Asset Dispositions in a Bankruptcy Case: Guidelines for the Successful Stalking Horse

This article is intended to familiarize you generally with the landscape of an otherwise fairly complicated process involving the sale of assets of a debtor in bankruptcy. It also highlights some of the more important and easily misunderstood issues faced by potential purchasers of such assets.

The Bankruptcy Sale Process

This article is intended to familiarize you generally with the landscape of an otherwise fairly complicated process involving the sale of assets of a debtor in bankruptcy. It also highlights some of the more important and easily misunderstood issues faced by potential purchasers of such assets.

Historically, the principal focus of a Chapter 11 reorganization case was the rehabilitation of the debtor’s business through the proposal and confirmation of a Chapter 11 plan. During the case, the business would be operated by a trustee or the debtor-in-possession while negotiations were conducted with the various constituencies to determine the amount of debt that would need to be repaid in order to obtain confirmation of a plan. In some cases, some of the debtor’s assets would be sold in order to pare down the business to a profitable core, one that would likely survive without the need for further protection from the bankruptcy court.

More recently, otherwise strong businesses with too much debt have sought the protection of the bankruptcy court and have shed assets through a sale process conducted by the bankruptcy court. Section 363 of the Bankruptcy Code provides for the use, sale or lease of property of a debtor in bankruptcy. The use, sale or lease of property that is not in the ordinary course of the debtor’s business requires notice to creditors and parties in interest and approval of the bankruptcy court. In general terms, sales of assets that do not constitute the normal operations of the business are deemed to be outside of the ordinary course. Section 363(f)1 of the Bankruptcy Code allows for the sale of property free and clear of any interest in the property sold if certain requirements are met. Section 363 sales have become an integral part of the reorganization process and may occur prior to proposal of a plan or as part of a plan.

Through the bankruptcy sale process, parts of a business or an entire enterprise may be sold. Innovative practices have made such sales more valuable to the reorganization of business enterprises because bankruptcy courts have, in recent years, become much more receptive to traditional acquisition techniques. These techniques, including auctions, customary acquisition agreements, use of financial advisors and payment of break-up fees, have made investing through the bankruptcy sale process more efficient. In addition, bankruptcy courts can assure purchasers, under the proper circumstances, that assets may be purchased free and clear of encumbrances and that successor liability may be minimized, thereby adding value to the assets being sold by the debtor. Thus, these sales create significant strategic and financial opportunities for investors.

As a prospective interested party in the sale process, there are a number of issues with which a prospective purchaser should become familiar. This article explores some of the basic procedures for conducting sales in bankruptcy and some of the issues of concern that different constituencies may have regarding such sales.


There is no set formula that must be adhered to in connection with the sale of a debtor’s major assets. In general, however, bankruptcy courts will require some sort of open bidding procedure, often in the form of an auction, before approving the sale of significant assets of a debtor. The purpose of this process is to ensure that the debtor’s estate, and thus its creditors, realize the greatest return from the sale of the assets. The actual bidding procedures may vary from case to case depending on various factors, such as the nature of the assets to be sold, the number of potential bidders, the continuing viability of the debtor pending a sale and whether the sale is to take place pursuant to Section 363 or pursuant to a plan of reorganization. Generally, however, the sale process will involve the same set of conditions and requirements.

Bidding procedures may involve a number of items, including setting the auction date, specifying the assets to be sold, establishing a break-up fee and the initial overbid and bidding increments (that is, the amounts by which subsequent bids must exceed prior bids). Any proposed bidding procedures must ultimately be approved by the court, after notice to interested parties and an opportunity for parties with a pecuniary interest (i.e., creditors) to be heard. To the extent a prospective purchaser can influence the terms of the bidding procedures that are proposed by the debtor, the prospective purchaser is able to gain an advantage over other potential bidders for the purchase of the assets to be sold.


You may first learn of an opportunity to purchase assets in a bankruptcy sale process from an investment banker or financial consultant exploring the marketplace in an attempt to gauge interest. In an effort to start what the investment banker or financial consultant hopes will be a competitive bidding process and to encourage the bidding to begin, the investment banker or financial consultant may offer incentives to the first to bid on the assets. Generally, the first to bid is known as the “stalking horse bidder,” and while there may be an initial reticence in “bidding against yourself,” there are some distinct advantages to being the stalking horse bidder.

