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B. LANE HASLER, P.C. LEGAL NEWS - 2017
Buying Assets In Bankruptcy
Think of it as a physical for your company.
The bankruptcy of a business in your industry presents an opportunity to acquire not only hard assets, such as equipment and real estate, but also accounts and employees. This is not, however, the normal business-to-business "used market" in which transactions may often be completed with minimal legal involvement.
The bankruptcy process moves very quickly and the bankruptcy laws create potential liability for a buyer, which, while easily avoided if properly addressed, require an attorney experienced in this area.
In March I assisted a client in just such an acquisition. On a Tuesday, I received the call by which a competitor of the client had filed for bankruptcy. There was an auction of its assets scheduled and the client wanted to buy the assets - for the right price. There are typically six steps involved in representing a buyer in a bankruptcy sale process.
The first step is to determine the auction procedures. A bankruptcy sale requires a minimum of public notice, a hearing, and a court order. As the assets being sold increase in value or are more complex in nature, there will typically be a sale procedures order approved by the Court. This procedures order will provide for (a) how a potential bidder qualifies, (b) the due diligence allowed; (c) the form and content of a bid; and (d) the auction mechanics. In my March transaction, there was such a procedures order. Therefore, I had to ensure the client understood the ground rules and was able and willing to comply.
The second step is to determine if there is a "stalking horse" bidder which is a buyer that has already completed its due diligence and agreed to buy the assets, but whose bid is subject to higher and better offers. Bankruptcy sellers will accept a "stalking horse" bid for two reasons - it provides a confirmed sale and it gives competing bidders a measure of comfort in knowing that the assets are real and worth at least the "floor" set by the "stalking horse" bidder. The down-side for a competing bidder is that the "stalking horse" typically gets protection for its willingness to make the first move and risk being outbid. This protection is in the form of a break-up fee, which is paid by the seller so is not material to a bidder, and bid protection, which is a minimum increment by which a competing bid must exceed the "stalking horse" bid. This bid protection is a problem for competing bidders if set too high. In my March transaction, there was a "stalking horse" bidder and the bid protection was 10% of its bid. While a significant sum, it was not a deal-killer.
The third step is to confirm that the client qualifies to bid and is able to make a compliant bid. These are separate items. The typical qualification requirements are the signing of a non-disclosure agreement and posting a deposit. The non-disclosure agreement should not be taken lightly, particularly if the seller is a competitor,. This is because it may contain restrictions on the potential buyer's ability to do business such as limitations on the buyer's ability to contact in the future any customer of the seller. Since the winning bidder will get the right to enforce these non-disclosure agreements, they are not something that goes away when the auction is over. The amount of the deposit is usually equal to the bid protection amount so it really isn't material. In my March transaction, the non-disclosure agreement posed no problems, neither did the deposit.
The fourth step is the due diligence review. Depending on the size of the asset base and the type of assets, it can be as simple as the seller opening the doors to the buyer for a walk-through or as advanced as a virtual online data-room where the seller has posted accounts receivable, intellectual property and contract documentation for buyer review. Once the potential bidder has qualified, the bankrupt seller is under an obligation to comply with reasonable due diligence requests. This gets interesting when the asset sale is of a going concern business and the potential buyer is a competitor. Obviously the seller does not want to give a "free look" to its competitor who then has the information it may use in its existing business so there is no need to buy it. The non-disclosure agreement discussed above will address much of this situation, but there may be negotiations as to the scope of due diligence as well. In my March transaction, the primary assets were intellectual property and customer accounts, including receivables. The seller established a secure website where the documentation could be reviewed by buyers.
