Recent Publications

June 19, 2009
Financing Opportunities for Lenders: Asset Acquisitions out of Chapter 11 Cases
Michael J. O'Grady

The current economic environment has created opportunities for the financing of distressed asset acquisitions.  Our firm has recently seen an increase in the number of parties interested in acquiring assets out of chapter 11 cases and a corresponding increase in the number of lenders which are interested in financing these acquisitions. 

The chapter 11 sale process offers an asset buyer many protections which are limited or do not exist in an out-of-court distressed asset sale.  The primary protection is the "free and clear" sale order which is entered by the Bankruptcy Court approving the sale.  The order typically provides that the assets are to be transferred to the buyer free and clear of all liens, claims and encumbrances.  It will also typically extinguish post-closing claims which could otherwise be asserted by a creditor against the buyer, such as those based on successor liability.  The "free and clear" order does have its limits however, and any lender considering the financing of a distressed acquisition should consider some of the potential pitfalls of financing an acquisition out of a chapter 11 case.  Before issuing the loan commitment, we suggest that you carefully consider a few of the issues which come along with most chapter 11 sales.

First, consider the process.  Almost all bankruptcy sales involve an auction of some sort, therefore, in many cases, the borrower will have a range, rather than a specific financing requirement.  The process begins with the approval of bidding procedures by the Bankruptcy Court, which establish the rules of the auction, including key dates for submitting opening bids, due diligence, the auction process, sale approval, and closing.  The issuance of a financing commitment will often be requested during the due diligence process so the lender will need to move quickly to underwrite the transaction.  In addition to typical conditions, the financing commitment or term sheet should include a condition tied to the satisfactory review of the Bankruptcy Court sale order, which must provide, among other things, that the borrower/buyer is a good faith purchaser.  The sale order is critically important and we recommend that the lender retain its own bankruptcy counsel to review and comment on the sale order.

Second, consider the due diligence.  While proper diligence on the part of the borrower and lender when financing any acquisition is important, it is particularly important in the context of a bankruptcy sale.  In a bankruptcy sale, the representations and warranties provided by the seller/debtor will be very limited and the recourse for the borrower in the event of a breach will similarly be very limited given that the seller is insolvent and liquidating.  One key question to consider:  Does the borrower have a strong diligence team on the acquisition?  A good turnaround consultant and an experienced bankruptcy attorney are two must-haves in our opinion.  These professionals are critical to help the borrower dig below the surface in a distressed asset transaction.  We also recommend that the lender have its deal counsel involve bankruptcy counsel in documenting and reviewing the acquisition and financing documentation to make sure there will not be post-closing surprises for the lender.  We sometimes find that clients who are the most interested in these types of transactions are also the most risk-tolerant and therefore, the least likely to be willing to engage professionals for assistance.  We encourage you to work with your borrower to make sure that they have the proper team of professionals in place for the deal.

Third, consider the appeal period.  A purchaser that acts in good faith, pays value, and acts without knowledge of adverse claims in the sale transaction is entitled to the protection of Section 363(m) of the Bankruptcy Code, which says, in essence, that a sale to a good faith purchaser cannot be reversed or set aside on appeal.  Based on this provision of the Bankruptcy Code, purchasers and their lenders often close immediately after the Bankruptcy Court approves the sale, rather than waiting the appeal period.  However, a recent court decision from the 9^th Circuit, Clear Channel Outdoor, Inc. v. Knupfer, 391 B.R. 25 (BAP 9^th Cir. 2008) held that, even though a sale to a good faith purchaser cannot be reversed or set aside on appeal under Section 363(m), portions of the sale order can be modified on appeal, including the provisions which specifically authorized the sale to be free and clear of existing liens.  This obviously creates additional risk for an asset purchaser and its lender that may elect to close on the sale before the expiration of the appeal period.  Our suggestion is to carefully consider whether to fund a closing prior to the expiration of the appeal period, particularly where objections to the sale were filed and overruled by the Bankruptcy Court.

Michael J. O'Grady is a partner in the FBT Lending and Commercial Services Group and the FBT Bankruptcy and Restructuring Group.  Michael handles a broad spectrum of sophisticated finance transactions for both borrowers and lenders, including, for example, syndications, asset-based and cash flow financing, chapter 11 exit financing, DIP financing, as well as real estate construction and acquisition loans.  He has negotiated and documented numerous multi-party intercreditor arrangements, construction, acquisition, and permanent loan facilities, letter of credit facilities to support bond financings, ground lease financings, rate swap transactions, and loan assumptions, among others.  His Bankruptcy and Restructuring practice includes debtor and secured creditor representation in workouts and chapter 11 cases, as well and the representation of buyers and sellers in the disposition of assets in insolvency proceedings.