Although a Chapter 11 filing can be an option of last resort for most businesses, being proactive and exploring options at the earliest opportunity can reap great rewards. Using a targeted Chapter 11 filing can work wonders, especially where asset sales are concerned. One recent example illustrates this principle very clearly. Business owners should understand that the Chapter 11 process is their friend in a crisis, not something to be avoided.
The debtor in this case was a small life sciences company that had come under a federal government investigation due to a False Claims Act qui tam complaint (a “whistleblower” matter). The company was faced with the possibility of incurring great expense in legal costs and investigative fees, which would have nearly brought the business operations to a standstill. A cloud had begun to form over the company as a result of the federal investigation. Things did not look good, but creative use of the Chapter 11 process helped save the day.
Section 363 of the Bankruptcy Code allows the bankruptcy court to authorize the sale of a debtor’s assets “free and clear” of interests, claims, liens, and encumbrances. The buyer takes possession of the assets without any of these encumbrances, underlying claims, or the government investigation. The debtor used a strategy here known as finding a “stalking horse buyer.” Before the bankruptcy was filed, a buyer was found and the buyer-seller contract was negotiated. There was a “no shop” provision in the contract that prevented the debtor/seller from shopping the sale around for excessive amounts of time.
Specific provisions were negotiated as part of a comprehensive asset purchase agreement that would happen as part of the Chapter 11 bankruptcy filing. Both buyer and seller were satisfied with the provisions. Finally, in November 2012 the “stalking horse bidder” finalized a formal asset purchase agreement of the company’s assets for approximately $6 million. Key parts of the agreement were that the buyer would be able to take on the assets completely free of the the government’s investigation, any allegations under the False Claim Act, and any other liens or encumbrances. Only bankruptcy law would have allowed such a exceptional outcome.
When the Chapter 11 petition was filed, motions were also filed concurrently to approve the sale agreement, the break-up fee, the expense reimbursement, and other assorted issues. The sale and auction was expedited to allow the company to carry it out before it ran out of operating capital. When all was said and done, the actual auction netted over $14 million, far more than the stalking horse buyer offer. Basically, the company was able to sell its assets for over 2.6 times its revenue. The stalking horse buyer made one concession after another, and the end result was a fantastic outcome for the debtor in possession. When the auction sale was finally approved by the bankruptcy court, it expressly approved the sale “free and clear” of any liens, encumbrances, or government investigation.
This real-world example illustrates how the Chapter 11 bankruptcy process can be creatively used to solve even the seemingly most daunting of problems. The key lesson here is that when something bad happens, the first think a business owner should do is explore his or her options. Instead of being thought of as a option of last resort, bankruptcy should be considered as simply as another method of solving problems.