How to Handle Corporate Distress Sale Transactions

By Corinne Ball and John K. Kane

March 2007

Corinne Ball is a partner in the New York City office of Jones Day, practicing in its Business Restructuring and Reorganization Practice. She is a member of the American College of Bankruptcy, the American Bankruptcy Institute, the ABA Business Bankruptcy Committee (formerly chair of the Chapter 11 Subcommittee and the European Insolvency Task Force), and the Advisory Committee on Corporate and Securities Law for the Practicing Law Institute. John K. Kane is a partner in the New York City of office of Jones Day. Partner John R. Cornell and associates Lisa G. Rothman and Ross Barr contributed to this article.

A. Introduction
 
1. Economic conditions over the past few years have increased the number of distressed companies that are seeking to sell assets as part of their plans to improve their financial condition. Rising interest rates, oil prices and large legacy costs are some of the contributing factors. These distress sale situations can present both significant risks and significant opportunities for potential buyers.
 
2. To make the most of these situations, buyers need to be skilled in spotting distressed sellers and conducting the acquisition process in a manner that minimizes those risks and maximizes those opportunities. As discussed below, chapter 11 provides both buyers and sellers with tools that will help them make the best of a distressed merger and acquisition transaction.

B. Identifying the Distressed Seller
 
1. Signs of Distress. The filing of a bankruptcy petition is not the only sign of distress. Others include:
 
a. recent ratings downgrades, which may trigger defaults under financing arrangements, limit access to commercial paper markets and cause turmoil with suppliers, who may be unwilling to continue to extend credit;
 
b. near-term scheduled expiry of credit facilities, which may cause liquidity concerns and unusual cash-preserving behavior;
 
c. a complex capital structure, dominated by multiple affiliated issuers of multiple issues of public debt with covenants limiting the granting of liens, asset sales, and other fund-raising activities, all of which may lead to liquidity problems;
 
d. the pendency of significant regulatory investigations or decisions, which may trigger (or increase) class actions or shareholder derivative actions;
 
e. indications of discord with auditors or expectations of qualified accountant's opinion;
 
f. a shift in lender representatives, such as a change in the lender personnel responsible for dealing with the borrower or the retention of professionals;
 
g. debt reduction programs, such as asset sales and equity offerings;
 
h. cost reduction initiatives, such as layoffs, pursuit of union concessions, and rationalization of, or exit from, certain business lines; and
 
i. unexpected changes in senior management, especially in those with responsibility for financial matters.

C. Risks of a Distressed Transaction Without Chapter 11
 
1. Violation of Fiduciary Duties. Fiduciary duties of seller's officers and directors will shift as the seller approaches insolvency, potentially creating confusing and inconsistent negotiations. When a corporation becomes insolvent or even approaches insolvency -- a status characterized as approaching the "zone of insolvency" -- directors' duties are to a community of interests: the corporation, creditors, and shareholders. See Hechinger Investment Co. of Delaware v. Fleet Retail Finance Group, 274 B.R. 71 (D. Del. Feb. 20, 2002). Additionally, the majority of courts hold that directors are still protected by the business judgement rule. See Production Resources Group, LLC v. NCT Group, Inc., 863 A.2d 772, (Del. Ch. 2004) ("the business judgment rule remains important [once the firm is insolvent] and provides directors with the ability to make a range of good faith, prudent judgments about the risks they should undertake on behalf of troubled firms"); Angelo, Gordon & Co. L.P. v. Allied Riser Communications Corp., 805 A.2d 221, 229 (Del. Ch. 2002) ("even where the law recognizes that the duties of directors encompass the interests of creditors, there is room for application of the business judgment rule"). Interestingly, in the Olympia & York chapter 11 case, the bankruptcy court held that a controlling shareholder has the same duties as that of a board member to the community of interests. The filing of a petition under chapter 11 of the Bankruptcy Code is a bright line test and ends some of the confusion when a corporation is entering the zone of insolvency. Once that line is crossed, the allegiance, goals and fiduciary duties of corporate directors are transformed.
 
a. The Third Circuit has recently made it easier for bankruptcy trustees and debtors in possession to file suit against corporate directors and officers for alleged breaches of fiduciary duties. See Stanziale v. Nachtomi, 416 F.3d 229 (3d Cir. Aug. 3, 2005). The court concluded that the District of Delaware erred by imposing a heightened pleading standard under Delaware's strict Chancery Rule 8 in lieu of the more lenient federal standard under Federal Rule of Civil Procedure 8. Although at first glance these standards appear to mirror one another, Delaware courts have interpreted Chancery Rule 8 "to require pleading facts with specificity...[which] is not the federal notice pleading standard." Id. at *14. Under the federal "notice pleading" standard, a plaintiff must allege supporting facts, but "only those that provide the defendant fair notice of the plaintiff's claim and the grounds upon which it rests." Id. at *16. This decision will undoubtedly allow many more claims involving allegations of breaches of fiduciary duties to proceed to the discovery stage of litigation.
 
2. Due Diligence. Due diligence may be especially challenging because the seller may be attempting to minimize or hide its problems.
 
3. Rejection of the Agreement. The seller may file for bankruptcy protection (or be the subject of an involuntary filing) after a purchase agreement has been signed or after the transaction has closed. Once a bankruptcy petition has been filed, the purchase agreement can be rejected by the seller. See In re Chicago Hudson, LLC, 2006 WL 2088430 (Bankr. N.D. Ill. July 24, 2006).
 
4. Fraudulent Conveyance and Transfer Claims. Buyers also face risk from fraudulent transfer statutes if the seller closes a sale transaction and then shortly files for bankruptcy. If the seller was technically insolvent at the time of the sale, the buyer and the seller's directors may be vulnerable to liability. See, e.g., Official Comm. of Asbestos Personal Injury Claimants v. Sealed Air Corp. (In re W.R. Grace & Co.), 281 B.R. 852 (Bankr. D. Del. 2002) (holding contingent liabilities from mass torts must be considered in order to determine insolvency at the time of sale of division of debtor). Very recently, however, the Second Circuit has disagreed (although not fully) with this proposition. See Lippe v. Bairnco, 99 Fed. App'x. 274 (2d. Cir. May 17, 2004) ("[T]he hypothetical existence of any unaccrued tort claim at the time of a challenged transfer does not give rise to a debtor-creditor relationship"). FSP, Inc. vs. Societe Generale, 2005 WL 475986 (S.D.N.Y. Feb. 28, 2005).
 
a. Furthermore, a corporate parent seeking to improve its balance sheet by spinning off a subsidiary may face fraudulent transfer claims in connection with the transaction. See Complaint, Mirant Corp. et al. v. The Southern Co. (In re Mirant Corp.), No. 03-46590 (Bankr. N.D. Tex. Jun. 16, 2005). In that case, Mirant sued its former parent, the Southern Co. ("Southern"), seeking the recovery of at least $ 2 billion in connection with transfers made to Southern prior to Mirant's spin-off in April 2001. Mirant alleged that Southern had caused it to incur significant debt and then stripped out approximately $ 2 billion in payments and transfers prior to the spin-off, even though Southern knew or should have known that Mirant had been left with inadequate resources to meet the obligations it was forced to incur.
 