If you, as the prospective stalking horse bidder, make an acceptable offer for the debtor’s assets, you and the debtor will likely enter into a letter of intent, or possibly go directly to definitive documentation by way of an asset purchase agreement. It is important to remember that it is generally not possible to lock up the purchase prior to obtaining approval of the sale from the bankruptcy court. Usually, third parties will have the opportunity to come to court on the day the sale is scheduled for approval and offer a higher purchase price. This is more likely to succeed if the new offer is on the same terms as the initial offer. This notwithstanding, after the parties have agreed to the terms of the deal, but before a firm offer is made, the purchaser has the most leverage in imposing its terms on the debtor. For example, the stalking horse bidder can condition its bid on court approval of certain bidding procedures. If the proposed procedures are not approved, the purchaser will generally reserve the right to withdraw its bid without penalty.

The Mechanics of the Bidding Process

In negotiating the initial offer, the goal of the prospective purchaser obviously is to acquire the desired assets at the best price. Generally, you can expect that the debtor will establish a “data room” for interested bidders to conduct due diligence. If you are going to enter the bidding process and conduct due diligence, expect to be asked to sign a confidentiality agreement. Any offer to purchase the debtor’s assets will require court approval, will be subject to higher and better offers and will immediately become public knowledge. In part, these requirements are designed to ensure that only sales that are negotiated at arm’s length, in good faith and without collusion are approved by the bankruptcy court.

In each instance, when considering whether to bid on assets sold through the bankruptcy sale process, the following fundamental issues should be considered with respect to the bidding procedures to be used to solicit bids and conduct the sale.

The sale date

From the perspective of the stalking horse bidder, the earlier the auction the better. An earlier auction provides less time for other prospective bidders to formulate their bids and may make it more likely that additional bidders will fail to satisfy the requirements set forth in the bid procedures. There may, however, be a less subjective reason for holding the sale as soon as possible. If the debtor’s assets are declining in value, the sooner the sale the more value the assets will bring. In many instances, however, local rules of practice will impose parameters with regard to how much and to whom notice must be given. In contrast to the stalking horse bidder, who wants to move the process along as quickly as possible to frustrate potential competitors, the creditors’ committee or some similar body of creditors will want to stimulate the bidding in the hope of receiving one or more higher bids. From the creditors’ perspectives, the longer the process, the greater the likelihood of obtaining the best possible price for the assets. This is particularly true if the assets are not declining in value.

The form of the asset purchase agreement

The purchaser will want to impose its form of asset purchase agreement on other bidders. This is especially true if the asset purchase agreement is drafted in a format that meets the stalking horse bidder’s unique business needs and may not be adaptable for other bidders. The stalking horse bidder will determine which assets it wishes to acquire and then seek to limit any subsequent bids for those same assets. In being the stalking horse bidder, one has the ability to structure a transaction and to purchase assets that one most wants, and potentially to deny other bidders the opportunity to buy different assets or a different amount of assets, or to pay for such assets in a different manner, i.e., with stock or notes.

Of course, from the perspective of almost all of the other constituencies in the case, i.e., the creditors’ committee, the debtor and the lender (if any), all will likely want a single form of asset purchase agreement so as to encourage other bids and to allow a fair comparison of overbids (discussed below). These constituencies will want any deviation from the purchaser’s contract specified before the hearing approving the bidding procedures, and, if possible, to have such differences quantified.

A word here about the provisions of the asset purchase agreement pertaining to representations and warranties. The purchaser will want some recourse if something should go wrong after the sale closes. The purchaser will generally understand that the debtor may not be able to respond to a breach of contract claim. However, if the estate will have substantial assets after the sale, the purchaser would not want to limit its claim for potential breaches of representations and warranties. The principal concern of the purchaser should be to obtain full disclosure of all information about the assets it is buying through representations and warranties, and some assurance that the debtor’s operational controls are maintained so that the assets do not lose value through the bidding and pre-closing period. Thus, the purchaser will want, at the very least, to ensure that the accuracy of the representations and warranties be a condition precedent to closing and may want a hold back of a portion of its purchase price to cover post-closing adjustments and breaches of representations and warranties.

The debtor and the creditors’ committee will want to avoid making any representations, warranties or indemnities that could create a risk of additional claims that will dilute the sale proceeds available for distribution to creditors. The argument most often used by the debtor and the creditors’ committee to avoid making such representations and warranties is that the purchaser can rely on the sale order issued by the bankruptcy court for comfort. If drafted properly, the sale order will offer greater protection than any representation or warranty–for example, a sale order will vest title in the purchaser free and clear of all liens and encumbrances, and can cut off successor liability. Generally, the only way to obtain representations and warranties in the asset purchase agreement is to create an economic incentive by offering to pay for the representations and warranties.

