Written by: Shawn Fox
McGuireWoods LLP; New York
The sale of all or substantially all of the assets of a business pursuant to §363 (363 sale) of the Code in a chapter 11 case has become more commonplace in recent years as acquirors seek to purchase target businesses in an accelerated manner while shedding many of those businesses’ liabilities. This strategic choice often involves the asset purchase agreement (APA) and the 363 sale procedures for conducting the auction sale (bidding procedures) being negotiated prior to the commencement of the target company’s chapter 11 case. These negotiations take place most often among the debtor, the secured creditors and the initial proposed acquirer. In cases where the debtor has leveraged its assets in excess of its value, however, the debtor may play less active role in the negotiation of the APA. The initial proposed acquirer is usually referred to as the stalking-horse bidder and its bid called the “stalking-horse bid.” The stalking-horse bid usually sets the floor valuation for the business that is to be sold pursuant to the 363 sale.
The stalking-horse bidder usually negotiates an expense reimbursement and a break-up fee in the APA for serving as the stalking-horse bidder. The expense reimbursement is generally provided so that the stalking-horse bidder may recover some of the fees and expenses that it has spent doing due diligence and creating a market for the business. A break-up fee is routinely allowed in the 363 sale process, as long as the break-up fee meets the applicable test for approval in the district. See In re O'Brien Environmental Energy Inc. (Calpine Corp. v. O'Brien Environmental Energy Inc.), 181 F.3d 527, 535 (3d Cir. 1999); AgriProcessors Inc. v. Fokkena (In re Tama Beef Packing Inc.), 321 B.R. 496, 497 (8th Cir. BAP 2005); In re Integrated Resources Inc., 147 B.R. 650, 662 (S.D.N.Y. 1992) appl. dismissed in Official Committee of Subordinated Bondholders v. Integrated Resources Inc., (In re Integrated Resources Inc.), 3 F.3d 49 (2d Cir. 1993). In most instances, a stalking-horse bidder requests a super-priority administrative expense claim, subject to bankruptcy court approval, on account of the expense reimbursement and break-up fee. Approval of the expense reimbursement and break-up fee (often on an emergency basis) by the bankruptcy court as part of the bidding procedures for conducting the 363 sale is often a condition of the effectiveness of the APA. Ideally, failure to obtain such approval should give the stalking-horse bidder the right to terminate the APA and walk away from the transaction with no liability to itself.
Super-priority administrative expense treatment of break-up fees and expense reimbursements has, in the past, proved sufficient to provide for the payment of such amounts when either a sale to a third party (not the stalking-horse bidder) is consummated or the 363 sale as proposed in the APA fails to close through no fault of the bidder. However, in instances where a debtor has leveraged its assets to the point that there are no unencumbered assets and no equity in the unencumbered assets, there may not be assets from which to pay the break-up fee or expense reimbursement. In such instances, the stalking-horse bidder may not receive anything on account of its super-priority claim for the break-up fee or the expense reimbursement. For example, in In re CXM, Inc., 307 B.R. 94 (Bankr. N.D. Ill. 2004), a stalking-horse bidder that had an approved break-up sought to recover this fee when a third party outbid the stalking-horse bidder and closed an alternative transaction. The purchase price under the approved alternative transaction did not, however, leave sufficient funds to pay all of the liens that had attached to the sale assets. As such, even though the stalking-horse bidder had obtained approval of the break-up fee, the stalking-horse bidder did not receive payment on account of this break-up fee from the sale proceeds. Id. at 98.
In addition to requesting super-priority administrative expense treatment of expense reimbursements and break-up fees, in instances where the assets that a party wishes to acquire are overleveraged, or leveraged to the point where it is not clear that there will be sufficient proceeds to pay off the liens that have attached to the sale assets and to pay the expense reimbursement and the break-up fee, there are at least two ways in which to obtain a recovery on account of the expense reimbursement and break-up fee, even if the secured creditors’ liens are not paid in full from the sale proceeds. However, both of these methods will require counsel to be proactive in the negotiation of the expense reimbursement and break-up fee in each case.
One way in which one may preserve the recovery for the stalking-horse bidder in an overleveraged case would be by negotiating a carve-out from a secured creditor’s lien on the sale assets as part of the APA (which would require the secured creditor signing on to that portion of the APA) or in a separate agreement that was to be included as part of the bidding procedures. This carve-out agreement would require the secured creditor to allow for the payment of the expense reimbursement and break-up fee from the proceeds of the sale of an alternative transaction or the assets themselves. In this instance, the stalking-horse bidder will have preserved its right to receive payment of the break-up fee and expense reimbursement as long as it is entitled to either under the terms of the APA.
Another alternative to ensure payment of a break-up fee and expense reimbursement that may be more palatable to a debtor and the bankruptcy court would be obtaining a guaranty of these amounts from the secured creditor. This would allow your client a right to payment that would be enforceable independent of the sale of the assets contained in the stalking-horse bid, regardless of whether a sale of the assets was ultimately approved.
In an ideal world, one would negotiate both a carve-out and a guaranty of the expense reimbursement and break-up fee to protect the interest of the stalking-horse bidder. However, obtaining either the carve-out or the guaranty of the expense reimbursement and break-up fee will greatly improve your client’s likelihood of recovery in an overleveraged asset sale.