5. Successor Liability. The general rule is that a purchaser in an asset transaction, as opposed to a stock, merger, or other consolidation, may acquire assets without being forced to assume unwanted debts and liabilities. There are, however, exceptions to this general rule. In many circumstances, including those where the purchaser can be said to be a "mere continuation" of the target or where the purchaser uses the acquired assets in the continued production of its target's product line, state and federal laws will look past an asset sale construction and, for liability purposes, treat the purchaser as a successor that is liable for the obligations of its seller. Sales pursuant to the bankruptcy code, as described below, can mitigate these risks.

D. Chapter 11 Sales
 
1. Process Overview. An asset sale in the context of a chapter 11 proceeding will help to mitigate the risks identified above and provide both the buyer and the seller with a variety of other substantive and procedural benefits. An asset sale by a chapter 11 debtor occurs as either a sale of assets other than in the ordinary course of business under section 363 of title 11 of the United States Code (the "Bankruptcy Code") (a "Section 363 Sale") or under the debtor's plan of reorganization (a "Plan Sale"). Although both of these procedures are described below, the balance of this outline will focus on Section 363 Sales, which are usually preferable to Plan Sales and appear to be more common in current practice.
 
2. Section 363 Sales. Section 363 Sales permit debtors to sell assets outside of the plan confirmation process, thus potentially disenfranchising stakeholders. As a result, bankruptcy courts will require a sound business purpose for the use of section 363 and a strong showing that a sale outside of the plan confirmation process is justified. See In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 1983) (stating that a bankruptcy judge must consider all the salient factors of the proceeding to determine if a sound business purpose exists, including "the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and, most importantly perhaps, whether the asset is increasing or decreasing in value"); In re Decora Industries 2002 U.S. Dist. LEXIS 27021 (D. Del. 2002); In re Global Crossing, 295 B.R. 726 (Bankr. S.D.N.Y 2003) (stating that a section 363 sale is subject to the business judgment rule and will be approved if "the following elements are present: (1) a business decision; (2) disinterestedness; (3) due care; (4) good faith; and...(5) no abuse of discretion or waste of corporate assets").
 
3. The most common justifications for a Section 363 Sale, which is typically much faster than a Plan Sale, are that the value of the assets involved will rapidly deteriorate or that the seller urgently needs the cash from the sale to continue its remaining businesses and avoid a liquidation, which, in either case, will lead to a lower recovery by creditors. See, e.g., In re Trans World Airlines, Inc., et al., No. 01-00056 (PJW), 2001 WL 1820326, at *4 (Bankr. D.Del. Apr. 2, 2001) ("TWA had no other strategic transaction available to it and had no offer for value to which it could turn. Nor could TWA rely on its self-help plan because TWA was unable to procure adequate capital infusion to implement that plan. Its only alternative was a free fall chapter 11 filing with the high likelihood of a piecemeal liquidation of the enterprise.")
 
a. A Section 363 Sale typically begins with the selection of a "stalking horse" purchaser who has entered into an agreement to purchase the assets in question. This may be done by a mini-auction to select the stalking horse bidder, prior to a formal bankruptcy court-sponsored auction. The stalking horse deal is then subjected to a bankruptcy court-sponsored auction conducted in accordance with bidding procedures agreed between the seller and the stalking horse and approved by the bankruptcy court.
 
Prospective stalking horse bidders should be aware of risks that may arise after selection by the debtor of the stalking horse but prior to bankruptcy court approval of the stalking horse bidder. Recently, for example, after an auction process that lasted for several months, NuCoastal LLC ("NuCoastal") was selected as the stalking horse bidder for Enron's pipeline assets. The debtor then filed papers with the bankruptcy court to approve NuCoastal as the stalking horse bidder. Prior to the hearing to approve NuCoastal, a competing bidder submitted a higher offer to the debtor and the committee of unsecured creditors. In a highly unusual maneuver, the committee switched its support from NuCoastal to the competing bidder prior to the hearing. See generally, Tom Fowler, Enron Pipelines Draw Higher Bid, Houston Chronicle (June 26, 2004).
 
Furthermore, in another contested auction that lasted five months, a group led by billionaire investor Carl Icahn's Aretex LLC ("Aretex") was initially selected over a group led by Wilbur Ross's WL Ross Co. LLC ("WLR") as the stalking horse bidder in the sale of substantially all the assets of WestPoint Stevens Inc. ("WestPoint"), the bankrupt maker of Martha Stewart sheets and towels, conditioned upon the entry into final documentation. In re WestPoint Stevens, Inc., No. 03-13532 (Bankr. S.D.N.Y.). However, the parties were unable to reach agreement on the terms of an asset purchase agreement ("APA"). During this time, WLR submitted a revised bid and a draft APA, the terms of which were accepted by the debtors as the higher and better offer. Judge Robert D. Drain of the United States Bankruptcy Court for the Southern District of New York denied WLR's bid and designation as the stalking horse bidder because, among other reasons, the APA contained a break up fee of $ 5 million plus $ 1 million in the reimbursement of reasonable expenses if the debtors accepted a bid from a bidder other than Aretex or $ 3.5 million in the reimbursement of reasonable expenses if Aretex's bid was accepted. In that case, a break up fee was unnecessary where the debtor was certain to have at least two bidders in the auction: WLR and Aretex. Furthermore, Judge Drain advised the debtors to sell the assets under a Plan Sale, in lieu of under a 363 sale, in which the debtors would essentially hold the auction first and then seek confirmation of the plan by its creditors. Ultimately, Icahn won the auction, purchasing the company for $ 703 million. See generally Icahn beats Ross to buy WestPoint for $ 703M, BUSINESS DAY, Jun. 26, 2005, available at www.biz-day.com.
 
While these actions may subject a debtor and a committee to claims of bad faith, a prospective purchaser should be aware of these risks and try to mitigate them as much as possible through negotiated auction procedures for selection of a stalking horse. In the end, however, any non-ordinary course agreements (such as a purchase agreement) are not binding on the debtor until approved by the court, so stalking horse bidders will be vulnerable until their status is confirmed by the bankruptcy court.
 
b. The objective of the auction process is to obtain the "highest and best" offer for the assets, thus maximizing the proceeds to the estate and, indirectly, the seller's creditors. See, e.g., In re Food Barn Stores, Inc., 107 F.3d 558 (8th Cir. 1997) (discussing bidding procedures and their importance in maximizing the value of the estate); In re Abbots Dairies of PA, Inc., 788 F.2d 143, 149 (3d Cir. 1986) (stating generally that "an auction may be sufficient to establish that one has paid 'value' for the assets of a bankrupt"); In re Ground Round, Inc., No. 04-11237 (WCH) 2004 WL 1732207 (Bankr. D. Mass. Jul. 12, 2004) (authorizing 363 sale because the price offered was, "under the totality of the circumstances the highest and the best offer for the [f]ranchise [a]ssets").
 
Note that "highest and best" does not necessarily mean the highest price but includes non-monetary considerations such as certainty and speed of closing. See In re Gulf States Steel Inc., 285 B.R. 497 (Bankr. N.D. Ala. 2002) (stating that trustee has discretion in determining which bid is the "highest and best" and may consider factors other than the dollar amount) (citing In re Bakalis, 220 B.R. 525 (Bankr. E.D.N.Y. 1998)). For example, in the recent 363 sale of assets in the Georgetown case, International Steel Group ("ISG") was approved as the stalking horse bidder. However, ISG did not submit the highest offer at the court-sponsored auction. When the debtor moved to approve the sale, ISG successfully argued that its bid was the "best" even though not the highest. While the winning bidder would probably ship the debtor's assets overseas, ISG argued that it would re-start operations and this would provide intangible benefits that would become economic benefits. One of the reasons for ISG's successful challenge was the support of the committee of creditors. Prospective buyers should always keep this constituency in mind when negotiating a sale.
 
