Key Provisions in Bankruptcy Asset Purchase Agreements
The Business Advisor
On July 14, 2020, I moderated a webinar entitled, “Acquiring and Selling Assets in Distressed Situations: Navigating the Section 363 Bankruptcy Sale Process and Negotiating the Asset Purchase Agreement.” As follow-up to the webinar, I thought it would be useful to highlight several key provisions in asset purchase agreements that practitioners will want to pay attention to when purchasing assets in connection with bankruptcy sales.
Good Faith Deposits
Although the Bankruptcy Code does not contain any requirement concerning a deposit, it has become routine to require prospective purchasers to escrow good faith deposits in connection with their bids. While the amount of the deposit may vary, it is not uncommon for a debtor to require up to ten percent of the purchase price be placed in escrow. A potential bidder should pay careful attention regarding when it is entitled to the return of its good faith deposit (to avoid having funds tied up with the estate for an extended period of time) and may want to try to negotiate, especially as the stalking horse bidder, that any claim by the debtor for breach of the asset purchase agreement (APA) is limited to the amount of such deposit.
Break-Up Fee/Expense Reimbursement
Inducements for a potential bidder to serve as the stalking horse include the break-up fee, the amount of money the debtor must pay to the stalking horse purchaser if the contemplated transaction fails to be consummated, typically due to the fact that the debtor has accepted a competing bid; and an expense reimbursement, the payment of actual expenses incurred by the stalking horse on account of the time and effort to prepare and negotiate the asset purchase agreement. These provisions are routinely approved in bankruptcy with respect to stalking horse bidders who are not insiders or otherwise connected to the debtors. Although break-up fees of three percent of the purchase price are typical with appropriate expense reimbursements, prospective stalking horse purchasers may have room to negotiate higher percentages in smaller deals. Thought should be given to the timing of payment of the break-up fee/expense reimbursement (i.e., upon selection of an alternative bidder at the auction, upon entry of the sale order, or at closing) and the priority of such claim (i.e., whether to request a super-priority administrative expense claim that comes ahead of other administrative expense claims in the case). In a case with a secured lender with a blanket lien on the debtor’s assets, a side agreement may be advisable with the secured lender pursuant to which such lender agrees to subordinate its lien to the payment of the break-up fee and expense reimbursement.
No Shop/No Talk Provisions
Stalking horse bidders understand that sales in bankruptcy cases are subject to higher and better offers. However, stalking horse bidders are sometimes concerned that debtors may decide to switch horses before entry of the bidding procedures orders, in which case the break-up fees and expense reimbursements likely never get paid. To mitigate this risk, the stalking horse bidder may bargain for a “no shop” provision, which prohibits a target company from soliciting or encouraging third-party bids, or a “no talk” provision, which prohibits not only solicitation, but also any discussions or negotiations between the debtor and unsolicited bidders, which is enforceable only until the entry of the bidding procedures order.
Purchased Assets to Include Avoidance Actions
Because most avoidance actions are filed after the sales have closed, prospective purchasers do not always realize that go forward key suppliers and vendors might be targets of preference and fraudulent conveyance actions later in the bankruptcy cases. Compounding the problem is the fact that these suits are brought by the bankruptcy estate, and the purchaser has little or no leverage to resolve such litigation. In order to avoid this situation, it is somewhat common for purchasers to include avoidance actions as part of the definition of purchased assets. Due to the fact that avoidance actions might be the only source of recovery for unsecured creditors, a creditor’s committee will likely attempt to either remove or narrow the scope of this definition or seek additional consideration in connection with the sale of avoidance action claims. For example, while a committee might support a narrow definition that includes key trade creditors, it would likely not support a provision that includes insiders or recipients of fraudulent transfers.
A potential purchaser must carefully scrutinize the universe of potential contracts and leases (“Contracts”) to determine which are essential to the go forward business and the related cure costs that must be paid to assume such Contracts. A major point of negotiation is often who will pay cure costs, the debtor or purchaser, and whether there will be a cure cost cap above which the responsible party switches. If the purchaser is paying the cure costs, the purchaser should consider including a provision in the APA that allows for early negotiation with contract counterparties concerning cure amounts. Further, if the purchaser is paying cure costs, thought will have to be given as to whether the APA allows the purchaser to add or remove Contracts from the proposed assumed Contracts list up to the date of the auction (which is what the debtor often pushes for in order to know the universe of contracts to be assumed) or as far out as the closing (which is what the purchaser prefers in order to have leverage over contract counterparties in connection with cure negotiations/disputes).
As part of the termination rights section, most stalking horse purchasers negotiate certain milestone deadlines that the debtors must meet in order to keep the sale process moving forward expeditiously and that allow prospective purchasers to terminate if such deadlines are not met. To the extent the prospective purchaser is also providing the debtor with post-petition financing, it may have additional leverage over the timing of the sale process through additional milestone dates and other terms contained in the financing documents. The prospective purchaser must give careful thought to which dates and milestones are most important to it and should draft the termination section accordingly.
Perhaps one of the most overlooked provisions in the APA is the notice provision. Notice is extremely important since absent proper notice, a sale might not be deemed “free and clear” of pre-bankruptcy liabilities. Although the Bankruptcy Rules require that proper notice of the sale be given to parties-in-interest, a prospective purchaser is going to want to do its own due diligence to make sure that proper notice was, in fact, given. For example, when it comes to assuming and assigning Contracts, the Bankruptcy Rules require that notice be addressed in the same manner as though such contract counterparty was served with a summons and complaint. In a case where misconduct is alleged to have occurred prior to the bankruptcy, such as in the Weinstein case, the purchaser should work closely with the debtor and its human resources/legal departments to make sure that any potential victim or anyone who has made demands on the company is given notice of the sale. In a case where environmental liability is a concern, all adjacent landowners and anyone who might claim harm as a result of such liability should be given notice of the sale. Finally, the purchaser might want language in the APA requiring the debtor to publish notice of the sale and specifying which publications must be used in order to make sure that notice is as broad as possible. Although publication notice does not always suffice in lieu of actual notice, there are many cases where the “free and clear” nature of the sale might turn on the form of publication notice.