Practical Approaches to Selling Assets in Chapter 11

Among the chief concerns of businesses in chapter 11 is the need to generate
sufficient liquidity to fund ongoing operations. In many instances, under-performing
business units require more cash than is generated by the core business. In still
others, the core business itself (at least temporarily) operates in a cash-flow
negative environment. Compounding these issues, many debtor-in-possession loans do
not provide more than a short-term solution to these liquidity constraints. For this
reason, cash-generation techniques continually warrant attention from company management
and bankruptcy practitioners alike. After all, any attempt to address the underlying
business issues that precipitated the chapter 11 filing in the first place must be
predicated on creating enough financial "breathing room" to implement the turnaround.

To create liquidity, restructuring advisors use a variety of techniques, ranging
from less invasive tactics such as exerting control over cash disbursements, lowering
levels of on-hand inventory, and focusing on the collection of receivables to more
drastic strategies like shutting down under-performing business units, reducing head
count and selling non-core assets. Under the proper circumstances, a combination
of the above strategies can effectively address these cash constraints. One primary
focus of the financial advisor is therefore to recognize the appropriate combination
of these remedies given the client dynamics and financial/operational constraints.
For example, it may not be appropriate (or even possible) to enforce strict
disbursement limitations when the company's primary vendors are sole-source suppliers.
Likewise, head count reductions may have little or no impact on cash in a
capital-intensive business.

The following discussion focuses on the factors affecting the viability of one of
these cash creation techniques: an asset-sale strategy. Particular emphasis is then
placed on maximizing sale proceeds, minimizing time delays (which can be significant)
and addressing other considerations that may hinder the sales process.

Viability of an Asset-sale Strategy

Most financiers recognize the benefits of monetizing under-performing or unused
assets. However, given the time delays that often occur and the prevalence of
distress pricing, undertaking this strategy in chapter 11 is not always the best use
of company resources. Thus, before initiating a full-scale asset sale process, it
is imperative to complete an honest internal evaluation of the subject assets relative
to both the company's short- and mid-term cash needs and its resources available to
manage the process.

The first aspect of this evaluation should focus on the overall marketability of the
assets, particularly under different sales scenarios. For instance, a piecemeal
liquidation of assets via auction or outright sale to a liquidator may be able to
provide fast cash (relatively speaking), but the ultimate proceeds may amount to only
a fraction of the fair value of the property. Likewise, given prevailing market
conditions (i.e., a glut of similar assets in the marketplace or a shift away from
the specific technology used in the assets), there may not even be a viable market
for the assets.

A second facet of the evaluation should center on matching estimated cash proceeds
against the company's short- and mid-term cash needs. If the assumed proceeds do
not effectively meet these cash obligations, the asset-sale strategy alone will not
work. Under this scenario, the advisor must decide whether to temporarily abandon this
strategy in favor of a more lucrative one or to use this strategy in combination with
other techniques. It is important to note that concurrently undertaking a variety
of cash-generating strategies can require additional resources and can hinder the focus
and success of each individual approach.

A final factor to consider in the self-evaluation relates to the identification of
alternative internal uses for the assets and other opportunity costs. If retaining
assets could prevent certain necessary capital expenditures, then the sale probably does
not make sense. Too often, companies sell fixed assets for far less than they are
worth only to discover a few months later that they will need to spend full price
for similar equipment needed within another division. On the other hand, the expenses
associated with retaining certain assets sometimes exceed the benefits from finding these
alternative uses. For this reason, it is crucial to reflect on the various types
of asset holding costs (e.g., rent, maintenance, utilities, security, etc.) when
determining the viability of an asset sale.