Furthermore, valuations supporting the determination of the highest and best offer are not determinative for all purposes, and cannot support a permanent impairment of senior lien rights outside of a chapter 11 plan. After the Bankruptcy Court in WestPoint approved the sale to Icahn, which included a distribution of securities of the purchaser's parent company to the first lien debtholders in full satisfaction of their claims and to the second lien debtholders in partial satisfaction of their claims, certain of the first lien debtholders appealed the sale order to the district court. The valuation ascribed to the parent securities and used by the bankruptcy court to declare Icahn's bid the highest and best was also used to determine the amount of securities necessary to satisfy the first lien debtholders' claims in full. On appeal, the issue was whether the bankruptcy court could approve a sale providing for a distribution to the second lien debtholders prior to the full payment in cash of the first lien debtholders outside of the plan confirmation process. The district court determined that the bankruptcy court could not rely upon sections 363(b) and 105(a) to ignore the first lien debtholders' rights to cash satisfaction of their claims under the operative documents and to cram down what was essentially an equity-based plan of reorganization outside of a chapter 11 plan confirmation process. As a result, it remanded the proceedings to the bankruptcy court, and ordered it to sell the securities and any other assets excluded from the section 363 sale in order to satisfy in full and in cash the claims of the objecting first lien debtholders, and only thereafter distribute any remaining securities or other proceeds to the second lien debtholders. In re WestPoint Stevens, Inc., et al., 333 B.R. 30 (S.D.N.Y. Nov. 16, 2005). Therefore, although it was proper to use the bankruptcy court's valuation of the securities to determine whether Icahn's bid was the highest and best, a different cash value would likely be realized on the sale of the securities through the market.
 
c. In In re Refco, No. 05-60006 (S.D.N.Y. Nov. 14, 2005), the debtor, which was in the commodity brokerage business, commenced a chapter 11 case following discovery of what appeared to be fraud. Refco filed for chapter 11 relief in order to facilitate a relatively quick sale of its assets and in a venue which would attract more potential purchasers because they would take the assets free and clear of any claims or interests. Initially, Refco filed its motion for approval of the proposed bidding procedures, which included a break up fee to its stalking horse bidder. There was an objection from other potential bidders at the hearing on the motion, as well as creditors, to both the magnitude of the requested fee and the need for any break up fee at all in light of the apparent interest of many other bidders. The court was impressed by the objectors' arguments, especially as to magnitude of the fee under the circumstances of the particular sale, where the price included only a slight margin over the net capital to be transferred to the purchaser, suggesting that viewing the breakup fee as a percentage of the purchase price was not appropriate under the circumstances of this sale. Yet, after argument, the court stated that there was value in having the bid and bringing a potential sale to the court, and such effort should be compensated. The court was prepared to approve a substantial break up fee, but not the fee requested. The purchaser declined to continue as the stalking horse. The debtor nonetheless proceeded with an auction without a stalking horse. The outcome was a sale at a substantially higher price, but interestingly a sale which required the debtor to cause certain of its regulated subsidiaries to commence a case under the Bankruptcy Code and transfer their assets pursuant to a court order providing that the transfer of the assets was free and clear of liens, claims, encumbrances. Under section 109(a) of the Bankruptcy Code, these subsidiaries were required to seek liquidation, as opposed to reorganization, relief under the subchapter governing stockbroker liquidation, which involves the appointment of a chapter 7 trustee. Pursuant to the first sale order, the regulated subsidiaries commenced their own chapter 7 cases, a trustee was appointed, and the sale hearing for the subsidiary cases was held almost immediately, and the requisite order under section 363(f) was granted. Refco is unique in many respects, but it serves as guidance for break up fees and managing the sale of nondebtor subsidiaries concurrently with the debtor.
 
d. Prospective buyers should also be aware that a bankruptcy court has the authority to re-open the auction and perhaps even entertain higher offers submitted after the auction has been closed. See Corporate Assets, Inc. v. Paloian, 368 F.3d 761 (7th Cir. 2004). This is an unusual occurrence, but the point is that even winning bidders face the risk of being outbid after the auction has closed, similar to the NuCoastal - Enron matter discussed above.
 
4. Plan Sales. Sale of assets occurs as part of the seller's plan of reorganization and must therefore be approved under the plan confirmation process: approval of a plan of reorganization requires the approval of the Bankruptcy Court and holders of two thirds in amount of claims and a majority in number of each class of impaired creditors and, in some cases, two thirds of voting stockholders. 11 U.S.C. § 1126. A plan can also be confirmed under the Bankruptcy Code's "cramdown" provisions. See 11 U.S.C. § 1129(b). Except in the case of pre-packaged plans, this process typically takes significantly more time than a Section 363 Sale.

a. Under section 363, only the trustee, or the debtor in possession through sections 1107 and 1108 of the Bankruptcy Code, may sell assets of the estate. In chapter 11, however, a creditor may file a plan of reorganization. 11 U.S.C. § 1121(c). Therefore, a creditor who wishes to sell estate assets that are subject to its liens may seek to do so through its proposed plan of reorganization. However, sections 1121(c) and (d) of the Bankruptcy Code (providing the debtor with 120 day exclusive period within which to propose a plan of reorganization) presents a significant obstacle to a creditor's proposal of a Plan Sale, especially because the debtor's exclusivity may be extended by the court after notice and a hearing and, provided that cause is shown, is often so extended. See, e.g., In re Farmland Industries, Inc., 286 B.R. 888 (Bankr. W.D. Mo. 2002) (granting two extensions to debtor's exclusivity).
 
b. However, once the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "BAPCA") goes into effect on October 17, 2005, it will be easier for creditors to file a plan that provides for the sale of estate assets earlier in the case, despite the debtor's exclusivity. Under the revised section 1121, the debtor's exclusivity may not be extended beyond 18 months after the petition date. BAPCA, S. 256, 109th Cong. § 141 (2005). Therefore, there is greater pressure on the debtor to propose a plan that is confirmed under section 1129 of the Bankruptcy Code prior to the end of this finite exclusivity period. If the debtor's plan is not confirmed by that time, the creditor may then file a plan that includes a Plan Sale.
 
