Section 363 Sale: 5 Steps to Sell the Business Free and Clear

You can use a Section 363 sale in Chapter 11 to close the sale of your business on a much faster schedule than you would in a Chapter 11 plan of reorganization. In a 363 sale, you stay in control as the debtor in possession, and the court approves the sale after notice and a hearing. The buyer gets the business free and clear of liens, often closing in 60-90 days, versus the 12-18 months it usually takes to confirm a plan.

A Section 363 sale takes these steps:

• First, a stalking horse bid sets the minimum price.
• Then, you as the debtor-in-possession file a motion in bankruptcy court asking for DIP financing and approval of bid procedures.
• Next, a broker shops the business to other potential buyers to get the best price.
• There is an auction to get the highest bid.
• Finally, the court approves the sale and the sale closes.

A major benefit to buyers is that the sale occurs free and clear of liens, claims and interests. If the purchaser doesn’t want a particular asset with those strings attached, it can get the bankruptcy court to strip them away. There are exceptions where a lienholder will not be stripped, but Section 363(f) provides five conditions any one of which can force a lien off a particular asset. One way is with the lienholder’s consent. Another is when the court determines the lien is in bona fide dispute. The third way is if the sale price is greater than the total value of all liens on the asset. Leases and other contracts can be transferred to a buyer in a 363 sale. But the debtor in possession must cure defaults under the contract and show that the buyer can carry out its obligations.

Selling a Business in Chapter 11

The first step is to sign up a stalking horse buyer before you file. This is a buyer who enters the sale first, and whose offer will be accepted if there are no better offers. It signals to creditors that this bankruptcy has a purpose and a good prospect of producing value for them. If another buyer turns up, you get the advantage of competitive bidding with your stalking horse as the base offer.

Many buyers won’t go through the trouble of due diligence and an auction just to see some other company swoop in and take the prize. To get one to commit to buy your company, you may have to make an agreement that if someone does come in and make a higher offer, you pay them a break-up fee of say 1-3 percent of the price. You may also be expected to repay their expenses. The court must approve the break-up fee, and it will be scrutinized if it’s above 3%.

The second step is to file Chapter 11, with motions for DIP financing to keep the company operating, and for approval of bid procedures setting out the rules for the auction. Get DIP financing covering at least 90 days of operating costs. The bankruptcy court usually hears and approves bid procedures at a hearing 21-30 days after the bankruptcy petition is filed. But the court won’t authorize a sale in the first 21 days unless you can show it’s necessary to avoid irreparable harm. Your creditors must get at least 21 days notice by mail of a proposed sale. But you can ask the court to shorten that period.

The third step is to market the company to strategic and financial buyers for 30-60 days. If you have a stalking horse bidder, you have to give other potential buyers a chance to see whether they can outbid the horse. The more buyers you attract the better the prospects for a high final price. To prepare for the auction, get your financial books and records in order, take an inventory, and put together a clear and precise due diligence package. Opening a data room within 48 hours of filing lets you start shopping the business that fast.

Qualified bidders must be in a position to close and that means proof of funds. They must beat the stalking horse by a minimum overbid, typically 5 percent. This means you can’t get the business for just a dollar more than the stalking horse bid. A secured creditor may credit bid the amount of its claim instead of paying cash to win the bid, although this may chill bidding.

A fourth step, if competing bids come in, is a court-supervised auction. The highest and best offer wins. Creditors or other parties may object to the sale if they feel the process has been unfair or other issues are raised. Any objection has to be made at least seven days before the sale. The court will apply the business judgment standard to decide whether to approve the sale. It also will find whether the proposed buyer is acting in good faith. Once approved, the sale order is automatically stayed for 14 days, unless the court orders otherwise. The Code says that sales to a good-faith buyer stand, even if a higher court later reverses the sale order. The only exception is if the sale is stayed pending appeal.

After the court approves a sale, you typically close in a few days to several weeks. The proceeds of the sale go first to secured creditors, then priority creditors, and then to unsecured creditors.

Risks

There are risks. Assets are sold as-is with no reps or warranties. With a short window to do due diligence, buyers tend to discount their offer. Key employees may flee the sinking ship during Chapter 11. This has an effect on the value of the business as a going concern, and a loss of institutional knowledge may discourage buyers from wanting the business. The cure costs on leases and other contracts can run into hundreds of thousands of dollars.

Much Higher Value than a Liquidation

Even so, a 363 sale in bankruptcy generates a much higher value than a liquidation. Going concern values usually run about double the price in liquidation, and unsecured creditors can recover 30-60 percent of their claims instead of almost nothing in Chapter 7. The point is to keep value alive in a distressed business that in Chapter 7 would become just a collection of assets with little worth to anyone.