Distressed Deals: “To Chapter 11, or Not to Chapter 11? That is the Question. . .”
Many buyers of distressed businesses opt to acquire the target’s assets through a Section 363 sale following a Chapter 11 filing. But, a WilmerHale memo says that the magnitude of the COVID-19 crisis and the volume of distressed sellers that may well result from it might cause some buyers to rethink that approach. Here’s the intro:
When a company faces financial distress and seeks to sell its assets, both the seller and the buyer may prefer to implement the transaction through a Section 363 sale in a Chapter 11 bankruptcy case of the seller. A Chapter 11 sale process provides certain protections to the buyer from fraudulent transfer and other claims of the seller’s creditors, and a seller may be able to maximize the purchase price of its assets through a Section 363 auction process.
But even before the COVID-19 crisis, Section 363 asset sales also came with disadvantages. The Chapter 11 process can be costly, and it does not scale down well for transactions with lower purchase prices. In addition, a Section 363 sale can take several months to implement after the filing of the Chapter 11 case, and that time can also be costly in terms of the seller’s operating costs and the potential diminution in value of the seller’s assets while its Chapter 11 case runs its course. And for a buyer, even where it is a “stalking horse” purchaser with a breakup fee and other bidding protections, a Section 363 auction may invite competition for the seller’s assets that the buyer would prefer to avoid.
In the face of the COVID-19 crisis, when a greater level of financial distress among companies is anticipated, the balance of factors that may push buyers and sellers toward or away from a Chapter 11 sale process may shift. For reasons of risk tolerance, court access, and time and cost, buyers and sellers may be more likely to attempt non-bankruptcy distressed asset sales as a result of the crisis. Here we explore these reasons and analyze why they may cause sellers and buyers to favor out-of-court transaction options such as private sales, Article 9 secured party sales and sales by assignees for the benefit of creditors.
The memo walks through the various considerations identified above that might make a transaction outside of bankruptcy the preferred approach for many buyers and sellers. It notes that determining the right path for a deal is going to depend on an analysis of the facts and circumstances of the particular transaction, but that in the current environment, that analysis might well result in a different conclusion than has been typical in the past.
-John Jenkins, DealLawyers.com April 14, 2020
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