5. Exit Financing. A recent trend in distressed investment and takeovers centers on post-petition reinvestment by equity security holders. In re Delphi Corp., No. 05 - 44481 (Bankr. S.D.N.Y. Dec. 18, 2006). In Delphi, the Debtors, with the support of General Motors and the Unsecured Creditors, motioned the court for its approval of the Plan Framework Support Agreement and Equity Purchase Commitment Agreement.
 
a. The Plan Framework Support Agreement: The PFSA, in large part, dictate stakeholder recoveries at emergence and post-reorganization Delphi's corporate governance structure. Under the PFSA, post-emergence, Delphi's board will consist of 12 directors - ten independents, the Chief Executive Officer and an Executive Chairman. Appaloosa and Cerberus, the plan investors, will have the right to elect six independent directors and may, if acting in concert, veto the election of the Executive Chairman. By its terms, the PFSA is conditioned upon Delphi's (1) reaching a consensual agreement with U.S. Labor Unions, (2) reaching a consensual agreement with GM, and (3) implementing the "Transformation Plan," a five point plan comprising the basis of Delphi's operational restructuring.
 
b. The Equity Purchase Commitment Agreement: Under the EPCA, the plan investors committed to purchase, at a discount, $ 220.5 million in common shares, any unsubscribed shares in connection with a 56.7 million share rights offering, and $ 1.2 billion in preferred shares. As such, exclusive of the investors' current ownership of debt and equity and depending on the rights offering's subscription rates, post-emergence, plan investors could own between 30% and 72% of all equity. Moreover, in return for their commitment of capital, the plan investors received commitment fees of $ 21 million for the preferred shares, $ 55.125 million for the common shares and a capped reimbursement for their expenses. Commitment fees were non-refundable, and the plan investors retained the right to terminate the EPCA if the PFSA terminated on its terms or otherwise.
 
i. The Lockup: Two important features of the EPCA are the lock-up and the "Alternative Transaction Fee". The EPCA temporarily bars both the Debtors and General Motors, a major party to the Delphi reorganization, from seeking an alternative transaction. Furthermore, under the EPCA, Delphi could be subject to a $ 100 million Alternative Transaction Fee. It should be noted, however, under the terms of the order, prior to Court approval of a disclosure statement, each the debtor's payment of commitment fees and expenses reduces any Alternate Transaction Fee, dollar for dollar. In re Delphi Corp., No. 05 - 44481 (Bankr. S.D.N.Y. Dec. 18, 2006).
 
c. Recent Developments: As of January 31, 2007, Delphi appeared no closer to reaching an agreement with UAW and, reportedly, Cerberus was considering terminating its investment.

E. Advantages of Chapter 11 Sales
 
1. Buyer's Perspective. The buyer takes the assets free and clear of all liens, thus permitting it to assume with certainty only specified liabilities. According to section 363(f) of the Bankruptcy Code, property may be sold "free and clear of any interest in such property of an entity other than the estate, only if--(1) applicable nonbankruptcy law permits sale of such property free and clear of such interests; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest." Adequate notice of the proposed sale is also a condition to a sale free and clear. See, e.g., Folger Adam Security, Inc. v. DeMatteis/MacGregor, JV, 209 F.3d 252 (3d Cir. 2000); In re Takeout Taxi Holdings Inc., 307 B.R. 525 (Bankr. E.D. Va. 2004). For example, historical liabilities such as employee legacy costs, environmental liabilities, tax liabilities and litigation can be left behind.
 
2. Successor Liability Risks. Prospective buyers should, however, be aware of the risks of potential successor liability claims. See, e.g., In re Savage Industries, Inc., 43 F.3d 714, 720 (1st Cir. 1994); Ninth Ave. Remedial Group v. Allis-Chalmers Corp., 195 B.R. 716 (N.D. Ind. 1996). Section 363(f) of the Bankruptcy Code authorizes the sale of a debtor's property "free and clear of any interest in such property of an entity other than the estate...." However, the phrase "interest in such property" is not defined by the Bankruptcy Code and, in the absence of a precise statutory meaning, bankruptcy courts have reached different conclusions regarding whether reliance upon section 363(f) alone is sufficient to preempt other state and federal laws that would hold a successor liable for the obligations of its predecessor. The Third Circuit recently broadened the scope of section 363(f) in In re Trans World Airlines Inc., 322 F.3d 283 (3d Cir. 2003). At issue in Trans World Airlines was the authority of the bankruptcy court to (i) declare that the purchaser of TWA's was free from successor liability relating to employment and sex discrimination claims brought against TWA; and (ii) enjoin the claimants from pursuing such claims against the purchaser. In affirming the bankruptcy court's order, the Third Circuit found that although the interests of the claimants "in the assets of TWA's bankruptcy estate are not interests in property in the sense that they are not in rem interests, they are interests in property within the meaning of section 363(f) in the sense that they arise from the property being sold." Thus, because any liability as "successor" is necessarily dependant upon there first being an acquisition of assets from a "predecessor," the rationale of Trans World Airlines ought to apply with equal force to all forms of successor liability regardless of the nature of the underlying claim. Although not dispositive, buyers should endeavor to include specific provisions in their sale orders stating that they are absolved of successor liability.
 
3. Specific Advantages.
 
a. Bankruptcy Court approval should bar fraudulent conveyance and transfer claims and should ensure the enforceability of the purchase documents, such as non-competition agreements and post-closing supply or services agreements.
 
b. Dynamics of the situation may permit the buyer to pick and choose assets and liabilities with more latitude than would be typical outside of bankruptcy. The seller's creditors will have a stronger voice in the process and may care less about requiring a buyer to take all liabilities associated with the purchased business, especially if those liabilities are primed by those creditors' claims.
 
c. Buyers will also have great flexibility in assuming contracts related to the assets being purchased. As a general rule, section 365 of the Bankruptcy Code permits a debtor to assume and assign its contracts as it sees fit, regardless of explicit or de facto restrictions on assignment, provided that: (1) the contract is executory in nature, (2) past defaults are cured, usually by the payment of money damages, and (3) adequate assurance of future performance by the assignee is given. Section 365 does not permit the assumption and assignment of: (1) a contract that may not be assigned under applicable law, e.g. personal service contracts, which some courts have found to include government contracts, see, e.g., In re West Electronics, Inc., 852 F.2d 79 (3d Cir. 1988); In re ANC Rental Corp., 277 B.R. 226 (Bankr. D. Del. 2002), and patent licenses, see, e.g., In re CFLC, 89 F.3d 673 (9th Cir. 1996); In re Andres Hernandez 285 B.R. 435 (Bankr. D. Ariz. 2002); (2) contracts to provide financing to or issue securities of the debtor; or (3) nonresidential leases that have terminated under applicable nonbankruptcy law. Contracts that are not assumed and assigned can be rejected. Section 365 provides the buyer with enhanced leverage in dealing with contract parties, who may be willing to make compromises in order to avoid having their contracts rejected.
 
d. Many companies in bankruptcy have significant pension plan underfunding. Acquiring the debtor in possession in a plan of reorganization can result in joint and several liability by the acquirer for the pension liabilities of the debtor. In many cases, liability for pension plan underfunding and possible pension plan termination liability may limit the options for a sale of the emerged debtor. In some cases, a Section 363 Sale may provide a viable option for potential acquirers to purchase the assets of a bankruptcy entity without assuming any of the pension plans and related liabilities.
 
In a Section 363 Sale, an acquirer would have more options than in a purchase investment pursuant to a plan of reorganization. First, the acquirer could purchase the assets of the debtor without assuming the pension plans. Second, the acquirer may be able to assume some pension plans and not others. Lastly, the acquirer would have the option of assuming all of the plans, should it so desire.
 
If the acquirer does not assume the pension plans and the Pension Benefit Guaranty Corp. or the debtor terminates the pension plans prior to the sale, liabilities would remain with the debtor, along with corporation claims. The corporation generally has contingent claims in bankruptcy. Several courts have held that the corporation lien for termination liability would not attach, due to the automatic stay in bankruptcy; therefore, the debtor's estate would not be subject to liens at the time of the sale. If the pension plans are not terminated prior to the asset sale, the acquirer could leave the assets and liabilities of the plans behind in the sale, subject to approval of the sale by the bankruptcy court. Any post-sale termination of plans left behind by the debtor would likely not result in liability to the acquirer.
 
