The Effective Use of Section 363 Sales
When a company is not likely to survive a restructuring, its assets may have value to a third-party buyer. Absent legal protection, a buyer of a financially distressed business will usually be concerned that the company’s creditors could pursue the acquired business on various legal theories, including “successor liability,” and on that basis may decline to purchase assets of such a business.
It is possible that a sale through a chapter 11 bankruptcy can offer the buyer a means to acquire the assets without concern that a creditor of the seller will pursue the buyer, which also enables a way for the creditors to maximize the value of the assets, rather than merely liquidating the company. Such a transaction is known as a “section 363 sale,” as the process takes place under section 363 of the U.S. Bankruptcy Code.
In a section 363 sale, the assets that may be subject to bank and other judgment liens can be sold free and clear so that the buyer receives the assets lien free. The cash proceeds for the assets then attach to the liens in the same order and priority as they previously attached to the assets. This process allows the assets to be sold for the maximum price, leaving the disputing parties in the chapter 11 to litigate over the cash paid.
From a buyer’s perspective, one of the principal drawbacks of a section 363 sale is that it is subject to overbidding. While it is, theoretically, in the best interests of the bankrupt debtor company, it does expose the buyer to the risk of overbidding and loss of the transaction. Nonetheless, various devices can be employed by buyers to minimize this possibility. One such way is that a buyer can be designated a “stalking horse,” or lead buyer, and enter into a purchase and sale agreement which will have certain protections for the stalking horse that are approved by the bankruptcy court in the event that the stalking horse is not the winning buyer. Other parties usually have the right to overbid the price of the stalking horse at the sale hearing. If they do, the stalking-horse bidder will usually be entitled to a breakup fee, which includes its costs and expenses to investigate and document the agreement.
We recently employed the effective use of a Section 363 sale in the bankruptcy filing of HyreCar, Inc. in the District of Delaware. HyreCar operates an app that matches “gig” drivers (Uber, Lyft, Doordash et, al,) with vehicle owners. The company also provides a unique insurance product which covers drivers and owners for those periods during the vehicle usage that are not covered by the applicable ride app (e.g. if an Uber ride).
While HyreCar had an excellent business model it was beset with a number of litigation liabilities. This made the purchase of the assets outside of a bankruptcy very unattractive for buyers. In a span of 75 days, we assisted the company in filing a Chapter 11 bankruptcy, arranged for interim financing of the company and engaged investment bankers to market the sale of the company. We identified a “stalking horse” buyer with whom we went to auction. After a spirited bidding process the stalking buyer was outbid, and the assets went to a competitor Getaround, Inc.
But for the effective use of Chapter 11 to arrange financing and provide a platform for a Section 363 sale, HyreCar may well not have been able to survive.