The fifth step is the bidding. The bid procedures set an auction date and time. The bid procedures order will also usually require that the bids be for the same set of assets (no bidding for less than all) and on the same terms as the "stalking horse" bid. If a buyer is interested in less than all or if there are differing terms that the buyer requires then prior to the auction day, the buyer can raise those concerns with the seller. However, it is very unusual for a change since the "stalking horse" buyer must agree and it is unlikely to want to help a competing bidder. However, it never hurts to ask, particularly if the changes may promote a more robust auction and the seller has the ability to cut a deal with the "stalking horse" bidder to go along, for example by paying an enhanced breakup fee. The auction itself may be simply one round with written bids due and opened on a specific date. More often, it is an actual "live" auction held at the bankruptcy court, but without the bankruptcy judge presiding, rather the bankrupt seller will arrange for use of the courtroom or an ancillary room. There typically is a court reporter, and the seller's bankruptcy counsel will handle the process starting with a request for a bid higher and better than the "stalking horse" bid and then bidding continues in the minimum increments established in the bid procedures order. It is not unusual for bidders to participate by telephone with their attorney present at the auction. In my March transaction, the auction was in the bankruptcy court with buyer participating by telephone through their attorneys.
The last step is entry of a sale order and closing. Once the bidding has concluded, the bankrupt seller will present the winning bid to the bankruptcy court for approval. The form of the sale order can be very brief, referring back to the bid procedures order for details, or it can be sizeable with detailed descriptions of the assets, conditions to closing and post-closing dispute resolution procedures. The buyer must ensure that the sale order includes specific references to the sale of all assets. Additionally, that it is "free and clear of all liens claims and encumbrances" which means the buyer is getting a federal court order giving it the best title possible to the assets. A related issue that has generated much interest and litigation is whether the sale order may insulate the buyer from "successor liability" if the buyer acquires substantially all of the seller's assets. In such sales, creditors have occasionally attempted to assert claims against the buyer on the theory that it is a continuation of the seller's business. A carefully worded sale order provides protection - but not an absolute bar - to such claims. Closing a purchase is like any other acquisition, comply with the terms of the purchase agreement, but also comply with the sale order. In my March transaction, the sale order was very detailed and protected the buyer in all of the ways discussed above. The buyer realized an opportunity and obtained assets very beneficial to its business at a good price in a quick transaction.
Think of it as a physical for your company.
Every few years, you should pull copies of the "essential contracts" that are critical to your operations and have them reviewed by an attorney.
Start with your purchase order or client contract that you use every day. This document has the biggest impact on your business. It sets your obligations and how you get paid. Next, get your employment contract or handbook. This is one of your largest costs, so it is important to make sure your promises are properly documented. These two contracts are largely within your control - subject to market conditions - so should be the most favorable to you that the law will allow.
The other side of your business contracts are those written by others. First are your primary vendors such as material and service suppliers. Just because they have "form" contracts doesn't mean you shouldn't understand what is in them and either ask for changes or shop for an alternative supplier. Second is your landlord. Your facilities are much more difficult to change than suppliers, so it is important to get the best lease possible upon each renewal.
Why review these contracts? Because the law changes. Statutes are revised and courts issue decisions interpreting contracts. What was "state of the art" when your contracts were written may no longer be the law. Even "form" documents are updated. For example, every ten years the American Institute of Architects updates their suite of construction project documents. The next update is being released in April 2017.
Does this mean you will be re-writing every one of these documents? No. Your attorney should explain any issues and put the situations into a business risk perspective. The current language creates a risk - what are those risks, what is their probability and how much will they cost. The proposed language will carry with it risks and costs as well so the same analysis should be presented. You then decide whether to accept the risk or change the documents.
Okay, the biggest question of all, how much will this cost you? The cost will obviously be related to the number and complexity of your contracts, but your attorney should do this type of project on a fixed fee basis. The right attorney will have the experience with these types of contracts to identify the issues and explain them. A fixed fee, however, has to be fair to both sides so the attorney will limit the time spent with you reviewing the issues and document revisions. Once the contracts are updated, who then is better to handle any questions about them in the future and thus a long-term relationship is established.
Doing It Yourself
I blame the Internet.