Growing authority suggests section 363 additionally applies to set-off. The estate may be sold pursuant to section 363 free and clear of any set-off provisions, even those tying an assumed contract to a rejected contract, provided the contracts are not "economically interdependent." The Shaw Group v. Bechtel Jacobs Co. (In re It Group, Inc.), 350 B.R. 166 (Bankr. D. Del 2006).
 
e. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 is shortened to 15 days under section 363(b)(2)(B) of the Bankruptcy Code.
 
f. Section 1145 of the Bankruptcy Code may in limited circumstances provide an exemption from the registration requirements of the Securities Act of 1933 for the issuance of securities by the buyer in payment of the purchase price. See, e.g., Hasbro, Inc., SEC No-Action Letter, Fed. Sec. L. Rep. P79,497 (Sept. 28, 1989).
 
g. State law shareholder approval requirements and bulk sales laws are inapplicable.
 
h. Buyers have protection in the event they desire to provide interim financing to their sellers. These loans can be granted priority over prepetition claims, can be applied towards the purchase price if the buyer prevails, and can require that they be repaid in connection with the consummation of a transaction with a different buyer.
 
i. Debtors in foreign bankruptcy proceedings and other multinational corporations may use chapter 11 to sell assets located in the United States. See, e.g., In re Oxford Automotive, Inc., No. 04-74377 (Bankr. E.D. Mich.); In re Aerovias Nacionales de Colombia S.A. Avianca, Nos. 11678 and 03-11679 (Bankr. S.D.N.Y.); In re NM Holding Co., LLC (f/k/a Venture Holding Co., LLC), No. 03-48939 (Bankr. E.D. Mich.).
 
4. Seller's Perspective. Because the buyer will take the assets free and clear, the seller can take the position that they are being sold "as is." The practical effect of this is that the seller (and its creditors) can argue for limited representations and warranties that will not survive closing.
 
a. With bankruptcy court approval of the transaction, the seller's officers and directors will be insulated from post-closing attacks based on breach of fiduciary duty claims. See, e.g., In re Industrial Valley Refrigeration and Air Conditioning Supplies, Inc., 77 B.R. 15 (Bankr. E.D. Pa. 1987). This is especially valuable in an insolvency setting, where fiduciary duties may be hard to define.
 
b. The asset transfer may be exempt from stamp and similar transfer taxes. See In re T.H. Orlando LTD., 391 F.3d 1287 (11th Cir. 2004) (mortgage refinancing transaction is exempt from state documentary stamp tax where transaction was a pre-condition to further financing and, therefore, necessary to consummation of debtors' reorganization plan); In re Bethlehem Steel Corp., Nos. 01-15288 (BRL) through 01-15302, 01-15308 through 01-15315 (BRL), bench ruling abstract dated April 22, 2003 (state and local taxing authorities unsuccessfully argued section 1146(c) of the bankruptcy code does not cover pre-confirmation transfers because not made "under a plan confirmed"; court held section 363 asset purchase agreement was itself basic outline of plan of reorganization); but see In re Hechinger Investment Co., 335 F.3d 243 (3rd Cir. 2003) (pre-confirmation transfers held not covered by B.C. § 1146(c)); In re NVR, LP, 189 F.3d 442 (4th Cir. 1999) (same); States of Ill. & Wash. v. National Steel Corp., 2003 U.S. Dist. LEXIS 15695 (N.D. Ill. 2003) (same).
 
c. Chapter 11 will provide the seller with much more control over the sale process. With the protection of the automatic stay, in most cases the seller will be free to conduct, with the bankruptcy court's supervision, a relatively orderly auction of its assets.
 
5. 2005 Amendments. Although most of the BAPCA's amendments to the Bankruptcy Code, which go into effect on October 17, 2005, impact only consumer bankruptcies, some amendments were made to section 363, which is applicable to all bankruptcy filings. Specifically, the BAPCA:
 
a. amended section 363(b) of the Bankruptcy Code in response to the notoriety of a few "dot com" cases in which courts were asked to authorize the liquidation of contact information on customers and other visitors to commercial websites. Under the amendment, if a debtor was in the business of offering products or services to individuals and has a policy of prohibiting the transfer of "personally identifiable information" (i.e. an individual's name, address, telephone number, social security number, email, credit card information, etc.), then the trustee may not transfer such information unless: (1) such sale is consistent with the debtor's privacy policy; or (2) the court approves the appointment of a "consumer privacy ombudsman" who will have the right to appear and be heard at any hearing on the sale and will provide the court with information on the debtor's privacy policy in effect, the costs or benefits to consumers if the sale is approved, and potential alternatives. BAPCA, S. 256, 109th Cong. §§ 232, 233 (2005); see also Hon William Houston Brown and Lawrence Ahern III, 2005 Bankruptcy Reform Legislation With Analysis, 2005 Bankr. Reform Legis. with Analysis 55, § 5a (2005). Whether the sale proceeds under (1) or (2) above, it may not violate applicable nonbankruptcy law.
 
b. amended section 363(d) of the Bankruptcy Code to provide that "the sale of property must be in accordance with applicable nonbankruptcy law that governs the transfer of property by a corporation or trust that is not a moneyed, business or commercial corporation or trust." Id., § 1221. Basically, this amendment confirms that sales of assets by non-profit entities must comply with applicable nonbankruptcy law. Unlike other sections of the BAPCA, this section is applicable to cases pending as of the date of the BAPCA's enactment, April 20, 2005, and those filed after that date. Id., § 1221(d).
 
c. added new section 363(o), which preserves any defenses that a party to a consumer credit transaction, as regulated by the Truth in Lending Act (the "TILA"), may have once the contract is sold by a debtor in bankruptcy. Id., § 1204. This section ensures that the provisions of the TILA that seek to prevent predatory lending survive a 363 sale.

F. Key Process Points
 
1. Preliminary Agreements. Confidentiality agreements. Buyers should avoid blanket prohibitions on disclosure of the existence of discussions or the terms of a proposed transactions in order to preserve their ability to promote their transactions to the seller's creditors and perhaps collaborate with other bidders. In this regard, buyers should be aware of section 363(n) of the Bankruptcy Code, which provides that if a Section 363 Sale price "was controlled by an agreement among potential bidders," the trustee or debtor can avoid the sale or recover any excess consideration, can recover its costs, and can seek punitive damages. Courts have incorporated a bad or corrupt intent requirement into this provision. See In re New York Trap Rock Corp., 42 F.3d 747, 752 (2d Cir. 1994) (holding that section 363(n) is designed to preclude only covert agreements that are intended to control price and thereby deprive the estate of fair value for its assets).
 
