets, the stalking horse will also typically negotiate certain protections for itself during the bidding process.  These bidding protections, which include a bust-up fee and expense reimbursement, will be set forth in the 363 sale motion and are generally approved by the bankruptcy Court.  As a result, stalking horse bidders seek to insulate themselves against the risk of being out-bid.  To do so, proposed stalking-horse bidders commonly require that any outside bidder will typically have to submit not only a bid that is higher than that of the stalking horse, but will also need to include an amount to cover the stalking horse’s transactional fees and expenses.

    Bidding Procedures – The stalking horse will also negotiate certain bidding procedures with the debtor, which will be set forth in the 363 sale motion that will be evaluated, and most likely approved, by the Court.  The sale procedures generally include the time frame during which other potential bidders must complete their due diligence and the date by which competing bids must be submitted.

    Other delineated procedures typically included in the motion include the amount of any deposit accompanying a bid and the incremental amount by which a competing bid must exceed the stalking horse bid.  In addition, if the sale procedures provide for an abbreviated time frame in which to complete an investigation of the assets, a competing bidder will be at a distinct disadvantage and may be unable, as a result, to even submit a bid.

    Deal Structure – As the first in line, the stalking horse bidder will also negotiate all of the important elements of the transaction, including which assets to acquire, what contracts – if any – to assume, the purchase price and other terms and conditions.  In doing so, it establishes the ground rules by which the sale process will unfold and the framework for the transaction, which will be difficult, if not impossible, for another outside bidder to change. 

    “First Mover” Advantage – The stalking horse bidder will typically be viewed by the Court as the favored asset purchaser in that it will have negotiated all of the relevant terms and procedures, and established its financial ability and intent to acquire the assets.  As a result, short of an overbid by an outside party, which typically involves an additional amount to cover the stalking horse’s bust-up fee and expenses, the stalking horse bidder will prevail.

    Cooperation of Stakeholders – As the lead bidder, the stalking horse also has an opportunity to negotiate with other key stakeholders in the process and establish a close relationship with those parties that may prove advantageous when all offers are evaluated.

    Bust-up Fee and Expense Coverage – Lastly, if an outside party happens to submit the high bid, the stalking horse will typically receive its bust-up fee and expense reimbursement. This generally includes items such as due diligence fees, legal and accounting fees, and similar expenses, but is limited by negotiation. 

    Disadvantages to the Stalking Horse Bidder

    Risk of Being Outbid – As noted, the stalking horse will expend a great deal of time, energy, and resources analyzing and negotiating for the purchase of the assets.  All a competing bidder must do is show up to the sale and submit an over-bid.  If the competing over-bidder prevails, the stalking horse runs the risk of walking away with only its bust-up fee and expense reimbursement.

    Risk of Bidding Too High – After negotiating the APA, the stalking horse then participates in the 363 sale process.  If no other bidders materialize, it may be because the stalking horse effectively over-paid for the assets. 

    Inability to Alter Terms – If some new information comes to light that would otherwise suggest a reduction in the price or alteration of the terms, the stalking horse may have difficulty altering either of these and may be locked in to the negotiated structure.


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    Meanwhile, happy hunting.

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    Distressed M&A: Two Perspectives, One Conculsion

    Sunday, April 12th, 2009

    A recent MONDAQ article by Bryan S. Gadol and Wendy R. Kottmeier of Dorsey & Whitney’s Irvine, California office discusses financially distressed acquisitions and covers some of the high points attendant to an out-of-court “bargain basement” purchase:

    Fraudulent Transfer Claims: “[I]t is imperative for a buyer acquiring assets at a discount from a seller that is insolvent, or may become insolvent, to evaluate whether the purchase price is of a reasonably equivalent value based on a variety of factors, including the marketability of the assets at the time of the sale and the level of interest, if any, from other potential buyers.”  Without such a determination, the acquisition is subject to attack from disgruntled creditors and the purchaser may be required to return the acquired assets (or their fair market value).

    Successor Liability Claims:  “[U]nder certain legal theories purchasers of assets can sometimes be held liable as a successor for certain environmental, products liability, tax, employee benefits and labor and employment claims. Creditors of the insolvent seller have a greater incentive to look elsewhere to satisfy the seller ‘s unpaid debts, and consequently may choose to pursue successor liability claims against a purchaser.”

    Fiduciary Duty Claims: Until very recently, the boards of distressed corporations were routinely advised of their fiduciary duties to creditors, which arise when the corporation is in the “zone of insolvency.”  This means that the boards of distressed companies are obligated to act in the best interests of the corporation’s creditors – an obligation which extends to management’s decision to sell distressed assets “on the cheap.”  As discussed by Gadol and Kottmeier, recent Delaware case law has narrowed this liability by suggesting such fiduciary duties do not arise until the precise moment when the corporation becomes insolvent.  However, such “precision” may do nothing more than afford corporate boards a false sense of security, since the concept of “insolvency” is itself subject to multiple definitions – and the question of specifically when a corporation becomes “insolvent” is, at best, often a subjective one.

    Though somewhat cursory, the overview from Dorsey’s transactional lawyers is timely: Financial distress arising from the present economic downturn promises a wide range of opportunities for those companies poised to make strategic acquisitions.  As noted by a more extensive piece appearing in late February in The Deal Magazine, journalist Suzanne Stevens and prominent Los Angeles practitioner (and UCLA Law School professor) Kenneth Klee note:

    For companies that stay financially healthy, the wave of corporate distress now building promises plenty of targets.  S&P predicts a record default rate of 13.9% by issuers of high-yield bonds this year, for example.  Among other factors, the late, great buyout wave is expected to produce many opportunities for corporate dealmakers, sometimes for assets that they earlier battled private equity buyers to win.

    Who are the strategic buyers best positioned to take advantage of these buying opportunities?  Klee and Stevens identify at least two types:

    – Purchasers who find their key suppliers in trouble.

    – Foreign buyers looking to improve their positions in the U.S.

    There are undoubtedly more.  Klee and Stevens also touch on some of the various types of deals likely to result, including:

    – Acquisition of the target company’s debt and the offer of a much-needed capital infusion.

    – Bidding for the assets, either out of court or in connection with a “Section 363” sale inside a Chapter 11 case as a “stalking horse” or as a third-party participant.  Though the “stalking horse” bidder typically takes on the risk of being “cherry-picked” by a late-comer to the bidding process, most prospective “stalking horse” purchasers are able to protect both their due diligence investments and their positions through the imposition of “break-up fees” as a part of the sale price to a third party.

    What do strategic buyers have to contend with in consummating a successful acquisition?  In addition to the potential liability outlined by Gadol and Kottmeier, Klee and Stevens highlight the often-complex nature of such acquisitions:

    ‘Straightforward’ is not the first word these deals bring to mind.  In a field renowned as legalistic and technical, and with so many variables to consider – the target’s capital structure, creditor mix, supplier and customer relationships, among others – it’s easy for a dealmaker unfamiliar with distressed deals to put a foot wrong.

    Even so, with enterprise and asset valuations growing cheaper and the synergies available from a well-thought-out acquisition negotiated at bargain prices, the attraction of such a purchase makes putting a foot in worth the risk.

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