As most investors know, you can obtain a great deal purchasing assets out of a bankruptcy estate. But do you want to be the first interested party to negotiate and enter into a purchase agreement? Do you want to be the party that conducts all of the due diligence and sets the minimum purchase price?
A Stalking Horse
The initial bidder with whom a debtor or a trustee negotiates and enters into a purchase agreement is called the "stalking horse". The phrase "stalking horse" comes from an old hunting term referring to a horse, or an image of a horse, behind which a hunter would hide to get closer to his prey. However, a "stalking horse" in a bankruptcy sale cannot hide anything! As you may know, very little is concealed in a bankruptcy proceeding and an investor may be forced to disclose much more information about the deal, as well as about the investor itself, than in a typical nonpublic deal.
Because debtors and trustees have a fiduciary duty to maximize the value of the assets of their estates, they will usually engage in an extensive marketing process and negotiate with numerous potential purchasers prior to choosing a "stalking horse" and enter into the auction process with a "stalking horse" agreement already in place.
A "stalking horse" agreement is beneficial to a bankruptcy estate in that it can provide the incentive required to induce potential bidders to submit or increase their bids prior to the auction. To the extent bids can be improved prior to the auction, a higher floor is established for further bidding. But how does it benefit an investor?
Stalking Horse Benefits To An Investor
An investor can benefit by being the "stalking horse" in a bankruptcy sale by setting the terms it would like to include in its asset purchase agreement such as: the assets and liabilities to be acquired and assumed, representations and warranties, material adverse changes, termination provisions and other important deal terms. Another advantage of being a "stalking horse" bidder is having the additional time to conduct due diligence and obtain regulatory and/or other types of approvals, if necessary. Also, if there are numerous interested parties prior to an auction, the stalking horse bidder could negotiate and exclusivity with the trustee or debtor in possession. However, such exclusivity would most likely expire once the court approved auction process begins.
A "stalking horse" bidder will also be able to negotiate the bidding procedures and bid protections to be approved by the Bankruptcy Court as part of the auction sale process. Some of the procedures a stalking horse bidder may want to see in the Courts' approval order could include - the criteria to be met for a qualified bid, including a credit bid by a secured creditor, the bidding process timeline, and the minimum overbid acceptable.
A "stalking horse" bidder would also seek bid protections to protect itself in the event it is not the successful bidder at the auction. Such bid protections would include a break-up fee (typically 1 – 3% of the purchase price) and an expense reimbursement (typically subject to a cap). Such bid protections are allowed to compensate and reimburse the stalking horse for the time and expense it incurred in connection with its due diligence.
While a break-up fee and other bid protections provide incentive for potential bidders to increase their bids at the auction, they also serve to reward bidders who act as stalking horses. As such, another advantage a stalking horse bidder may have over other bidders is the chilling effect its stalking horse agreement and bid protections cause. Such chilling effect can ensure that the stalking horse bid will be the successful bid at the auction. However, even if the stalking horse loses at the auction, the stalking horse bidder can be paid its approved break-up fee and expense reimbursement at the closing of the sale to the successful bidder and still win!
Stalking Horse Risks To An Investor
It is very important to know the rulings of the court in the jurisdiction where you are seeking to purchase assets and whether it typically allows and approves bid protections. Some courts do not allow break-up fees. In other instances, it will be determined on a case-by-case basis depending on the facts and circumstances of the case. Some causes for denial of bid protections include numerous other interested parties and limited funds in the estate.
Bidding protections are designed to encourage active bidding. If a court finds that the actions of other bidders were enough to encourage active bidding prior to the auction, then a "stalking horse" may not be approved. While the chilling effect described above could be an advantage to a stalking horse bidder, some courts find that it can only hamper the debtor's or trustee's ability to sell the property and will not approve, or limit, any bid protections. One bankruptcy court in the Southern District of New York even vacated an order approving bid protections when it later found out there were other parties ready willing and able to purchase the assets, other than the stalking horse!
In addition to the bankruptcy court not approving (or vacating) your bid protections, other risks to being the stalking horse bidder may include paying too much for the assets. Because you are setting the minimum purchase price, you will not know if your purchase price is too high. However, if you are confident you are paying an appropriate price for the assets, you may be outbid at the auction. In that case, you unfortunately will not be able to purchase the assets you wanted and better hope your bid protections were approved by the bankruptcy court so you can at least be reimbursed for your expenses and possibly receive a break-up fee too!
When purchasing an asset out of a bankruptcy estate, it is very important to assess each bankruptcy case and asset sale carefully to determine if being the "stalking horse" is the best strategy for you. Therefore, it is imperative a purchaser of assets conducts proper due diligence in consultation with counsel well versed in bankruptcy as well as other relevant areas of law to protect yourself from the risks and complexities inherent in bankruptcy asset sales.
This article appeared on the March 17th, 2015 inforuptcy blog. Inforuptcy is a comprehensive resource for bankruptcy case information, bankruptcy assets for sale and leading bankruptcy news.
|Piazza, Deborah J. Partner||Partner||212.216.1140|