2. Standstill Agreements. Sellers should seek standstill agreements that will prohibit potential buyers from purchasing claims against the seller or colluding with other bidders to manipulate the process.
 
a. Without a claim, a disgruntled buyer may not have standing to object in the bankruptcy court to the sale process. An unsuccessful bidder in a Section 363 Sale usually lacks standing to challenge a bankruptcy court's approval of the transaction or the bidding process, except when challenging the "intrinsic fairness" of the sale process. See In re Colony Hill Assoc., 111 F.3d 269, 273 (2d Cir. 1997) (stating that under the "aggrieved person" standard for appellate standing an unsuccessful bidder whose only loss is speculative profits from the property auctioned, in the absence of fraud, mistake or unfairness, usually lacks standing to challenge the sale); see also In re Gucci, 126 F.3d 380, 388 (2d Cir. 1997).
 
b. Buyers should require, at a minimum, a "most-favored nation" provision that would loosen the standstill and other restrictions to the extent they are loosened for others. This will discourage the seller from offering special arrangements to favored buyers, such as insiders.
 
3. Exclusivity Agreements. Exclusivity arrangements are of dubious value in the chapter 11 setting because they are contrary to a fundamental objective of the bankruptcy process: obtaining the highest and best offer for the assets to maximize the proceeds available for creditors. See, e.g., In re Big Rivers Elec. Corp., 233 B.R. 739, 752 (W.D.Ky. 1998) (finding a "no-shop" clause invalid because it prevented the debtor from "initiating, soliciting, or negotiating offers and proposals for the sale or lease of its assets" which may have brought in greater value to the estate). As a result, while these agreements may be useful for optical or strategic purposes, buyers should not assume they are enforceable without bankruptcy court approval, which will be difficult to get.
 
4. Due Diligence. For a number of reasons, due diligence is especially important in a chapter 11 sale.
 
a. The seller's distressed situation may have caused its management to take aggressive or unusual measures in operating the business, such as using working capital in peculiar ways or deferring maintenance or capital expenditures. In some cases, there may have been fraud. A careful and skeptical due diligence investigation will be necessary to discover and understand the true nature of the business being sold.
 
b. There may be no post-closing indemnification for breaches of representations and warranties. Although the buyer will take the assets free and clear of liens, there may be defects or unusual circumstances that only thorough due diligence will uncover.
 
c. Due diligence is key to understanding the assets and liabilities the buyer is willing to purchase and may permit the buyer to create a menu of options from which the seller can choose the transaction that best suits its goals. This flexibility may give the buyer an advantage over other buyers.

5. Stalking Horse Decision. The buyer needs to decide whether it is willing to serve as the stalking horse.
 
a. Pros.
 
i. guaranteed opportunity to make a bid in the unlikely event an auction isn't held;
 
ii. key role in formulating minimum parameters of the deal and the bidding procedures;
 
iii. bidding procedures should compensate the stalking horse in the event another buyer prevails; and
 
iv. allows the buyer to highlight any unique aspects of its offer or other competitive advantages.
 
b. Cons.
 
i. it may be difficult to negotiate the stalking horse agreement, because of the distressed nature of the seller and the multiplicity of decision makers;
 
ii. the bidding procedures may be challenged and stalking horse may not be made whole if another buyer prevails; and
 
iii. the stalking horse's bid may prove to have been too rich, especially when there is a rapidly growing glut of a certain type of assets becoming available.
 
6. Purchase Agreement. The purchase agreement for a chapter 11 sale is typically quite similar to a purchase agreement outside of bankruptcy, with the following exceptions:
 
a. There will be detailed provisions describing the bankruptcy process, including the proposed bidding procedures and each party's required actions.
 
b. The consideration being paid may be unusual. It may include claims against the seller or equity in the business being purchased. In addition, since the comparison of offers will turn primarily on the value offered, buyers should make sure the purchase agreement spells out each element of consideration, including items such as the value of assumed liabilities, severance or similar costs saved by the buyer's continued employment of employees associated with the purchased business and the avoidance of shut-down costs. Items that would have been administrative claims are particularly noteworthy because they would have been paid before prepetition claims.
 
c. The agreement will include a process for the designation, assumption and assignment of contracts and should include mechanisms for the determination and payment of cure costs. In many cases, this agreement is predicated on estimates of cure costs and will specify what happens if a cure cost is ultimately determined to exceed the estimate. For example, a seller might agree to pay cure costs up to the amount of the estimate; if the cure cost exceeds the estimate, the buyer can choose to either pay the excess or direct the seller to reject the contract. As noted below, the final determination of cure costs may not occur until after the closing.
 
d. There will likely be fewer representations and warranties and limited post-closing indemnification for breaches of those representations and warranties.
 
e. There may be fewer post-closing covenants from the seller. This will depend on the seller's prospects post-closing and its ability (and desire) to retain the assets and contracts needed to perform these services or willingness to attempt to require the assignee of those assets or contracts to perform these services.
 
f. There may be fewer conditions to closing because in most cases the Bankruptcy Code nullifies things like shareholder and contract party consents.
 
g. The agreement will be governed by the Federal bankruptcy laws, in addition to the appropriate state laws, and the parties will submit to the Bankruptcy Court's jurisdiction for the resolution of disputes.
 
7. Bidding Procedures. The bidding procedures, which will be subject to challenge by the seller's creditors, will include some or all of the following:
 
a. A definition of who will be permitted to bid (a "qualified bidder") and the minimum requirements for a bid to be considered (a "qualified bid"). Typical qualified bidder criteria include the execution by the bidder of the seller's form of confidentiality agreement and convincing evidence of financial wherewithal. A "qualified bid" could require a significant cash deposit, that the scope of the bid be substantially equivalent to the scope of the stalking horse bid, a signed purchase agreement (including final schedules, which may be very difficult to prepare), no financing or other non-regulatory conditions, no break-up fees, and stiff overbid requirements.
 
b. A bid deadline and proposed auction date. Not surprisingly, the buyer will want the bid deadline and auction to be as soon as possible, while the seller will want them to be relatively distant in order to facilitate robust bidding activity. Stalking horses will also want to ensure that there will be enough time between the bid deadline and the proposed auction date in order to permit them to assess competing bids and be in a position to improve their initial bids at the auction. Stalking horses should also attempt to limit the seller's ability to extend the bidding deadline and should require the seller to cancel the auction and present the buyer's bid to the bankruptcy court for approval if no qualified bids are received by the bid deadline.
 
Section 363(k) of the Bankruptcy Code permits a buyer to offset (or "credit bid") against the purchase price the amount of any claims it may have against the property being purchased. Although the value of such a claim arguably should be discounted on account of the seller's bankruptcy, the buyer may get credit for the full amount of the claim, even if the claim is arguably under secured, and thus may get a competitive advantage against other bidders. Recently, the Third Circuit held that lenders holding liens on substantially all of the debtor's assets could credit bid the full face value of their secured claims, even if that amount exceeded the estimated economic value of the underlying collateral. See In re Submicron Systems Corporation, 2006 WL 27476 (3rd Cir. 2006). If the buyer holds significant amounts of claims, the ability to credit bid them may effectively end the auction and may therefore be hotly disputed. Also, if a stalking horse bidder intends to credit bid against the purchase price, it should confirm that any term sheets attached to the bidding procedures motion provide for the bidder's continued receipt of adequate protection for its pre-petition loan. Absent such a provision, the continued receipt of adequate protection after approval of the bidding procedures may be avoidable by the estate. In re LWD, Inc. 340 B.R. 363 (W.D. Ky. 2006).
 
c. Additionally, there may be times where joint bids by multiple bidders are more likely to succeed than lower single bids by each bidder, or sequential bidding on multiple assets may be appropriate. See, e.g., In re The Grand Union Co, 2000 WL 34033490 (Bankr. D. N.J. 2000). In such cases, joint bidders should get prior court approval in order to avoid being entangled in liability under section 363(n) of the bankruptcy code. As discussed above, section 363(n) prohibits collusive bidding by multiple bidders. The penalties for violation of this section are harsh: the sale can be avoided and the debtor may recover damages, costs and attorney's fees.
 