Break-up fees

A break-up fee is a fee paid to a prospective purchaser by a seller when an agreed-upon deal between the prospective purchaser and the seller “breaks up,” usually because the seller accepts a better offer from a subsequent bidder. In the context of bankruptcy sales, the stalking horse bidder may insist that it be paid a break-up fee if it is outbid for the debtor’s assets at a court-ordered auction. The purpose of the break-up fee is to compensate the stalking horse bidder for expending the effort and incurring the expense necessary to prepare the initial bid and for serving as a “stalking horse” in attracting other bids for the debtor’s assets.

The initial bidder typically wants to set the break-up fee as high as possible. Not only does a high break-up fee discourage other bidders, it also helps to ensure that the initial bidder will receive remuneration if a subsequent bidder ultimately acquires the debtor’s assets at the auction. In most cases, a bankruptcy court will approve a reasonable break-up fee arrangement to the extent the court believes the fee will not chill the bidding process and is necessary to induce the initial bidder into making a binding offer. The court may also look to the costs incurred or to be incurred by a stalking horse bidder when determining the reasonableness of a break-up fee.

The creditors’ committee will likely view the break-up fee relative to the proposed price. Because break-up fees would normally reduce the amount of sales proceeds the estate would receive, the creditors’ committee will want any fee limited to the minimum amount needed to induce the stalking horse bidder to bid. Limiting the break-up fee will limit the amount necessary for an initial overbid of the stalking horse bid.

Generally, the lender will be neutral toward the break-up fee, but will not want the issue of break-up fees and expense reimbursement to slow down the sale process. After all, the purchase price will have to pass muster with the lender for the transaction to move forward and the lender will largely be unaffected by these issues.

Overbid amounts and bidding increments

Overbid amounts and bidding increments are amounts by which subsequent bids must exceed prior bids. The stalking horse bidder will want the initial overbid to be substantially greater than its own offer, to create a threshold other bidders will be reluctant to overcome. The stalking horse bidder will also want to establish steep bidding increments to discourage competing bids. The stalking horse bidder may seek matching rights so that it will not have to overbid itself. Bankruptcy courts may be reluctant to grant these matching rights because providing a party with a “right of first refusal” may chill the bidding process. Of course, the stalking horse bidder should receive credit for the amount of the break-up fee (and the maximum expense reimbursement allowance) in any subsequent bid it makes. The debtor and the creditors’ committee will want small bidding increments for the opposite reasons.

In general, a court will require that the first overbid amount be at least as much as the proposed break-up fee (and expense reimbursement allowance) so that the estate will not be diminished if a subsequent offer is accepted. Subsequent bidding increments may be smaller.

The auction

The auction process may take many forms. Usually, there will be a deadline set by the court for interested parties to announce their intention to submit bids that exceed the initial bidder’s offer by the requisite overbid amount. If no such notice of competing bid is received by the bid deadline, no auction will be held and the parties will go forward with the proposed sale agreement. If one or more such notices are received by the deadline, however, some type of formal auction will generally be held, usually at the office of the debtor’s attorney or in open court.

The debtor and the creditors’ committee will generally look for the most cash, with a minimum of risk; however, the creditors’ committee may advocate a more risky deal if they are “out of the money,” that is, if there is no value in the assets being sold over and above that which is owed to secured, administrative and priority claimants. A higher, riskier bid may provide the creditors a chance at some recovery from the case which would not be available with the less risky deal.


Lastly, if substantially all of the debtor’s assets are to be sold, the purchaser and the debtor’s management may be interested in entering into employment agreements whereby the debtor’s management continues to work for the purchaser. Care should be taken in recruiting the debtor’s management. The issue of good faith (one which is very important for purposes of obtaining certain benefits conferred by the Bankruptcy Code in Section 363 transactions) focuses on the element of special treatment of the debtor’s insiders in the sale transaction. Continued employment should not be used to curry favor with the existing management. The actual or perceived chilling of a sale through the action or inaction of the existing management or incomplete access to all of the due diligence information could cause the bankruptcy court to deny approval of the sale or to limit the protections afforded the purchaser in the sale order.


  1. Section 363(f) states: The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if —
    (1) applicable non-bankruptcy law permits sale
    of such property free and clear of such interest;
    (2) such entity consents;
    (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
    (4) such interest is in bona fide dispute; or
    (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money
    satisfaction of such interest. 

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