Bankruptcy Asset Sales Overview

When a bankruptcy case is filed, "all legal or equitable interests of the debtor in property as of the commencement of the case" becomes property of the bankruptcy estate. See Bankruptcy Code section 541(a). Thus in the context of selling or buying property of the estate, many people often refer to "bankruptcy property" or "bankruptcy assets".

If any property of the bankruptcy estate will be sold, such a sale is usually referred to as a "bankruptcy sale," an "asset sale," or a "363 sale." The term 363 sale is based on Bankruptcy Code section 363, which governs the sales of bankruptcy property outside the ordinary course of business.

People seeking to purchase bankruptcy property or assets should understand the process governing the sale of bankruptcy assets, as well as the risks involved. This article is intended to provide a brief overview of that process.

Many bankruptcy cases do not involve 363 sales. For a bankruptcy sale to occur, there must first be an asset to sell. This depends on the type of case, the type of debtor, assets, and exemptions.

For example, in a consumer chapter 7 case, for assets to be sold, the debtor must have equity in assets that is not protected by any exemption under the jurisdiction's applicable exemption scheme.

In a corporate chapter 7 case, there are no exemptions applicable and any assets the company owns may be the subject of a sale (assuming no or insufficient encumbrances).

In reorganization cases, such as chapter 13 and chapter 11, the debtor or debtor in Possession will typically be the party deciding whether or not to sell an asset.

When a bankruptcy petition is filed, the case is filed either as an "asset case" or "no asset" case. As you may surmise from the name, in asset cases, the bankruptcy estate contains assets, but that does not mean they will be sold through the case. As mentioned above, in reorganization cases, the choice usually belongs to the debtor.

No asset cases are typically consumer chapter 7 cases where the listed assets are either encumbered or fully exempt such that there are no assets in the bankruptcy estate to administer. However, even in no assets cases, it may later turn out that there actually are non exempt assets. In such cases, the trustee will file a "Notice of Asset" letting creditors know that there will be some distribution in the case. Typically, the Notice of Asset document does not identify the asset to be sold.

Bankruptcy property can be sold either by private sale, through a chapter 11 plan, or by public auction. Selling through a chapter 11 plan takes time, which is a short commodity in most cases. Further, justifying to a Court that a private sale is better than an auction in terms of achieving a fair price is often difficult. Therefore, auctions have become commonplace in bankruptcy asset sales. Such sales are governed by Bankruptcy Code section 363, and the remainder of this article will therefore focus on these types of bankruptcy sales.

Before diving into the process of bankruptcy asset sales, let's get familiar with the following terminology:

A good faith purchaser is generally understood to be "one who purchases the assets for value, in good faith and without notice of adverse claims¹. Some courts also require a finding that the asset was purchased "for value."² Purchasers typically want to have the court find they were a good faith purchaser so that the sale cannot be undone.

A stalking horse bidder is a potential buyer of the subject asset whose bid or offer serves as the floor or baseline for all other bids or offers. The stalking horse bidder typically enjoys certain benefits over other prospective buyers such as additional time for due diligence, terms negotiated specifically for the stalking horse, and sometimes a breakup fee (explained below) if approved by the court.

A break-up fee is monetary compensation to the stalking horse bidder in the event the final sale is to a different party. Such a fee must be approved by the Bankruptcy Court. Most parties seeking approval of a break-up fee argue that the fee is fair, and perhaps required, to compensate the stalking horse bidder for the risk, effort and expense involved in effectuating the intended sale.

This terminology is from Bankruptcy Code 363(f), which allows the sale of an encumbered asset to proceed subject to certain restrictions. The liens on the property sold are extinguished as to the property (so the purchaser may enjoy the property "free and clear" of liens), but attach to the proceeds of the sale.

A chapter 7 bankruptcy case does not involve the filing of a plan of repayment as in chapter 13. Instead, the bankruptcy trustee gathers and sells the debtor's nonexempt assets and uses the proceeds of the sales to pay holders of claims (creditors) in accordance with the provisions of the Bankruptcy Code³.

In liquidating the debtor's remaining assets, the trustee must follow the requirements of Bankruptcy Code section 363. Pursuant to subsection (b)(1), at a minimum this means that notice must be provided to creditors and parties in interest in accordance with Federal Rule of Bankruptcy Procedure 6004.

A hearing may not be required unless someone objects to the proposed sale. If an objection is made, then a hearing will be required. As stated in In re Telesphere Communications, Inc (et al), 179 B.R. 544 (Bankr. ND Ill 1994):

If the trustee intends to make the sale free and clear of all liens pursuant to subsection (f), then a noticed motion must be served in accordance with Federal Rule of Bankruptcy Procedure 6004(c), and the trustee must satisfy one of the 5 requirements set forth in that section.

