Business Bankruptcy Auctions: 6 Rules for Buying Assets From a Bankruptcy Estate

Hoping to score a deal on business assets or property? It’s possible. Companies in bankruptcy sometimes auction off equipment, inventory, even real estate, and if you play your cards right, you can pick up big-ticket items at a bargain price. Most of these transactions go through a bankruptcy court approved “Section 363” sale and the assets may be sold free and clear of liens, and often below market value. But be forewarned: the process is fast, competitive, and ultimately the bankruptcy court has the final say. Six rules are worth bearing in mind.

The Docket for the Bankruptcy Case

Section 363 sales take place in federal bankruptcy courts, where there is a record (called a “docket”) for each bankruptcy case filed. First you need to know where to look. If you’re in the market for a company’s inventory, equipment, property or other assets, you’ll need to find that company’s bankruptcy case in the docket for the court in which it filed for bankruptcy. Get to know the docket for the bankruptcy case because every filing is listed there. Filings include anything that the court’s clerk records in the file for that case. When a company files to liquidate assets, it typically will file a motion and a notice that includes terms of the sale, instructions on how to participate in bidding, and a deadline for when bids must be submitted. In bankruptcy court, time is always of the essence, so when you see the motion and notice, mark the calendar for key dates.

As for when that asset sale will be held, the bankrupt company must give creditors at least 21 days notice of a public sale, or of the terms of a private sale to a third party. Objections are usually due 7 days before the sale, but the court can set other deadlines for both notice and objection.

Conduct a Full Investigation

A Section 363 sale is typically an ”as is” sale and the property, equipment or other asset you are buying is being sold as is. Before committing, conduct a full investigation. If possible, schedule an inspection with the owner of the property. Bring experts with you on your inspection to evaluate what you’re thinking of buying, and then give serious thought to whether the property makes economic sense.

In a ”free and clear” sale, the purchaser takes title to the assets free of any security interests and other liens. But you’re still on the hook for the condition of the asset, any environmental liabilities that may burden it, and any state or federal regulatory approvals you may need to use it. If the seller was operating a business, buying its assets may also mean taking over its contracts, leases and other agreements. You may need to cure defaults in those agreements before you’re entitled to benefit from them, so be sure to evaluate that possibility. Nor may such a sale be free of other liabilities, such as product liability, mass torts or labor claims.

Credible Bidder

Before the sale, make sure that you’ve obtained adequate financing. A loan that is “subject to approval” may not suffice. Have your loan commitment in hand and ready to go so that you can prove to the court that you are a credible bidder. As for the bid itself, the bidding procedures may require you to bid without due diligence or financing contingencies. It may also require a refundable “good faith” deposit of 5% to 10% of the bid price. It is difficult to obtain traditional financing fast enough to qualify for some of these asset sales, so look at alternative financing options.

Your bid may also have to beat a stalking horse offer, an initial bid on the assets of a bankrupt company that serves as a bid that other bidders must surpass if they want to buy the assets. The key advantage that the stalking horse bidder holds is that it can get a head start on the diligence process and it can shape the bidding procedures, negotiate key economic terms and gain approval of bid protections. The stalking horse bidder’s protections are typically limited to breakup fees of up to 3% of its price, plus expense reimbursement. All of this needs bankruptcy court approval, and the stalking horse’s bid becomes public, allowing other bidders to outbid at the auction.

Whether an auction is public or private, qualified bidders (those who meet the minimum criteria outlined in the court’s notice) are able to improve their offers before the auction concludes. When the bankruptcy judge signs off on the sale, he or she is supposed to look not just at the price, but also at the sale terms and the likelihood that the transaction will close. Note your price limits before the bidding starts so you don’t fall in love with something and overpay for it. Get a deal, but be sure you won’t be mad at yourself later.

At the auction, a secured creditor with a lien may bid its claim instead of cash (also called a “credit bid”) unless the court orders otherwise. Bidders who agree among themselves to control the price risk having the sale voided, paying damages, costs, attorneys’ fees, even punitive damages, depending on their conduct.

In approving the deal, the court takes into account any objections from creditors, other interested parties, or the debtor. A bid, however attractive, is not confirmed until the sale has been approved by the court. The bankruptcy court’s approval order is stayed for 14 days (unless the court orders otherwise). If the sale is later reversed on appeal, a good faith purchaser keeps the assets, unless the sale was stayed pending appeal. Courts apply heightened scrutiny to sales to insiders.

After the court approves your bid, you sign a purchase agreement, title is transferred, you pay for your assets, and it’s yours. Talk to an experienced bankruptcy attorney and financial adviser about navigating a 363 sale. It can be a good way to acquire assets, so long as you’re prepared.