8. Overbid Requirements and Minimum Bidding Increments. Overbid requirements require bidders to exceed the stalking horse bid by a specified amount. This amount is usually in excess of the stalking horse's break-up fee in order to insure that the bid will actually provide the seller with more consideration, after payment of the break-up fee, than the stalking horse bid. Bidding increments govern subsequent bids by either requiring that each subsequent bid must exceed the preceding bid by a specified amount or must provide the seller with a minimum increment of additional consideration over the preceding bid, the difference between these two approaches being whether one considers the effect of the break-up fee in assessing whether the increment has been met. The stalking horse could also seek the right to match any other bids.
 
9. Criteria for Determining which Bid is the Highest and Best. In the event the stalking horse does not succeed in limiting qualified bids to the same set of assets and liabilities as the stalking horse is purchasing, the buyer may insist that the bidding procedures specify the manner in which the seller must allocate consideration to certain assets in order to facilitate the comparison of bids for different sets of assets and liabilities. Buyers may also want the bidding procedures to include rules specifying how the seller must value different forms of consideration. For example, these rules might state that non-public securities should be ascribed no, or a significantly discounted, value, while cash would of course be valued at face value. The buyer would attempt to construct these rules to favor its form of consideration over other forms of consideration.
 
10. A Break-Up Fee. Bidding procedures often provide that the stalking horse bidder will receive a break-up fee (sometimes with an additional expense reimbursement) if it ultimately loses the deal to another bidder. The break-up fee is intended to compensate the stalking horse for its expenses and lost opportunity costs. Generally, courts will uphold break-up fees below three percent of the purchase price. See, e.g., In re Hupp, 140 B.R. 191, 194 (Bankr. N.D. Ohio 1992). This aspect of the bidding procedures is often the most controversial one because it can be viewed as a windfall to the stalking horse and as guaranteed to chill bidding. To be approved, break-up fees must be designed to enhance the bidding process and must be reasonable. See In re WestPoint Stevens, Inc., No. 03-13532 (Bankr. S.D.N.Y. Apr. 7, 2005) (denying break-up fee as unreasonable because there were already competing bidders involved in the auction and, as a result, the break-up fee was not necessary to keep the bidding going and because it was not necessary as a catalyst to keep creditors, who were already invested in the capital structure of the company and who were already asserting their credit bidding rights, actively bidding). Depending on the court, break-up fees are assessed by application of the business judgment rule, see In re Integrated Resources, Inc., 147 B.R. 650 (S.D.N.Y. 1992), or the best interest of the estate test, see In re S.N.A. Nut Co., 186 B.R. 98, 104 (Bankr. N.D. Ill. 1995). Unsuccessful initial bidders may also seek to recover expenses related to due diligence and preparing the initial bid as administrative expenses entitled to priority under section 503 of the Bankruptcy Code. See, e.g., In re O'Brien Environmental Energy, Inc., 181 F.3d 527 (3d Cir. 1999) (break-up fees denied because party failed to establish that break-up fees were necessary to preserve the value of the debtor's estate pursuant to section 503(b)(1)(A)). Recently, in Delphi the bankruptcy court for the S.D. approved an "Alternative Transaction Fee" of $ 100 million as part of the Equity Purchase Commitment Agreement. In re Delphi Corp., No. 05-44481 (Bankr. S.D.N.Y. January 12, 2007)
 
11. Auction Rules. A wise bidder will endeavor to include in the bidding procedures a clear timetable and set of rules to govern the auction at which the winning bidder is selected.
 
12. Auction, Sale Hearing and Sale Order. At the auction, qualified bidders will have the opportunity to bid against each other, subject to the bidding procedures. Once a winner is selected, the bankruptcy court will hold a hearing to consider the proposed sale and, if it is approved, enter an order stating so and authorizing the seller to consummate the transaction. The sale order should include several key provisions:
 
a. The sale order should state: that the seller has advanced sound and sufficient business reasons for, and has reasonably exercised its business judgment in determining to enter into, the proposed sale; that the proposed sale was negotiated in good faith, without collusion, and constitutes the highest and best offer for the assets; and that, therefore, the sale is approved.
 
b. The sale order should state that: the assets are being sold free and clear of all claims; that the buyer will have no liability (including successor liability) as a result of the sale other than liabilities that are specifically assumed; that the buyer is a "good faith purchaser" within the meaning of section 363(m) of the Bankruptcy Code; and that the sale order will be effective immediately, without the ten-day stay otherwise imposed by Bankruptcy Rules 6004(g) and 6006(d). These last two items will protect the buyer against an appeal of the sale order, even if that appeal results in the reversing of the sale order. Sale proponents attempting to prove "good faith" should note that boilerplate language in the sale order simply stating such may not be sufficient. The court may have to make specific findings of fact defining the buyer as a good faith purchaser. See In re M Capital Corporation, 290 B.R. 743 (9th Cir. 2003) (dismissing motion appeal based on purchaser's alleged good faith dismissed because good faith must be determined by the trial court); In re Abbotts Dairies of Pennsylvania, 788 F.2d 143 (3rd Cir. 1986) (holding appeal of order confirming the sale not moot absent finding by the bankruptcy court of "good faith" purchase).
 
c. The sale order should approve and ratify the bidding procedures and the seller's conduct of the bidding process. In the absence of fraud, unfairness, or mistake at a judicial sale, a court is not likely to upset the results of the sale. See In re Food Barn Stores, Inc., 107 F.3d 558, 564 (8th Cir. 1997). On the other hand, a court will be mindful that the primary objective in a bankruptcy sale is to maximize the value of the estate. See id. at 565. "To summarize, we think that the important notions of finality and regularity are appeased if the court acts consistently with the rules by which the particular sale is conducted and in compliance with the bidder's reasonable expectations." Id.
 
d. The sale order should provide a process for the assumption and assignment of the contracts the parties have agreed will be conveyed to the buyer. This process is usually begun by the seller filing an assumption notice that identifies the contracts the seller desires to assume and assign and the proposed cure amounts for those contracts. The assumption notice is served on the contract parties, who will have a specified period in which to object to the proposed assumption and assignment or the proposed cure amount. If there are no objections with respect to a particular contract, upon payment of the cure amount, it will be conveyed to the buyer, usually effective as of the closing date. If an objection is received, it will be settled either by the agreement of the parties or by the Bankruptcy Court, although buyers and sellers should endeavor to retain flexibility (and the corresponding leverage) to reject contracts as to which objections are filed.

13. Appeals. Provided both the buyer purchased the assets in good faith and the sale was not stayed pending appeal, the sale order may not be reversed on appeal. Under 363(m) of the Bankruptcy Code, even a higher court's later reversal of an authorization of sale will not void the transaction. In WestPoint Stevens, the first lien lenders appealed the bankruptcy court's sale order to the district court. The first lien lenders claimed, in part, that the lower court erred in (1) allowing the debtor to sell its assets free and clear of the first lien lenders' interests and (2) concluding that Carl Icahn's bid was higher and better than that offered by the Steering Committee. The district court, however, refused to consider either issue. The first lien lenders had not claimed that Icahn purchased the company in bad faith, and all unstayed aspects of the transaction had been effected. With the transfer concluded in good faith, the issue was moot.

