United States: Buying Assets From A Distressed Company Or Debtor In Bankruptcy

Given the current state of the economy, now may be a good time to pick up some telecom assets, real estate, office equipment or practically any other type of asset from a distressed company or even a company in bankruptcy. Consideration should be given to whether such an acquisition should be pursued while a company is in the shadows of bankruptcy, or after the company is in bankruptcy. This legal alert will focus on the pros and cons of purchasing assets prior to versus after a company files for bankruptcy.

Confidentiality. Outside of a bankruptcy case, the buyer and seller are generally free to agree to keep a potential sale confidential. In a bankruptcy case, the sale must be made public by the filing of a motion in the bankruptcy court requesting the court’s approval of the sale. Notice of the sale must be sent to all creditors, unless the court limits notice to appointed committees, such as the unsecured creditors’ committee and others who have formally requested notice of all matters arising in the case.

No Shop Provisions. Outside of a bankruptcy case, a sale agreement may include a no shop provision to prevent the seller from seeking a more lucrative offer from another buyer. In a bankruptcy case, no shop provisions are not permitted because the debtor is required to seek over-bids. Although this makes the buyer a stalking horse (i.e., the initial bidder) for higher bids, as discussed below, break-up fees are permitted as compensation for the stalking horse.

Assets Sold Subject to Liens, Claims, etc. Assets sold outside of a bankruptcy case are subject to pre-existing liens, claims and interests. This requires the buyer to determine the extent and nature of liens and claims and take subject to or negotiate releases directly or through the seller. This process can be time consuming and expensive and does not provide full assurance that all liens and claims have been addressed.

Successor Liability. Successor liability is generally not an issue in asset sales. However, where a substantial asset is purchased, such as a manufacturing facility, or substantially all of the assets of an entity, the buyer may be found to be liable as a successor to the seller, particularly if the employees of the seller are hired by the buyer.

Fraudulent Conveyance. Fraudulent conveyance issues arise if the seller subsequently commences a bankruptcy case. A pre-bankruptcy sale will be found to be a fraudulent conveyance if it is determined that the seller received less than reasonably equivalent value from the sale and (1) was insolvent at the time of the transaction, or was rendered insolvent by the transaction; (2) was left with an unreasonably small amount of capital to continue its business; or (3) the seller incurred, or intended to incur, debts beyond the ability of the seller to pay such debts as they matured. In a fraudulent conveyance action, the debtor in bankruptcy or trustee seeks to avoid the transaction by recovering the property transferred or the value thereof, subject to certain exceptions for bona fide purchasers.

Bulk Transfer Laws. If the seller’s principal business is the sale of inventory from stock inventory, then a sale outside of the seller’s ordinary course of business where inventory is included in the sale could come within the scope of the onerous provisions of Article 6 of the Uniform Commercial Code, which governs "Bulk Sales." Bulk transfer laws have been repealed in most states.

Sale Free and Clear of Liens, Claims, etc. Assets sold pursuant to court order in a bankruptcy case may be sold free of liens, claims and interests. The liens and claims attach to the proceeds of sale.

Protection From Appeals. Unless the party appealing a sale order obtains a stay pending appeal, a good faith purchaser of assets in a bankruptcy case is protected from reversal on appeal.

No Fraudulent Conveyance. An asset sale in a bankruptcy case is free from fraudulent conveyance issues because the bidding process ensures that the best offer has been obtained, i.e. the debtor receives reasonably equivalent value in exchange for the assets sold, although issues can arise if the buyer is aware that the debtor originally acquired the assets to be sold by way of a fraudulent transfer.

No Bulk Transfer Laws. Bankruptcy sales are specifically excluded from Article 6 of the Uniform Commercial Code.

Break-Up Fees. No shop provisions may not be utilized in a bankruptcy sale. The result is that the prospective buyer is often used by the debtor as a stalking horse. To compensate the prospective buyer for the time and cost of due diligence, negotiations, etc., break-up fees are permitted if the prospective buyer is outbid for the assets.

No Confidentiality. All terms of an asset sale agreement are open to the public in bankruptcy because of mandatory notice provisions and the fact that the sale agreement will be filed in the bankruptcy court and detailed in a motion to approve the sale.

Sale Must Be Shopped. In order to ensure that the highest and best price is received for the assets being sold, the debtor must shop the sale.

Court Approval Required. An asset sale in a bankruptcy case must be approved by the court after notice and a hearing. This process can take anywhere from 30 – 90 days depending upon the court’s calendar and the number and nature of objections to the sale.

Successor Liability. Even after a bankruptcy sale there may still be successor liability issues, most commonly involving mass tort such as products liability and environmental claims.