Maximizing Sale Proceeds

Assuming an asset-sale strategy is a viable option for generating liquidity, one's
primary goal becomes undertaking a game plan to maximize the sale proceeds. The first
step in this process involves developing reasonable expectations for the eventual
proceeds. A number of value indicators are often available to aid in this process.
The most basic of these indicators (and probably the least accurate) is book value.
Book value is merely an accounting convention reflecting the original cost of the asset
less any accumulated depreciation expense. It does not reflect current market conditions
and is skewed by depreciation methods that are often undertaken to limit the company's
tax exposure or to manipulate earnings. A more accurate value indicator is an
appraisal of the subject property, indicating either its fair value or liquidation value
(or both). While they are more accurate than book values, appraisals are often not
ideal indicators of value, either. This is because appraisals quickly become outdated,
particularly if conducted well before the chapter 11 filing. Also, it is important
to recognize that appraisals are often completed for specific business purposes
(particularly in the case of "value and use" appraisals) that can skew their results.
Finally, though appraisals and book values can provide important insight into the
values of certain assets, even more relevant value indicators can be obtained through
discussions with asset brokers/agents or by attending auctions for similar equipment.

The second step in maximizing sales proceeds is identifying the most likely type of
buyer. While almost all buyers are anxious to take advantage of "distress discounts,"
an equipment liquidator is not likely to offer nearly as much for equipment as an
end-user. For this reason, one should aggressively seek out all possible end-users.
Brokers can help in this search, and some non-traditional buyers (i.e., landlords,
competitors, neighbors, vendors, etc.) should also be contacted directly. In
addition to avoiding the substantial fees charged by the middleman (i.e., the broker
or the liquidator), selling directly to these end-users may generate proceeds closer
to fair value.

The third and final step toward maximizing sales proceeds involves managing the "fire
sale." Unfortunately, end-users do not always present themselves during the original
solicitation for bids. Hence, the decision must be made as to whether or not to
abandon the sales process or to proceed under less-than-ideal circumstances. When
proceeding, one must recognize the full slate of options available, including (1)
selling the property directly to a liquidator, (2) hiring an auctioneer to sell the
equipment piecemeal (see the Auction Basics chart below for various auction
types), (3) engaging one or more brokers to sell the property on the company's
behalf or (4) petitioning the court to lead an auction during a scheduled bankruptcy
hearing. Any of these options can work effectively. The first option is the quickest
to complete but often generates the lowest recovery, as it requires the liquidator to
front its own money (not always an attractive option for them). The second and third
options can also be effective, but they can take longer to complete. Also, there
may be no guarantee that all assets will in fact be sold, or that they will be sold
at a specified price. Finally, the fourth option can be both expeditious and
profitable. However, not all bankruptcy court judges are willing to supervise such
a process. Also, given the limited amount of time available in front of the judge,
this option requires more preparation and organization on the company's part in advance
of the auction.

Limiting the Time to Sell

While asset-sale strategies can often generate substantial liquidity for a chapter
11 company, the process can often take several months to complete. There are many
steps required to finalize the sale, and each step can take a considerable amount of
time (often, the length of each step is beyond the control of the company). The
first step in the process involves the solicitation of bids. To shorten the time in
this stage, it is important to contact all prospective buyers early and often.
Management may be inclined to contact end-users first and await their responses before
proceeding with brokers, agents and liquidators. However, if no bids are collected
after two or three months, they will be essentially starting over with the alternate
(discount) buyers. Running solicitations to all prospective buyers concurrently can help
avoid these timing delays.

The next step in the process involves the evaluation and renegotiation of bids. One
method for limiting time spent on these activities requires some forethought during the
solicitation process. By simply developing and distributing a uniform term sheet
(along with consistent guidelines for providing proof of the bidder's ability to pay)
to all prospective buyers, one will be able to easily compare bids and facilitate a
fair negotiation. Likewise, once the appropriate bid has tentatively been approved, it
is important that simple and standard contractual terms be shared with the prospective
buyer to alleviate unnecessary contract disputes. Given the overall supervision and sale
approval required by a bankruptcy court judge, there is scant rationale for preparing
long, complex and overly restrictive contracts.

