How Chapter 11 Can Be a Deal-Making Space During Economic Disruption
A Q&A with a Corporate Bankruptcy Expert.
By D Partner Studio | dmagazine.com | August 31, 2023
Rachael Smiley, a bankruptcy attorney and chair of the litigation section of FBFK, often gets asked if working in Chapter 11 bankruptcy is difficult or depressing due to the stress it can cause some of the parties involved. It’s quite often the opposite, she says. “Chapter 11 is a deal-making space, not a place where value goes to die,” she says. “Often times, you can get better value, which is a win for all parties—debtors, creditors, and buyers—who get the assets free and clear. There are opportunities all over the place.”
Here, Smiley answers questions that can help business leaders leverage bankruptcy assets and distressed deal opportunities during Chapter 11 asset sales, so the process is efficient and beneficial for all parties.
Can Chapter 11 be a positive process, even for debtors?
Yes. It is a very creative field to be in, as everyone is working quickly, nimbly, and constantly—often pivoting because of new information. The goal is to get all the information as quickly as possible for the best deal. The entire process is set up to get the maximum amount of value for creditors, and that causes people to get very creative. The questions to be answered are: “Who can we market it to?” and “What can we do with it?” When a company is insolvent, the fiduciary duties shift from owners and investors to creditors, and the debtor has a duty to obtain the highest and best value for the sale of its assets. The net result is that you often have a competitive process that results in bringing in more value than if trying to sell these assets at a piecemeal value, outside of Chapter 11.
What are the industries where are you seeing the most distress and the greatest increase in Chapter 11 filings?
Certain sectors of consumer retail that are particularly pointed at the middle-class consumer. Conversely, luxury and discount retail are both performing pretty well right now. Some visible examples are David’s Bridal, Bed, Bath & Beyond, and Party City. Generally speaking, these companies are in bankruptcy because of their relationships with their lenders and their inability to turn around an underperforming strategy into a performing one without seeking Chapter 11 protection. Consumers are spending on other things post-pandemic. The cost of housing and rent are still high, and people are spending more on travel. There is less demand for some of those middle-class consumer goods. In strip malls, middle-box stores are moving out, and more discount spaces are taking over.
What assets are of value to buyers and debtors in these industries?
Intellectual property would be a top asset that can be bought or sold from a bankruptcy case. Specialized equipment, real property, and leases are also commonly sold in Chapter 11 cases.
What does it mean to sell through Chapter 11?
Debtors can not only sell the branding, but also customer lists, logos, online platforms and more—all that can change hands and end up under new ownership. The buyer can often operate the business without a break in continuity, and customers may not realize that the business has changed hands. That can be an incredible value for the buyer.
Chapter 11 is a deal-making space, not a place where value goes to die…There are opportunities all over the place.
For example, Overstock purchased the IP of Bed, Bath & Beyond and uses the Bed, Bath & Beyond name, which will be online only. Thereby, it increases its product offerings to an expanded customer base under the Bed, Bath & Beyond name.
Where do buyers see a deal, and where do debtors see an opportunity to monetize assets?
In Chapter 11, there is a very specific process for offering assets for sale. Section 363 of the Bankruptcy Code allows a debtor or trustee to sell all or some of the debtor’s assets for the highest and best value. That can be the highest price, but there can be other determining factors that make something the highest and best value, such as the ability to close within a certain time frame. Non-economic factors can make something a best offer, too. A bankruptcy sale is often facilitated by an auction process. A prospective bidder will be identified by the debtor; we call that bidder the ‘stalking horse bidder.’ This bidder has been working with the debtor to explore purchasing assets for some time, and will usually be offered certain protections, like a breakup fee, to compensate them in the event they are outbid. Once the process and auction are complete, the debtor will go to bankruptcy court and seek permission to sell assets to the winning bidder.
Is it risky to engage in Chapter 11 deals?
Much of the successor liability risk is reduced or eliminated, because a successful buyer of assets in a bankruptcy case will get an order from the bankruptcy court selling the assets “free and clear of liens, claims, and encumbrances.” Your due diligence costs are significantly reduced in this process. The price is also typically good (it is in bankruptcy, after all) and these deals move very quickly. Chapter 11 is a nice way to acquire an asset without the commitment of significant time or money that would be necessary outside of the bankruptcy court arena.
What opportunities should business leaders watch for and be aware of when considering a Chapter 11 deal?
Keep an eye on your competitors. If they are in Chapter 11 and they are going to sell all their assets, your acquisition of some or all of those assets will allow you to increase your market share or corner the market. You might also look for opportunities that are ancillary to your core business. For example, if you are a manufacturer, and there is a distributor in your industry in bankruptcy, acquiring the assets of a distributor might allow you to expand the range of services you are allowed to offer.
How do you act quickly if you see an acquisition opportunity?
If you see an opportunity in a Chapter 11 case, you should get in touch with your bankruptcy counsel as soon as you are able. They can make phone calls and get information for you. The community of insolvency professionals nationwide is pretty small. They tend to know each other—lawyers, financial advisors, and investment bankers. Because the process moves so quickly, time is of the essence in a bankruptcy sale. A debtor will want to monetize whatever assets it can as quickly as possible, so you can’t sleep on these deals. And the “free-and-clear” order means you don’t have to spend months and months weighing potential successor liability.