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.