The third step in the sales process includes providing adequate notice to all other
bidders and parties-in-interest indicating the company's intent to finalize a sale.
There is not much variability in the notice period (it must be at least 30 days
in most jurisdictions); however, it may be reasonable to provide this notice even
before all contractual terms have been finalized. This will effectively start the clock
sooner (upon acceptance of a reasonable term sheet).

In outright and brokered sales, the fourth and final step of the process occurs
with the court approval hearing and the subsequent closing of the sale. Clearly, the
ability to effectively support and present the business reasons for the asset sale in
front of the bankruptcy court judge is paramount to gaining quick approval. In
addition, to avoid closing delays, it is imperative to agree in advance (with the
buyer) on a scheduled closing date and the means for collecting sale proceeds. If
at all possible, escrowing these funds in advance of the hearing is preferable, as
this will generally prevent delays caused by the buyer's cash constraints.

The final step when hiring an auctioneer does not occur until the assets are finally
sold and funds are passed through to the company. Even after the court approval
hearing, this process can be lengthy. However, delays can be easily avoided by
including constraints on the timing of the auction within the auction services contract
(perhaps agreeing that all assets will be auctioned within 21 days after the approval
hearing).

Other Considerations

Maximizing sale proceeds and limiting the amount of time to complete the sale are
the two primary considerations when undertaking an asset sale strategy. A few
additional considerations also warrant attention in bankruptcy cases. These issues can
impact the ultimate sales proceeds, the timing of the asset sales and the ability of
the company to use the proceeds to fund operations. The first issue involves collateral
constraints. To the extent that the subject assets are fully or partially secured by
outstanding debt, the ultimate cash proceeds may be required to repay the underlying
loan. Therefore, it is important to review collateral agreements and to hold open
discussions with lenders before assuming that a comprehensive asset sales strategy will
generate liquidity.

Another consideration within the asset-sales process relates to the differences
between selling real and personal property. In most cases, the sale of real property
can be more problematic. This is because buildings and real estate are often fraught
with issues not relevant in the sale of equipment, such as disputes over property
boundary lines, environmental liabilities and zoning restrictions. While advanced
preparations can be undertaken to address these issues through securing up-to-date
surveys and property inspections, such issues will tend to lengthen the time to sell
real property. Further delays can also occur because notice to all constituents cannot
be made until all major contingencies are resolved. While this provision is relevant
for both personal and real property, it is worth pointing out that more contingencies
are typically included in real estate contracts (i.e., financing contingencies,
due-diligence periods, etc.).

A final challenge facing sellers of assets in chapter 11 stems from the need to
demonstrate (in court) that the highest and best offer was received. It is not
uncommon for new bidders to wait until the ß363 hearing to present their higher
offers for the assets, thereby winning the bid. While accommodating these overbids can
benefit the estate, it also tends to discourage advanced bidding on the assets. A
few tactics can help address this issue. First, break-up fees can be included in
the asset-sale contracts, forcing new bidders to raise their bids by at least the
level of the fee. Second, incremental overbids can be required, effectively passing
along similar break-up costs to the new bidder. Finally, one may be able to avoid
the approval hearing altogether by following detailed bid procedures pre-approved by the
court.

Conclusion

Among the more challenging aspects of the asset-sales process is the search for
prospective buyers of the individual assets. Many practitioners are already discovering that
the development of the Internet can expedite this matching of sellers and buyers. Yet,
even with technological advances, the steps along the asset sales process remain virtually
unchanged. A viability assessment still must be completed, steps still need to be taken
to maximize proceeds and minimize time delays, and the practitioner still needs to be
aware of the various obstacles that can prevent a successful sale. With an adequate
amount of forethought and preparation, an asset-sales strategy can effectively create the
liquidity needed to run the business and (hopefully) fund a viable turnaround effort.

Footnotes

¹ Jon Slatkin is an associate at Jay Alix & Associates. He has extensive experience preparing business and asset valuations for
acquisitions, divestiture, litigation and financial planning purposes and has worked in the manufacturing, financial services, health care,
hi-tech and entertainment industries. Return to article