Bankruptcy Code §363 asset sales are becoming an increasingly attractive method employed by companies in the health care industry to monetize assets. My firm has seen the impact in our own caseload with three diagnostic imaging facilities (DIFs) we are advising recently utilizing 363 sales.
Under §363(b) (1) of the Code, a chapter 11 trustee or debtor-in-possession (DIP) may sell the bankruptcy estate's assets free and clear of most liens or other encumbrances. This aspect of the 363 sale, as well as the sheer speed of the process, is appealing to potential buyers who might otherwise harbor concerns of obtaining clear title to the property they wish to acquire. The caveat of obtaining clear title is that, in most cases, the buyer agrees to take the assets on an as-is, where-is basis.
More and more, DIFs across the country have been seeking chapter 11 protection, principally as a result of the of Medicare reimbursement cuts established by the Deficit Reduction Act of 2005 (DRA). The following is a common scenario: the DIF leases its facility, has one secured lender for its equipment, was capitalized prior to the DRA and now faces diminished margins and a negative cash flow. The pre-petition secured lender (which may itself be experiencing liquidity issues) is typically the party that has caused the DIF to seek chapter 11 protection. Additionally, decreasing or negative cash flow coupled with older, overleveraged (and often underwater) equipment is generally unappealing to asset-based lenders. Under these circumstances, the prospect of successfully reorganizing with the existing lender or refinancing its existing debt structure with replacement financing is unlikely at best. As a result, a §363 asset sale often emerges as the most viable avenue for satisfying claims against the DIF debtor.
The Process
The 363 sale process typically begins with a marketing effort to solicit interest from one or more potential buyers-ultimately aimed at producing the highest and best offer. The role of the financial advisor in a 363 sale is to maximize value for all parties in distressed company transactions. Often, financial advisors are vital to a successful sale process because of their specific expertise in distress and the existing relationships they may have with potential buyers. The end result of a successful 363 sale is the speedy transfer of assets, free and clear, for the highest price available.
Marketing the Assets
A key component in assuring the maximum return of value to the estate is the swift and efficient execution of a marketing plan. Before approving a sale, the bankruptcy judge will likely require evidence that the debtor's assets were sufficiently marketed. The debtor's financial advisor typically undertakes a process by which it seeks to inform as many potential purchasers as possible of the opportunity to acquire the debtor's assets. The advisor will typically utilize existing relationships with prospective purchasers and allocate the necessary time and resources required for effectively marketing assets and otherwise negotiating the bankruptcy sale process.
Generally speaking, an executive summary or "teaser" will be distributed to prospective purchasers. The teaser usually contains sufficient information to generate interest in the opportunity, such as top line financial data, the make and models of the debtor's equipment and any pertinent dates relating to the upcoming sale.
The financial advisor will also work with various parties to create the offering memorandum, which often takes form as a secured online due diligence website or virtual data room. At this point, the advisor typically requires that prospective purchasers enter into a confidentiality agreement to protect the debtor's operation and other sensitive data during the sale process. Executing the agreement allows the prospective purchasers to access the due diligence information.
Bidding Procedures
At the outset of the sale process, the parties should address bidding procedures (i.e, the requirements for participation in the auction and the standards a prospective purchaser must meet to become a "qualified bidder"). In most cases, this requires, among other things, the execution of an asset purchase agreement (APA) by the potential bidder and the deposit of earnest money or a "bid deposit." Bid deposits are typically held by the debtors' counsel or the chapter 11 trustee in an interest-bearing trust account. The deposits should be refundable to those submitting unsuccessful or withdrawn bids or applied toward the purchase price in the case of the winning bidder. Requiring bidders to meet certain requirements, particularly a demonstration of their ability to close on a sale can make for a more productive bidding process. Lastly, a word of caution regarding the secured creditor of the DIF and its right to credit bid: carefully choose the wording used in the bidding procedures that reserve this right. The goal of the 363 sale process is to maximize value, which will rarely be obtained through a credit bid, especially when older imaging equipment is involved.
Role of the Stalking Horse
"Stalking horse" is the colloquial moniker applied to the first bidder who has undertaken due diligence expenses and submitted an acceptable bid. The stalking horse serves several important functions. Initially, the stalking horse provides the debtor and the creditors with a degree of assurance that a §363 sale will take place and will close. This assurance is typically rewarded by providing the stalking-horse bidder with a break-up fee and reimbursement of due diligence expenses incurred if the stalking-horse bid is not accepted. The stalking-horse bid also serves as a floor for the upcoming auction. If the bid was in place prior to the engagement of a financial advisor, the presence of the stalking horse bid may help reduce chapter 11 administrative expenses by reducing the commission due to the financial advisor. Lastly, a stalking horse makes the deal more attractive to other potential bidders who may view this initial bid as an indication that the opportunity is valuable and worth pursuing.
Auction and Sale
Once the bidding procedures have been established and the stalking-horse bid has been selected, the auction sale is ripe to begin. The auction allows qualified bidders the opportunity to top the stalking-horse bid and establish competing offers with one party ultimately outbidding the others. The auction is typically held by the counsel for the debtor or the chapter 11 trustee. Representatives of other parties with interests typically attend, in addition to the qualified bidders. Allowing bidders to join the proceedings remotely via telephone may encourage additional participation, but not necessarily raise the final bid. In many cases, the auction will result in maximum value to the estate when the bidders meet in person and have an opportunity to interact with one another before or during the sale process. Depending on the number of qualified bidders, a separate round of bidding to establish a "back-up" offer can create valuable alternative in the event that the winning bidder fails to close on the transaction.
When deciding a motion to approve the proposed sale, the bankruptcy court will typically defer to the business judgment of the debtor or chapter 11 trustee but will also want proof that the sale will is in the best interest of the estate and its creditors.
Case Studies - Diagnostic Imaging Facilities
Our experience advising DIF debtors has taught us that §363 assets sales are most effective when the parties work together to reach a common goal of obtaining the greatest value for the estate. One of our recent cases involved a DIF debtor that leased space in two, well-established locations but used older, less desirable equipment. A second case involved a DIF debtor that had newer equipment and valuable executory contracts, but was located in a less desirable area. Each DIF suffered from DRA reimbursement rate reductions, and, perhaps more devastating to their respective operations, each DIF was also the victim of gross mismanagement. Notably, neither of the cases involved a committee of unsecured creditors, and each involved a secured lender that was owed far more than it could ever hope to recover. In both cases, we were able to utilize the 363 sale process to efficiently maximize the return to the creditors by securing the cooperation of all parties and worked to quickly and effectively market each opportunity to a pool of likely buyers.
Summary
With the help of an experienced legal and financial team, as well as proper planning and cooperation among the parties, §363 asset sales can offer a relatively quick and clean means of monetizing assets and generating maximum value to creditors in chapter 11. Section 363 sales are particularly useful for debtors within the health care industry and specifically with DIFs, as these cases often present scenarios where a single secured creditor is owed more than the likely recovery amount due to depreciated asset value, but the going concern value can still be captured. As more DIFs seek Chapter 11 protection, we can expect to see §363 asset sales utilized to deliver the most advantageous solution for all parties involved.