In a previous Legal Update, we focused on practical sell-side tips for gearing up for a 363 transaction. Here are some pragmatic steps that can help you, as an opportunistic buyer, prepare to be a stalking horse bidder or otherwise participate in a 363 transaction as a potential buyer.
1. Identify Target Companies. Are you maintaining a list of potential targets more generally? Were there any companies you removed from your target list prior to the COVID-19 downturn based on concerns about reaching agreement on valuation? Did you court any other businesses recently to no avail? Consider checking in with your contacts at the various target companies so that you stay top of mind and perhaps catch them at a moment when they are willing to engage. Recognize, though, that you should not expect immediate exclusivity from sellers, particularly those in financial distress. These sellers often will be reluctant to engage with potential buyers on an exclusive basis because their goal is typically to conduct a competitive sale process (often with a stalking horse bidder) that will yield the “highest and best” value obtainable for the assets under the circumstances.
2. Reach Out to Advisers. To support any potential activities, consider outreach to investment bankers with 363 experience to identify the most relevant opportunities. Investment bankers in this space often have a potential target list of companies identifying signs of distress. Send the names of any high-priority targets to your legal advisors—there is no cost in having conflicts run in advance if you think a deal may be on the horizon.
3. Do the Homework You Can. If you are not familiar with the 363 process, take the time to understand it and set your expectations in advance of kicking off (or jumping into) the transaction.
- Timing: The timeline will initially be driven by the target’s situation but almost always will include time for competing bids and an auction and sale hearing. Generally, anticipate 30-90 days of activity in advance of the motion filing date seeking approval of the proposed sale and bidding procedures and 45-130 days from the motion filing date to get to the sale hearing. Do not forget to consider how any regulatory approvals may further impact the timeline.
- Deposit: Sellers usually require a good faith deposit (often 10% of the purchase price) to be made by any stalking horse bidder. The deposit will be credited against the purchase price at closing (or returned if the stalking horse purchase agreement is terminated for a reason other than the bidder’s own breach). Ensure you have the cash on hand to make a deposit.
- Stalking Horse Protections: Understand the typical stalking horse protections—whether you intend to be a stalking horse bidder (because they will benefit you directly) or to just participate in an auction (because they will impact your competing bid). These protections include break-up fees often ranging from approximately 2-4% of the purchase price, expense reimbursement for reasonable and documented fees and expenses (sometimes subject to a cap), and influence over bidding procedures, including the right to access competing bid information, minimum overbids at auction, closing contingencies and the potential rights of secured lenders to credit-bid their indebtedness.
- Secured Debt: Understand the target’s outstanding debt, both to have an appreciation as to the priority ladder and the “currency” strength of possible competing bidders and to evaluate whether you might wish to attempt to purchase such secured debt to credit bid in connection with the sale. Necessary due diligence should cover not only lien searches and related items but also the role that the holders of the secured debt have played in the case or with respect to the target to date.
- Legal Documents: 363 transactions involve an asset purchase agreement but with key differences from non-distressed asset purchase agreements. Sellers will make representations and warranties, as well as agree to interim operating covenants, but often buyers will be unable to secure an indemnity or holdback/escrow for breaches of such representations, warranties or covenants, and any interim operating covenants will be subject to the seller’s obligations as a debtor or debtor-in-possession under the Bankruptcy Code as well as any order from the bankruptcy court. Buyers generally get the benefit of buying the assets free and clear of all liens and claims pursuant to a sale order of the Bankruptcy Court; however, be aware of the governing law in the applicable court that may limit the scope of such an order, including regarding any possible successor liability claims. Explore whether any insurance is available for any potential liabilities that are not discharged in the bankruptcy process.
- Bidding Procedures: Pay attention to applicable bidding procedures. When is the bid deadline, what conditions must be met to become a qualified bidder and what are the other relevant auction rules? Bidding procedures are particularly important if you are not the stalking horse.
4. Be Aware of the Special Considerations of a “Loan to Own” Strategy. If you are a current investor looking to effectuate a “loan to own” transaction through a 363 sale credit bid, you should be aware of the risks associated with this strategy, which include, among other things, equitable subordination, recharacterization, vote designation, cram up/down and credit bidding limitations. In addition, you should account for the potential need to fund the seller’s cash needs during an uncertain timeline, the potential of an unwilling seller, the inherent risk of two-step process and negative market/court perceptions.
5. Be Prepared to Be Creative. You never know what may come up in negotiating a 363 transaction. Seek advice from counsel on how to craft transition services and other related agreements to ensure that the business stays up and running from initial documentation to closing; negotiate debtor-in-possession (DIP) facilities to bridge the target’s funding needs during the bankruptcy process; form consortiums or joint ventures to co-bid on assets; and engage in other bespoke transactions. In many circumstances, these activities require knowledgeable and experienced practitioners who can advise on what bankruptcy courts will, and will not, allow.