Bankruptcy Sales: An Efficient Mechanism to Dispose of Assets and Maximize Value
The Bankruptcy Code provides for an efficient mechanism to dispose of assets by way of a bankruptcy approved sale pursuant to 11 U.S.C § 363, which many parties and their lawyers frequently overlook. In many disputes, both commercial and consumer related, there is a mutual desire amongst the creditors and the debtor to maximize the value of a particular asset. For instance, a sale that maximizes value will reduce a guarantor’s exposure and likely reduce the secured creditor’s claim as well. Thus, properly and efficiently selling the asset benefits both the creditor and the debtor/guarantor.
The assets in question can vary greatly. On one hand, the asset may be a going concern business, such as a professional practice or manufacturing facility or on the other hand, a single tangible asset, such as a motor vehicle or smaller individual asset. In almost all cases, maximum value for the asset is achieved when there is an orderly, efficient disposition of the asset. The return or recovery from such a sale far exceeds the value or recovery obtained from a classic distress sale triggered by a foreclosure or forced sale. For purposes of this discussion, I will assume that an asset disposition as opposed to a financial restructuring makes the most sense. My focus will be on the disposition of commercial or business related asset(s), since their size and value more easily justify the costs required to pursue a bankruptcy filing and ultimate sale.
Unfortunately, the stigma associated with a bankruptcy filing will frequently and unfairly eliminate a bankruptcy sale from the range of logical choices that parties consider when analyzing viable options to efficiently dispose of assets. However, many banks and more sophisticated litigants realize that the bankruptcy sale process is ideally suited for the prompt and efficient disposition of many assets and businesses.
In our practice we have seen a fairly common pattern whereby the effort to dispose of an asset involves protracted and costly litigation followed by significant delays, only to be followed by a bankruptcy filing. For instance, in the case of a commercial foreclosure relating to income producing real estate, it is not uncommon for a secured creditor to proceed with a foreclosure action coupled with a motion to appoint a receiver and a request to sequester rents in order to protect the creditor’s collateral. A typical debtor response is to attempt a workout or forbearance with the creditor in an effort to either: (a) restructure the debt; (b) secure replacement financing; or (c) sell the property. Absent an agreement, a debtor may then decide to file a Chapter 11 bankruptcy petition once its other options are exhausted. The end result is the asset disposition process is significantly delayed, significant fees and costs incurred, but no resolution is obtained.
Bankruptcy courts are ideally equipped to deal with the disposition of assets given that they routinely handle such cases. If the parties and counsel quickly recognize the realities of the case and then work towards a mutually agreeable resolution, the bankruptcy court can be a suitable forum to get the job done by way of a sale. Bankruptcy sales typically require bid procedures and a competitive, open auction process which seeks to maximize values.
Even if parties disagree over the disposition of an asset, yet another benefit of the bankruptcy sale process is the extensive use of mediation. The bankruptcy mediation process has been extremely successful and has provided a robust forum whereby parties can engage with an experienced bankruptcy meditator who has extensive experience in resolving asset disposition related issues.
Whether we are representing a secured creditor or a debtor, considering a bankruptcy sale option is a prudent course of action. For instance, all of the goals that a secured creditor seeks to accomplish in the state court forum can also be obtained in the bankruptcy court in a much more efficient and timely manner. In a typical foreclosure case in state court, a creditor typically does not get paid monthly mortgage payments during the foreclosure. A receiver may be appointed but the receiver generally pays the basic operating bills and tries to maintain the status quo until the foreclosure litigation is completed. In some cases payments are made to the creditor, but in others the funds are placed in escrow. This process could take up to a year, if not more, depending on the extent of the litigation. In a bankruptcy forum, the secured creditor gets the following immediate benefits: (a) the creditor’s lien is preserved and recognized; (b) the secured creditor is paid “adequate protection” or a payment which compensates the creditor for the use of its “cash collateral” or rents during the case; (c) the debtor is required to provide extensive financial reporting; (d) the debtor must provide proof of insurance coverage; (e) the debtor’s insiders or affiliated management companies must obtain a court order before receiving any renumeration; and (f) the debtor is otherwise subject to the oversight of the court and the U.S. Trustee.
Hearings in the bankruptcy court are generally held on very short notice. The benefit for the debtor is that the debtor remains in control of the asset or business and is known as a debtor in possession or “DIP”, subject to the oversight of the bankruptcy court. Provided that there is no gross mismanagement or fraud, the debtor remains in control and can work towards proposing a plan.
During the chapter 11, the parties can agree to a time frame for the disposition of the asset, which allows for an efficient and reasonable marketing plan so that asset values are maximized. Another benefit of a bankruptcy sale is that the secured creditor can credit bid in any proposed sale. Furthermore, if a sale or disposition of assets is contemplated as part of the confirmation of a debtor’s plan, then all documentary stamps or other transfer taxes, which would typically be due and payable would be exempt from payment pursuant to 11 U.S.C. § 1146. Finally, the court order obtained by a prospective purchaser from a bankruptcy court is highly valued and provides extensive protections to the buyer, namely, explicit findings that the buyer is a good faith purchaser for value and that the buyer obtains the asset free and clear of liens and encumbrances. Again, for sophisticated buyers or creditors participating in a bankruptcy case, obtaining a court order is the ultimate form of protection and an important reason to favor the bankruptcy sale process.
In conclusion, when the disposition of assets is contemplated, carefully considering the pros, cons and cost benefit of the bankruptcy sale process is essential.