I have been called in several times to clean up legal messes created when my clients tried to “do it themselves”. The common theme is that the projects did not seem complex - after all, how hard is it to renovate a house, buy or lease a horse, or negotiate a settlement with someone that owes your company money. The clients were all well-educated and experts in their respective fields, but not lawyers. The situations seemed manageable and, in almost every case, the other side had what looked like a good document that just needed a little modification. And the Internet provided a way to implement the modifications and gave the clients a false sense of security. But when problems arose - the renovations were not going as expected, the horse had undisclosed health issues, or the debtor filed bankruptcy - the document turns out to not provide the protections that my clients expected.
I assure you that the cost of fixing these documents far exceeded what it would have cost in legal services to do them right in the first place. First, the original documents had to be reviewed because, most often, they are an amalgamation of various related forms. Next, was the usually messy process of figuring out what happened and how the facts fit with the documents. Since the documents were not done properly, this was a difficult task. Finally, negotiations needed to occur in order to obtain the best outcome given the documents and the facts. Since the clients were not properly protected by the documents, the risk of litigation is much higher and a court process is the most expensive fallout of all.
You may be thinking at this point that the foregoing is just a self-serving way to urge the hiring of an attorney. It is not. The truth is, I would much rather earn less by providing legal services at the outset of a matter than resolving the problems arising from an improperly documented transaction. Everyone is better off. The client gets the essential deal terms clearly identified and protection from risks. The other party gets a clear understanding of what is expected from them and motivation to perform. Both sides avoid conflict and the distraction from their personal and professional lives that results from a legal dispute. I get a satisfied client that will provide future projects and referrals that together will exceed the work involved in handling the clean-up of an improperly documented matter.
When Something Has Gone Wrong
The first instinct when a problem comes up is to avoid it. The better option is to call an attorney. A call made early can generate many more options.
In January, I received a call from a contractor regarding a problem with the payout submission to a title company. A subcontractor had submitted a false lien waiver stating the amount due and paid a material supplier. This resulted material supplier contacting the owner and the title company threatening to file mechanics liens. The title company was suggesting the contractor return the last draw. The owner was questioning the contractor's paperwork even though this was a subcontractor-created issue.
The first step was to gather all of the paperwork and isolate the amount at issue and relative rights of the owner, title company and the material supplier. Of course, the contractor's paperwork was not organized and was incomplete. But after reconstructing the missing materials, the amount at issue was less than originally expected. This created option 1: the contractor confirmed to the owner that he would cover any amounts claimed by the material supplier. One interested party satisfied - the owner.
The second step was to review the title company agreement and related documents. The documents raised legal questions, which required research regarding the standing of the material supplier and the rights of the title company relating to a false lien waiver. This created option 2: the material supplier had no rights and the title company had a claim against the subcontractor who falsified the lien waiver. This kept the material supplier from bothering the title company further and the title company from requesting that the contractor return the entire payout. Another interested party satisfied - the title company.
The third step was simple, but bothersome for the contractor. Negotiate with the material supplier and pay it in order to both, avoid further disruption to the project and bolster the contractor's reputation with its trades, since trades talk. The key to this step was the work in step one which confirmed that the material supplier was actually owed less than it claimed when it contacted the owner and the title company. The amount was truly nominal compared to the trouble caused by the subcontractor's false lien waiver. This created option 3: the ability to strike a deal with the material supplier which the contractor paid and took an assignment of the material suppliers' claim against the subcontractor. The final interested party satisfied - the material supplier.
The final step is ongoing. The contractor now has a claim against the subcontractor for the amounts due to the material supplier which is much more direct than a fraud claim, which is messy because it is unclear whether the owner, the title company, the contractor or some combination of the foregoing are the proper holders of a fraud claim. The contractor has the right to recover the full amount owed by the subcontractor to the material supplier which is greater than the settled amount the contractor paid. Plus, the material supplier's contract provides for attorney fees so the contractor will be seeking to recover those as well. This created option 4: a direct right of the contractor to resolve this problem.
By contacting an attorney early, rather than trying to work out this situation on its own, the contractor was presented with options and was able to prevent a bad situation from getting worse.