7 successor liability. Section 363(m) protects Section 363 sales made “in good faith” from reversal on appeal unless the court stays implementation of the sale order while the appeal is pending. Section 363(m) provides a degree of finality unavailable outside of bankruptcy. The provision essentially moots the ability of any party to appeal a sale order once the sale has closed. When Section 363(m) is considered in conjunction with a sale “free and clear,” the allure of Section 363 sales to potential purchasers becomes very clear. Finally, Section 363 allows a debtor to assign to the purchaser or a third party favorable unexpired leases and executory contracts (contracts unperformed by both parties), but does not require the purchaser to assume the debtor’s obligations under less attractive contracts. For example, a buyer can acquire a brand and production facilities along with ongoing sales contracts without assuming a union contract with employees. The ability to selectively transfer contracts is one of the most attractive facets of a full Chapter 11 reorganization that can be accomplished through a Section 363 sale, without having to satisfy Chapter 11’s voting and solicitation requirements. Because of these benefits, some buyers may be willing to pay more for assets acquired with the protections offered by Section 363. More often, buyers may be unwilling to buy distressed assets without Section 363 sale protections. Limitations of Section 363 Sales Section 363 sales cannot be used to “short circuit” the reorganization process set out in detail in Chapter 11 by altering creditor rights or by providing releases beyond the typical terms applicable to a buyer of assets. Courts have struggled to differentiate between allowable Section 363 sales and disguised reorganization plans. For example, in an early Section 363 case, the Fifth Circuit Court of Appeals, in Pension Benefit Guaranty Corp. v. Braniff Airways, Inc., refused to approve a Section 363 sale because the proposed sale, which would have transferred ownership of Braniff Airways’ cash, airplanes, and terminal leases, significantly restructured the rights of its creditors and provided for-profit participation in the new company, essentially amounting to a backdoor reorganization effort. Careful consideration of the nature and extent of relief to be sought in addition to the sale of assets in light of emerging case law is a necessary step in deciding whether a Section 363 sale is a viable alternative. A feature of the Section 363 sale process that gives pause to some potential purchasers is that it takes place in the relatively transparent atmosphere of a bankruptcy case. Although protection of sensitive information is possible, the public nature of the proceedings must be balanced against the advantages noted above. Another limitation on Section 363 sales is provided by Section 363(f)(3), which allows sales of assets “free and clear” of all liens as long as the price at which the assets are sold is greater than the aggregate value of all liens on the property. In other words, it is not possible to sell debtor’s assets free and clear of “underwater” liens without the underwater lien holders’ consent. If the lien is subject to “bona fide dispute,” however, Section 363(f)(4) permits the sale of property subject to the disputed lien over the objections of the secured party. The Section 363 Sale Process Because both potential buyers and sellers intend to proceed rapidly once the seller/ debtor files for bankruptcy, careful and thorough planning in advance of initiating bankruptcy is necessary. Because Section 363 sales are often undertaken at the behest of a creditor or potential purchaser who is supplying the debtor with cash to continue to operate, the potential purchaser or creditor will often have completed its “due diligence” in advance of the bankruptcy filing. The initiating party often serves as the initial bidder for the debtor’s assets. The initial bid establishes a floor price for the assets to be sold. The initial bidder is called a “stalking horse.” In addition to establishing the floor price and ensuring that there is at least one bidder for the assets, the stalking horse negotiates a form asset purchase agreement that can be shopped around to other potential bidders. To protect the stalking horse bidder if it does not become the successful purchaser of the assets, many Section 363 sales agreements contain provision for a “breakup fee,” which is a specified amount to be paid to the stalking horse in the event that it is not the winning bidder. The amount of the “breakup fee” must be approved by the bankruptcy court. The bankruptcy court will apply either a “business judgment” test or a “necessary to preserve the value of the estate” test to determine whether to approve a breakup fee. Under the “business judgment” test, breakup fees are presumably valid, and the court simply asks whether there was reasonable basis for the breakup fee and whether the amount was established in good faith and with due care. Under the “necessary to preserve” test, the court must find that the breakup fee actually benefited the estate by inducing or preserving the stalking horse bid. The test that the court will apply varies, but, under either formulation, courts will generally approve a breakup fee of two to four percent of the initial purchase price. The identification of a stalking horse bidder and negotiation of a form asset purchase agreement is just the first step in the process. The debtor must not only apply to the bankruptcy court for approval of the Section 363 of the Bankruptcy Code – A Tool for Buying and Selling Financially Distressed Assets - Continued from Page 6 Section 363 of the Bankruptcy Code – A Tool for Buying and Selling Financially Distressed Assets - Continued on Page 10