So You Want To Sell (Or Buy) A Company Under Section 363? Here's How

With companies facing significant distress due to vast over-leverage, debtors have increasingly turned to asset sales under Section 363 of the Bankruptcy Code, rather than Chapter 11 plans, to dispose of their assets quickly and begin the process of winding down their estates. According to the UCLALoPucki Bankruptcy Research Database, less than 4 percent of all large, public company bankruptcies were resolved by substantial asset sales from 1990-2000. However, in the period from 2001-2010, that figure rose to nearly 20 percent - peaking in 2011 when 43 percent of large public cases were resolved by an asset sale.1

Why have asset sales gained such prominence? Simply put, they provide benefits and accelerated recoveries to most key constituencies in a Chapter 11 case. Most notably, Section 363 sales (1) permit substantive resolution of the case quickly and free and clear of prepetition obligations; (2) relieve debtors of meeting the complex requirements of a Chapter 11 plan, including cramdown; and (3) protect creditors in the form of credit bidding. However, out of the money creditors, such as unsecured creditors, will often object to bankruptcy sales because they take value from the estate and may not leave those creditors with any potential recovery.

In this article, we take a brief look at the history of asset sales in bankruptcy, the standard for approval of bankruptcy sales under Section 363 of the Bankruptcy Code, the process for Section 363 sales and potential issues of dispute that arise in the context of these sales. Finally, we examine more recent push back from judges limiting the ability to sell free and clear in some situations - that may lead to a decline in the use of 363 sales as parties embrace prepacks and accelerated Chapter 11s as efficient means to restructure.

1. Section 363: A Brief History And Overview

   Section 363(b)(1) of the Bankruptcy Code permits a debtor, after notice and a hearing, to 'use, sell, or lease, other than in the ordinary course of business, property of the estate . . . .' While a plain reading of this provision 'appears to permit disposition of any property of the estate of a corporate debtor without resort to the statutory safeguards embodied in chapter 11,'2 courts have looked back on more than 100 years of legislative history to determine the proper standards for asset sales.3

   The history stretches back to the Bankruptcy Act of 1867, which permitted a sale of a debtor's property prior to final liquidation. Congress stated: '[W]hen it appears . . . that the estate of the debtor, or any part thereof, is of a perishable nature or liable to deteriorate in value, the court may order the same to be sold, in such manner as may be most expedient . . . .'4

   The Bankruptcy Act of 1898 did not include a specific provision permitting pre-adjudication sales of a debtor's property. However, General Order in Bankruptcy No. XVIII maintained the requirements for sales when the property was perishable or liable to deteriorate in value.5 Over the next 40 years, the Second Circuit approved, inter alia, a private, pre-adjudication sale of a debtor's fashionable handkerchiefs at a price above appraised value and at a time when the value of the handkerchiefs would decline greatly at the end of the holiday shopping season. The Second Circuit's decision in this case, and several other cases, established that the concept of 'perishable' included not just physically perishable assets, but also property 'liable to deteriorate in price and value.'6

   In 1938, Congress enacted the Chandler Act, permitting Courts to 'authorize a receiver, or a trustee or a debtor in possession, upon such notice as the judge may prescribe and upon cause shown, to lease or sell any property of the debtor . . . .'7 Courts, relying on the 'for cause shown' language in the statute, continued to permit asset sales only in emergencies or when the asset was perishable.8 Other courts, however, permitted preplan sales when the sales were 'in the best interests of the estate.'9

   In 1978 Congress approved the Bankruptcy Code, including Section 363(b). Section 363 does not include the 'perishability' or deterioration standards, or any requirement to show 'cause,' thereby providing debtors 'easier access' to Section 363(b) relief.10 This is consistent with some earlier decisions rendered under the Bankruptcy Act. For instance, in Mintzer v. Joseph (In re Sire Plan, Inc.),11 the Second Circuit approved the sale of a partially constructed building owned by the debtor not because it was perishable or deteriorating, but because the sale was a sound business opportunity that the debtor had to seize quickly.12

2. The Modern Standard for Approval of Section 363 Sales

   The Bankruptcy Code does not detail any standard by which bankruptcy courts may approve a sale outside the ordinary course of business. However, bankruptcy courts have settled on a 'business judgment' standard for approval. The business judgment standard has been defined as whether there is 'an 'articulated business justification' and a 'good business reason' for proceeding with the sale without awaiting the final confirmation of a plan.'13

   The Second Circuit Court of Appeals detailed this standard several years after the enactment of the Bankruptcy Code in Comm. of Equity Security Holders v. Lionel Corp. (In re Lionel Corp.).14 In that case, the debtor, at the insistence of the unsecured creditor's committee, sought to sell its equity interest in a non debtor electronics component manufacturer, the debtor's most valuable asset, pursuant to Section 363(b) of the Bankruptcy Code. The opponents of the sale argued that the proposed sale side-stepped the plan confirmation process, and that no business reason supported the sale because the stock's value was not deteriorating and the proposed sale price was inadequate.15 On an expedited appeal, the Second Circuit reversed the bankruptcy court's approval of the sale, holding that the bankruptcy court erred in finding that the creditor committee's insistence and the risk of delay warranted the sale, and that the sale opponents demonstrated that there was no sufficient business reason for sale.16 In this decision, the Second Circuit articulated a number of factors bankruptcy courts should consider in determining whether a sound business justification existed for a sale pursuant to Section 363(b). These factors are:

   the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions, and whether the asset is increasing or decreasing in value.17 If courts find the presence of many of these factors, they should find that a business purpose for the sale exists and approve the sale.18 Courts have recently developed factors in addition to the Lionel factors.

   Perhaps the most notable, recent asset sale occurred in the General Motors bankruptcy. In that case, the U.S. Bankruptcy Court for the Southern District of New York approved the sale of General Motors' valuable assets to a new government-sponsored purchaser in just 41 days after the petition date.19 In so holding, the General Motors court added several additional factors to the business judgment analysis; specifically whether:

   the estate has the liquidity to survive until confirmation of a plan, the sale opportunity will still exist as of the time of plan confirmation, it is likely that there will be a satisfactory alternative sale opportunity, or a stand-alone plan alternative that is equally desirable (or better) for creditors, and there is no material risk that by deferring the sale, the patient will die on the operating table.20 Other courts, most notably Judge Shelley Chapman of the U.S. Bankruptcy Court for the Southern District of New York in Boston Generating, have subsequently incorporated the General Motors analysis into their consideration of Section 363 sales.21

3. The Process for Bankruptcy Sales

   Section 363(b) does not require that a debtor utilize a specific process. Rule 6004 of the Federal Rules of Bankruptcy Procedure, which implements Section 363(b), states that '[a]ll sales not in the ordinary course of business may be by private sale or by public auction.'22 In general, however, public auctions are the preferred means to carry out a sale of substantially all of a debtor's assets since auctions generally yield a higher value for estate's property and maximize the return to creditors.23 Auctions are typically governed by court-approved bidding procedures, which regulate the solicitation of purchasers, the selection of qualified bids, and the conduct of the auction.24

   As an initial step, a debtor will seek court approval of bidding procedures, laying out the terms of the sale process , including key deadlines, qualifications for bidders and proposed terms for any purchase...