Investors and those representing them go to great lengths to maximize the value of their deals in § 363 asset purchases. But if they’re not careful, they could easily find themselves in the following auction scenario, where a little ambiguity jeopardizes significant value that a “stalking horse” bidder thought it had already negotiated.
The Scenario
You’re an investor kicking the tires on a company in bankruptcy. You love the upside of this company, but you’re worried about expending significant time and money vetting the opportunity (including attorneys’ fees, quality-of-earnings analysis, valuation and appraisal work, and site visits), only to possibly end up in a bidding war with others taking a free ride on your due diligence.
To reel you in, the debtor offers you $250,000 in “Bid Protections” if you don’t win at auction (including a break-up fee and expense reimbursement), and a “credit” toward your cash bid at the auction in the amount of the Bid Protections.
You take the leap and sign the asset-purchase agreement (APA), hoping that no competing offers come in and there will be no auction. Unfortunately, a competing bid does come in, and you’re off to the races.
At the auction, your bid reaches $4.5 million, and the competitor now enters a bid of $5 million. You calculate the net economic value of the competitor’s bid to the bankruptcy estate to be $4.75 million — and if the competitor wins the auction with a $5 million bid, the cash value of the bid would be reduced by the $250,000 in Bid Protections the competitor must pay you.
Bidding turns to you, and, knowing you have a $250,000 credit for the Bid Protections, you enter a $5.1 million bid. The competitor bows out. Following the auction, your attorney sends debtor’s counsel a draft sale order setting forth that your final cash sale price is $4.85 million (your $5.1 million bid reduced by the Bid Protections credit). Debtor’s counsel asserts that you did receive the credit at the auction, that your $5.1 million bid was not qualified by any language referring to the Bid Protections, and that the sale could blow up prior to the hearing if you do not agree to pay the full $5.1 million in cash. How could this have been avoided?
Getting the Bid Credit You Deserve
For stalking-horse bidders, attempting to purchase a bankruptcy debtor’s assets comes with the risk of uncompensated due diligence. To provide incentive to prospective stalking-horse bidders, courts will often approve Bid Protections, which are commonly memorialized in the APA between the stalking horse and the debtor and included in the bid-procedures order. Also commonly included in the procedures order is a bid credit for the stalking horse for the amount of its Bid Protections, which created the issue in our scenario above.
A credit to the stalking horse for the amount of the Bid Protections makes sense to compare the economic values of bids on an apples-to-apples basis. In the scenario above, to assess the true value of a competing bid to the estate, the bid is reduced by the $250,000 in Bid Protections that must be paid to you if the competitor is ultimately successful. To capture this reality, your bid should include a continuing credit in the amount of the Bid Protections. But lack of clarity in the APA, procedures order or entry of the bids at auction can cause the stalking horse to inadvertently forfeit the credit for its Bid Protections.
To avoid any ambiguity as to the cash portion of your bid, be sure to do the following:
- The language in the APA must be clear that, in the event of an auction, the Bid Protections credit will be netted out of your purchase price. The following (or similar) language is recommended:
On the Closing Date, in consideration for the conveyance of the Assets, Buyer shall deliver the following consideration to Seller (the “Purchase Price”): payment of an amount (the “Closing Cash Payment”) in cash equal to $X less (A) the Cash Deposit; and (B) if there is an auction resulting in a final cash purchase price greater than that contemplated herein, an amount equal to the Bid Protections.
(Of course, be sure that “Bid Protections” is accurately defined in the APA.)
- Include language in the APA and procedures order that provides for a credit toward the cash purchase price for the amount of the Bid Protections, as described above, such as: “At the auction, Buyer shall receive a continuing cash ‘credit’ toward any bid in an amount equal to the Bid Protections.”
It is important to note that the credit is continuing. That is, the true economic value of every single bid of a competitor, no matter how many rounds of bidding, is always subject to (or reduced by) your Bid Protections, and every single bid of yours is always bolstered by the Bid Protections Credit. No matter how high the bidding goes, a successful competing bid will result in the payment to you of the Bid Protections, so this economic reality should be accounted for throughout the entire auction. Parties will sometimes argue that the “credit” only applies to the first overbid, but this is wrong.
- Most critically, when announcing your bid at the auction, be crystal clear as to the net effect of the Bid Protections credit. For example, in our scenario above, instead of simply entering a $5.1 million bid, use the following: “The Stalking Horse hereby submits a bid of $5.1 million, comprised of $4.85 million in cash plus the Stalking Horse’s $250,000 cash credit for the Bid Protections pursuant to the APA and Procedures Order.”
From a bankruptcy sale perspective, the entire process is always about maximizing value. If stalking-horse bidders are not actually given the full benefit of making a market by having the Bid Protections increment taken away from them after the auction, they will be less likely to take the risk and step up as stalking horses in the first place. Clarity on how this issue should be addressed would be helpful for all market participants, but more importantly, clarity regarding the components of your bid — in your APA and procedures order, and spoken clearly as part of every incremental bid — will ensure that you get the Bid Protection credit you deserve at auction.