When a debtor in Possession wants to sell assets outside the ordinary course of business, section 363 can be used to quickly effectuate the sale.

Since Bankruptcy Code section 363 does not mandate a single specific procedure for the sale, 363 sales can be accomplished in a variety of ways. However, many sales follow a similar process. Typically, the process begins with the debtor marketing the asset for sale, and finding a stalking horse bidder.⁴ Upon signing an asset purchase agreement with the stalking horse bidder, the debtor seeks to have the bankruptcy court approve the sale. As part of that approval, the sale will usually be subject to an "overbid" auction, and procedures for when, where and how to conduct the auction and events leading to the auction will be approved by the bankruptcy court.

Prior to auction, the stalking horse bidder will conduct its due diligence and prepare for the sale, while the debtor will continue to garner interest for the asset in an effort to have a competitive auction.⁵ At the auction, the Court will approve the sale to the winning bidder.

As mentioned, 363 sales can take a variety of forms. For example, there may not be a stalking horse bidder. Perhaps the debtor in Possession feels it doesn't need one, or perhaps no party is willing to take on the risks of the stalking horse. For whatever reason, the sale may proceed without one. In such case, the debtor seeks bankruptcy court approval of sale procedures, and hunts for interested buyers to submit offers based on those terms.

As a further example, a sale could occur without an auction. For bankruptcy assets that have little demand or require a unique buyer, this could be the best avenue of an efficient sale. In such a cases, proper valuation is the key issue that the court usually looks for in approving such a sale. The court must determine whether or not the price is "fair and reasonable."⁶ Courts differ on what is "fair and reasonable," and usually require some evidence from the parties regarding the fair market value of the asset and marketing efforts made in connection with the sale.

Because the procedures can vary greatly for a 363 sale, investors interested in purchasing bankruptcy assets should be aware of and carefully read the key documents regarding a sale, since those documents will dictate the process, deadlines and other requirements for the sale.

The following is a list of key documents to understand for 363 sales. Not all of these documents may be applicable in every case, however. Additionally, these documents are named differently from case to case and sometimes are combined into a single document. This article is designed to give you a general understanding of the types of documents involved in 363 sales:

This document is the agreement between the Debtor and the stalking horse purchaser. It is usually attached to the Motion to Approve Sale filed with the Bankruptcy Court and contains the sale terms that the Court is being asked to approve. If applicable, you should analyze this document to understand the terms of the existing deal.

This document is filed with the Court and seeks Court approval of the Asset Purchase Agreement and the contemplated sale of the assets thereby.

This document is filed with the Court and seeks Court approval of the procedures relating to the sale of assets. Such procedures include how notices will be given, how the auction bidding will proceed, whether or not a breakup fee will be allowed, and sets deadlines for everything to occur.

When the Court makes a ruling on the above named motions, it will enter a written order reflecting its decision. If a hearing was held on the motions (as is most often the case), the order will contain the result of the hearings. This is the document, therefore, that must be followed by all parties involved.

These are typically sent out by the debtor to notify creditors and parties in interest of the sale, the procedures relating thereto, and anything else the court required to be publicized. The notices must conform to the requirements set forth in the orders of the Court, if any.

Subscribers of Inforuptcy's assets database can access all the relevant documents relating to the asset sale and all the records of the associated bankruptcy case.

Bankruptcy asset sales can vary from elementary to extremely complicated. If you are new to this field, or simply want to become more involved in these types opportunities, do your research and start out small. Watch various deals for a while, "shadow" certain transactions of interest, contact sellers and learn about how different the process can be from sale to sale. Also make sure to take advantage of the resources we make available and read the pertinent documents. The more knowledge you arm yourself with, the quicker you'll be able to see the similarities in the transactions and spot the unique, valuable differences.

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[1] In re Gucci (2nd Cir. 1997) 126 F3d 380, 390 (internal citation omitted); In re M Capital Corp., 290 B.R. 743 (9th Cir. BAP 2003)
[2] In re Abbott Dairies, 788 F.2d 143 (3rd Cir. 1986).
[3] See www.uscourts.gov/bankruptcycourts/bankruptcybasics/chapter7.html#work
[4] Frazier, Kelly K (2009), A Comparison Shopping Guide for 363 Sales, Alexandria, VA: American Bankruptcy Institute.
[5] Id.
[6] Id. at 49-50.