Chapter 11 cases are filed for many reasons. One reason is a for an individual or business reorganization. Another possible reason is for a business liquidation. Why would a Chapter 11 case be used for a liquidation, when Chapter 7 already is available for that purpose? The reasons are many. In most situations, more value will be gained when the business is “wound down” by the owner gradually over time, rather than sold at “firesale” prices by a Chapter 7 trustee.
For example, some real estate cases have property values that will increase as the years go forward. Having the opportunity to wait for the right moment to sell such real estate can make a huge difference in what type of value is received. Other types of businesses may have complex operational requirements that cannot just be shut on or off at the flick of a switch. Chapter 11 solves these problems.
Some businesses are very complicated and can only be effectively managed by the debtor-in-possession himself or herself. If the debtor manages the shut-down or sell-off of the business assets over an extended period of time, far more value can be obtained than by casting the whole thing in the lap of a Chapter 7 trustee. Some Chapter 11 cases are filed with the sole purpose of conducting a sale or liquidation of the business assets.
Other advantages of using Chapter 11 for an extended business liquidation or sell-off are: (1) the automatic stay operates as a shield from creditors pending the sales or liquidation plan, which can sometimes take years; (2) the value of the business as a going concern is preserved more in a Chapter 11 than in a Chapter 7; (3) lenders have greater protections in Chapter 11 in order to fund post-petition business operations; and (4) sales of property can be accomplished “free and clear” of liens and encumbrances.
Sales of Chapter 11 assets are governed by Section 363 of the Bankruptcy Code. Sales can be done as part of a filed plan, or more often, by motion to the Court and the entry of an order. The sale of even “all” of a business’s assets can be done by motion under Section 363 as long as the sale is done for “sound business purposes.” See Stephens Industries Inc. v. McClung, 789 F.2d 387 (6th Cir. 1986). There are many situations when a debtor cannot wait for a long period of time to get a plan confirmed, and will need to rely on a motion (even an expedited motion) to get sales done.
Bankruptcy courts will look closely at such sales to make sure that they meet some general requirements: (1) the sale is based on reasonable business judgment; (2) marketing efforts have been adequate in the circumstances; (3) the offer is a reasonable one; (4) the transaction is done for reasonable value received; (5) due process and notification requirements have been met.
Sales under Section 363 have other features. First, a creditor with a security interest in a debtor’s assets cannot prohibit a debtor from selling those assets if there was some clause in the security agreement prohibiting a sale of such assets upon insolvency. In other words, the filing of the bankruptcy case invalidates any restrictive clauses that a creditor may have put in a security agreement. Second, a debtor can sell “substantially all” or only “a portion” of its assets. Such partial sales are a tried and true way of realizing maximum value in a Chapter 11 case.
Notice of the sale is required under 11 U.S.C. Section 363(b)(1), as well as F.R. Bankr. P. 2002. Notice to the parties must be given, with the opportunity for a hearing. In general, a court will approve a sale under a deferential standard. As long as the sale appears to be in the best business judgment of the debtor, and notice is provided, these types of sales usually encounter little if any resistance.
Once the preliminaries are taken care of, a debtor sometimes enters into an agreement with one particular buyer, known as a “stalking horse bidder.” An agreement with this party is one that is “subject to higher or better bids.” In other words, the stalking horse bidder’s offer establishes a “floor” which a debtor is assured to get. He may bet better offers, but at least will not go under this “floor.”
Section 363(f) permits the sale of assets free and clear of all liens, claims, and encumbrances, if any of the following conditions are met:
- A free and clear sale would be allowed under some non-bankruptcy law
- The secured party consents to a sale
- The sale price is high enough to pay off any security interest on the collateral
- The lien is disputed in good faith
- The secured creditor could be made to take a monetary amount in a legal proceeding.
It should be noted that Section 363(k) of the Code permits a secured creditor to “credit-bid” the amount of its secured claim, in order to purchase the property in which it holds a lien. In many smaller cases, however, a sale for a price of less than the value of all the liens is sometimes the only effective option. Sales also happen free and clear of warranties and representations. Sales are done “as is and where is.” The idea here is to move things along as quickly as possible. Section 363(f) recognizes the need for finality in these sales.
The use of Chapter 11 sales motions is a common way to realize value in either a business reorganization or a liquidation. Their use requires cooperation of the key players, realistic expectations, and good record-keeping for tax purposes.
The major advantages of using Chapter 11 to liquidate or reorganize are: control of the business by the debtor, who is best placed to know how to run his or her business; the ability to spread out the liquidation process over a long period of time, thereby ensuring that the best deals possible are negotiated with creditors or bidders; and the tremendous benefit of a buyer acquiring property free and clear of liens.