As we mentioned in a previous post, the COVID-19 pandemic has generated a wave of bankruptcies that we expect to continue into 2021. Companies entering 2020 in a strong financial position may now need to quickly shed distressed assets and generate cash. A Chapter 11 reorganization is likely to be too long and burdensome for companies in this position. Fortunately, the Section 363 sale process offers a speedier alternative for disposing of distressed assets and allows purchasers to acquire those assets free and clear of liens and encumbrances, ostensibly including environmental liabilities. But caveat emptor: not all environmental liabilities are extinguished. Stalking horse candidates (and other buyers of assets from a 363 sale) should consult experienced environmental transactional counsel to understand exactly what environmental liabilities remain and how to structure the purchase agreement and sale itself to maximize release from preexisting environmental liabilities.
The Section 363 Sale Process and Benefits
Section 363 of the Bankruptcy Code provides for the sale of assets through a competitive bidding process outside of a Chapter 11 reorganization. The process typically begins with a debtor marketing assets to potential purchasers. Due diligence occurs, and the potential purchasers submit bids for the assets. The debtor selects the best bid, and that party becomes the “stalking horse.” The debtor and stalking horse bidder then negotiate an asset purchase agreement. After the asset purchase agreement is negotiated, the debtor files a motion to approve bidding procedures with the bankruptcy court. Potential purchasers then submit their bids according to the court-approved procedures, and the debtor selects the winning (i.e. highest) bid. Once the debtor selects the winning bid, the court must approve the sale of the assets before they are transferred to the successful bidder.
Despite the competitive bidding process, Section 363 sales provide notable benefits to both debtors and prospective purchasers. First, the process is speedy. Debtors in need of quick cash can sell off distressed or illiquid assets through the Section 363 process without the approvals and voting needed for Chapter 11 reorganizations. Purchasers also like the process because they can often obtain assets at a discounted price. More importantly, however, Section 363 sales provide for the disposition of assets free and clear of liens and encumbrances. This benefits both debtors and prospective purchasers. Debtors may claim that the assets are being sold as is and therefore provide limited representations and warranties. At the same time, purchasers obtain the assets free and clear of liens and encumbrances and therefore acquire generally clean title supported by a bankruptcy order.
Section 363 Sales and Environmental Liability
The free and clear perk of a Section 363 sale is especially attractive from an environmental liability perspective. Section 363 provides for the sale of assets free and clear of any liens or encumbrances. This generally applies to environmental liabilities.
Note, however, Section 363 does not provide a complete shield to environmental liability for purchasers. One court held that a Section 363 sale may discharge environmental claims that could have been brought during bankruptcy proceedings, but not necessarily those claims arising after bankruptcy proceedings conclude (Ninth Ave. Remedial Group v. Allis-Chalmers Corp., 195 B.R. 716 (N.D. Ind. 1996)). Based on this holding, environmental liabilities may reach Section 363 asset purchasers through successor liability.
Additionally, Section 363 asset purchasers are generally responsible for complying with environmental obligations associated with the asset upon acquisition. If a property requires remediation at that time, the Section 363 purchaser may therefore be responsible for the remediation. In re GMC, 407 B.R. 463, 508 (S.D.N.Y. 2009). And of course, CERCLA liability runs with the owner/operator of the property. So any owner or operator, even those by virtue of a Section 363 sale, should be wary of potential CERCLA liability.
These uncertainties, however, should not discourage prospective purchasers from considering the Section 363 process. There are strategies to further mitigate the potential for environmental liability. These strategies include certain changes regarding known environmental liabilities in the asset purchase agreement and changes to the notice to potential environmental creditors. Additionally, there are changes that can be requested in the sale order to minimize environmental liability to the purchaser.
Section 363 sales provide notable benefits to both debtors and purchasers. Quick and efficient sales of distressed assets can help debtors get cash. On the flip side, purchasers can acquire assets generally free and clear of liens and encumbrances, including environmental liabilities. While Section 363 sales don’t completely discharge environmental liabilities, there are a number of strategies that a purchaser may implement to further mitigate the risk of environmental liability. So as the wave bankruptcies continues, companies should give serious consideration to the Section 363 process and its benefits with respect to environmental liability.