G. Conclusion.
 
1. Chapter 11 provides buyers and distressed sellers with a number of substantive and procedural benefits. These include ways to minimize post-closing uncertainty and provide a measure of order to what may otherwise be a chaotic situation.
 
2. To take advantage of these benefits, however, buyers and sellers alike must be skilled at both identifying the signs of distress that often foreshadow a chapter 11 filing and working within the sale process provided by chapter 11.

How to Handle Distressed Sale Transactions
By Corinne Ball

DISTRESSED SALE TRANSACTIONS
Overview of Presentation
 
- Identifying the Distressed Seller
 
- Risks of a Distressed Transaction without Chapter 11
 
- Chapter 11 Sales
 
- Advantages of Chapter 11 Sales
 
- Key Process Points
 
- Conclusion
IDENTIFYING THE DISTRESSED SELLER
 
Signs of Distress
(Financial)
 
- Ratings Downgrades
 
- Expiration of Credit Facilities
 
- Complex Capital Structure: Multiple Issues of Public Debt
 
- Debt Reduction Programs: Significant Asset Sales
 
Signs of Distress
(Non-Financial)
 
- Significant Regulatory Investigations
 
- Class Actions Triggers
 
- Auditor Issues
 
- Shift in Lenders/Lender Personnel
 
- Layoffs/Union Concessions
 
- Unexpected Changes in Senior Management

RISKS OF A DISTRESSED TRANSACTION WITHOUT CHAPTER 11
 
- Fiduciary Duties Violation
 
- Due Diligence
 
- Rejection of the Sale Agreement
 
- Fraudulent Conveyance
 
- Successor Liability

CHAPTER 11 SALES
 
Section 363 Sales
 
- Ability to Sell Assets Outside of Plan Confirmation Process
 
- Faster Process with Less Obstacles
 
- Sales Free and Clear
 
- Selection of the "Stalking Horse"
 
- Subsequent Court-Approved Auction
 
- Standard: "Highest and Best" Bid
 
- Subsidiary Filing for Purpose of Sale
 
- Court Authority to Re-Open Auction

Plan Sales
 
- Slower Process
 
- Sales Free and Clear
 
- Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 - 18 Month Debtor Exclusivity - Greater Pressure on the Debtor and Greater Opportunities for Creditors

EXIT FINANCING
 
Emergence Financing - The Delphi Model
 
- Plan Framework Support Agreement

- Corporate Governance: Plan Investors control Board.

- Equity Purchase Commitment Agreement

- Equity Investment: (1) Direct purchase of common shares; (2) Direct purchase of preferred shares; and (3) Backstop to rights offering.
 
- Potential Total Post-Reorganization Equity Ownership: 70%
 
- Commitment Fees: $ 76 million.
 
- Alternative Transaction Fees: $ 100 million.

ADVANTAGES OF CHAPTER 11 SALES
 
Buyer's Perspective
 
- Assets Free and Clear of All Liens - But Successor Liability May Remain
 
- Court Approval Should Bar Fraudulent Conveyance and Transfer Claims and Ensure Enforceability of the Asset Purchase Agreement
 
- Dynamics May Allow Buyer to Pick and Choose Assumption of Only Specified Liabilities (Employee Legacy Costs, Environmental Liabilities, Tax Liabilities and Litigation Can Be Left Behind)
 
- Flexibility in Picking and Choosing Contracts
 
- No Assumption of Pension Liabilities
 
- Waiting Period for HSR Approval is Shortened to 15 Days
 
- Possible Exemption from Registration Requirements of the Securities Act
 
- State Law Shareholder Approval Requirements are Inapplicable
 
- Buyers Can Provide Interim Financing without Significant Risk
 
- Chapter 11 Available in Foreign Proceedings with Regard to Assets Located in the United States

ADVANTAGES OF CHAPTER 11 SALES
 
Seller's Perspective
 
- Selling the Business "As Is"; Very Limited Reps., Warranties and/or Indemnities
 
- Bankruptcy Court Approval Insulates Board from Liability
 
- Seller Has Control Over Sale Process
 
- May Be Exempt from Stamp and Transfer Taxes

2005 AMENDMENTS
 
- Exclusivity
 
- Extension of Reclamation Period to 45 Days
 
- Longer Period to Assume or Reject Leases, but Limited Extensions to the Initial Period
 
- Greater Protection to Utility Companies - Tougher Burden for Debtor to Prove Adequate Assurance of Future Performance
 
- Tax Provisions - Shorter Time Within Which Priority Claims Due Will Affect Debtor's Cash Flow
 
- Sale of Assets by Non-Profit Entities Must Comply with Non-Bankruptcy Law
 
- Preservation of Defenses to Predatory Lending Even After Consumer Credit Agreement is Sold

KEY PROCESS POINTS
 
Preliminary Agreements
 
- Confidentiality Agreements
 
- Standstill Agreements
 
- Exclusivity Agreements
 
- Due Diligence

KEY PROCESS POINTS
Selection of the Stalking Horse
 
- Advantages:
 
- Guaranteed Opportunity to Make a Bid
 
- Being on the Inside: Key Participant in the Process and Ability to Manipulate the Parameters of the Deal
 
- Insight and Ability to Craft the Bidding Procedures
 
- Highlight Unique Aspects of the Deal
 
- Break-Up Fee and/or Expense Reimbursement
 
- Disadvantages:
 
- Negotiating with Multiple Parties in Interest
 
- No Guarantee of Break-Up Fee
 
- Risk of Overbidding

KEY PROCESS POINTS
The Purchase Agreement
 
- Similar to a Typical Purchase Agreement, except...

- Description of the Bankruptcy Process
 
- Atypical Consideration
 
- Assignment of Contracts
 
- Fewer Reps. and Warranties
 
- Fewer Post-Closing Covenants
 
- Fewer Conditions to Closing
 
- Agreement Governed by Bankruptcy Law in Addition to State Law

KEY PROCESS POINTS
The Bidding Procedures: The Key to the Process
 
- Importance of the Bidding Procedures
 
- "Qualified Bidder" & "Qualified Bid"
 
- Establish Tight Deadlines
 
- The "Credit Bid"
 
- Possible Court Approval of Joint Bidders
 
- Overbid Requirements
 
- Criteria for Which Bid is the "Highest and Best"
 
- Break Up Fee
 
- Auction Rules

KEY PROCESS POINTS
The Sale Order
 
- Sale is Approved
 
- Exercised Sound Business Judgment & Good Faith
 
- Highest and Best Offer
 
- Free and Clear of Liabilities
 
- "Good Faith Purchaser"
 
- Waiver of 10-Day Stay Period
 
- Process for Assumption & Assignment of Contracts

KEY PROCESS POINTS
Appeal
 
- Pre-Conditions:

- (1) The buyer purchased the assets in good faith and
 
- (2) The sale was not stayed pending appeal

- Result:

- The sale order may not be reversed on appeal

CONCLUSION
 
- Chapter 11 Sales Can Provide Significant Advantages
 
- The Bidding Procedures are Key
 
- Always Communicate with All Parties in Interest